Foundational Principles of Contract Law 9780199731404, 0199731403

Table of contents :
About the AuthorAcknowledgmentsPart I. Theories of Contract Law, Four Underlying Principles of Contract Law, and the Transformation of Contract Law from Classical to ModernChapter 1. The Objective and Coverage of This Book
Doctrinal and Social Propositions
Social and Critical Morality
Terminology
and the Tenor of the Footnote ApparatusChapter 2. Theories of Contract Law Chapter 3. Four Underlying Principles of Contract Law and the Foundational Contract-Law StandardChapter 4. The Transformation of Contract Law from Classical to Modern Part II. The Enforceability of PromisesChapter 5. Bargain Promises and the Bargain PrincipleChapter 6. The Theory of Efficient BreachPart III: Moral Elements in Contract LawChapter 7: The Unconscionability PrincipleChapter 8. Donative PromisesChapter 9. The Duty to Rescue in Contract LawChapter 10. The Mitigation PrinciplePart IV. Behavioral Psychology and Contract LawChapter 11. Behavioral Psychology and Contract LawPart V. The Role of Fault in Contract LawChapter 12. The Role of Fault in Contract LawPart VI. Expectation DamagesChapter 13. The Building Blocks of Formulas to Measure Expectation Damages Chapter 14. Formulas for Measuring Expectation Damages for Breach of a Contract for the Sale of GoodsChapter 15. Formulas for Measuring Expectation Damages for Breach of a Contract to Provide Services Chapter 16. Damages for a Purchaser's Breach of a Contract for the Provision of an Off-the-Shelf CommodityChapter 17. The Cover PrincipleChapter 18. The Certainty PrincipleChapter 19. The Principle of Hadley v. BaxendaleChapter 20: Other Limitations on Expectation Damages: Litigation Costs, the Time Value of Forgone Gains, and the Risk of the Promisor's InsolvencyChapter 21. The Theory of OverrelianceChapter 22. Critiques of the Expectation Measure, and Alternative Damage RegimesPart VII. Liquidated DamagesChapter 23. Liquidated DamagesPart VIII. Specific PerformanceChapter 24. The Specific-Performance Principle: Actual and Virtual Specific PerformancePart IX. The Role of Restitution in Contract LawChapter 25. The Role of Restitution in Contract Law (with Mark Gergen)Part X. The Disgorgement Interest in Contract LawChapter 26. The Disgorgement Interest in Contract LawPart XI. The Elements of a ContractChapter 27. The Elements of a Contract: Expressions, Implications, Usages, Course of Dealing, Course of Performance, Context and PurposePart XII. Interpretation in Contract LawChapter 28. The General Principles of Contract InterpretationChapter 29. Objective and Subjective Elements of InterpretationChapter 30. Expression RulesPart XIII. Contract FormationChapter 31. OffersChapter 32. Modes of AcceptanceChapter 33. The Termination of an Offeree's Power of AcceptanceChapter 34. Prizes and RewardsChapter 35. Implied-in-Law and Implied-in-Fact ContractsChapter 36. Incomplete ContractsPart XIV. Form ContractsChapter 37. Form ContractsPart XV. The Parol Evidence RuleChapter 38. The Parol Evidence RulePart XVI. Mistake, Disclosure, and Unexpected CircumstancesChapter 39. Introduction to Mistake in Contract LawChapter 40. Evaluative MistakesChapter 41. Mechanical Errors ("Unilateral Mistakes")Chapter 42. MistranscriptionsChapter 43. Shared Mistaken Factual Assumptions ("Mutual Mistakes")Chapter 44. Disclosure in Contract LawChapter 45. Unexpected Circumstances: Impossibility, Impracticability, and FrustrationPart XVII. Problems of PerformanceChapter 46. Introduction to Problems of PerformanceChapter 47. The Order of Performance: Constructive ConditionsChapter 48. The Principle of Anticipatory RepudiationChapter 49. The Principle of Adequate Assurance of PerformanceChapter 50. Augmented Sanctions: Material Breach, Total Breach, and Opportunistic Breach
Cure
Suspension and TerminationChapter 51. The Principle of Substantial PerformancePart XVIII. The Principle of Good Faith in Contract LawChapter 52. The Principle of Good Faith in Contract Law (with Mark Gergen)Part XIX. Express ConditionsChapter 53. Express ConditionsPart XX. Relational ContractsChapter 54. Relational ContractsPart XXI. Third-Party BeneficiariesChapter 55. Third-Party BeneficiariesPart XXII. Requirements of a WritingChapter 56. The Statute of FraudsChapter 57. No-Oral-Modification ClausesIndex

Citation preview

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FOUNDATIONAL PRINCIPLES OF CONTRACT LAW

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The Oxford Commentaries on American Law The Editorial Advisory Board The Honorable Morris S. Arnold Senior Judge, United States Court of Appeals for the Eighth Circuit The Honorable Drew S. Days III Alfred M. Rankin Professor Emeritus and Professorial Lecturer in Law, Yale Law School, and Former Solicitor General of the United States James H. Carter Senior Counsel, WilmerHale, New York The Honorable Harry T. Edwards Senior Judge, United States Court of Appeals for the District of Columbia Circuit Michael Greco Of Counsel, K&L Gates LLP, and Former President, American Bar Association Richard H. Helmholz, Ruth Wyatt Rosenson Distinguished Service Professor of Law The University of Chicago Law School Mary Kay Kane Chancellor and Dean Emerita University of California, Hastings College of the Law Lance Liebman William S. Beinecke Professor of Law, Columbia University Law School, and Director Emeritus, American Law Institute Kent McKeever Director, Diamond Law Library, Columbia University Law School Alberto J. Mora Senior Fellow, Carr Center for Human Rights Policy, Harvard University and Former General Counsel, United States Navy Joseph W. Singer Bussey Professor of Law, Harvard Law School Michael Traynor President Emeritus, American Law Institute Stephen M. Sheppard, Chair Dean and Charles E. Cantú Distinguished Professor of Law, St. Mary’s University School of Law

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The Oxford Commentaries on American Law:  An Introduction to the Series Welcome to The Oxford Commentaries on American Law. In this series, Oxford University Press promotes the revival of the art of the American legal treatise by publishing careful, scholarly books that refine the laws of the United States, synthesizing them for the bench, for the bar, for the student, and for the citizen—​while providing a foundation for future scholarship and refinement. The treatise, sometimes called the commentary or, in its elementary form, the hornbook, is the most traditional of law books. Written for use by lawyers, judges, teachers, and students, the treatise is a source of law in itself. From the Roman Institutes of Gaius and for Justinian, through the great volumes on English law called the Glanville and Bracton, to the Institutes of Sir Edward Coke and the Commentaries of Sir William Blackstone, and even to their criticisms in the manuals and codes of Jeremy Bentham, treatises were—​along with case reports and statutory collections—​both a repository and a source of the law. This was true in the United States throughout the nineteenth and the twentieth centuries, when the treatise was the dominant law book for the mastery of any given field. Great lawyers—​ the likes of Joseph Story, James Kent, Oliver Wendell Holmes, John Henry Wigmore, William Prosser, and Allan Farnsworth—​wrote elegant books that surveyed the law from a unique perspective and that were read and quoted by judges, lawyers, and scholars. These books were studied by generations of students, who consulted them anew throughout their legal careers. They remain essential to understanding American law. Yet in the last decades of the 1900s, as the law book marketplace changed, treatises became less fashionable in the U.S. Treatises remain significant to the legal systems of Europe, Asia, and South America, as well as in some specific fields of U.S. law. However, the general need for new ideas in U.S. law to incorporate changes and answer new questions has hardly grown less. Thus, the need persists for clarification in the law by careful analysts seeking to define the most useful and balanced approaches to legal rules as applied to specific situations. The purpose of such analysis is to organize, explain, and apply the most significant sources in a field of closely related laws, rather than to account for every single decision or variation in it. The treatise is therefore a tool to describe rules and principles in the law and to organize them for applications to specific situations, in answer to questions in the law that are likely to arise. These principles and rules are derived sometimes from the statements and texts of legislators and regulators, sometimes from the practices of judges, lawyers, and officials, sometimes from the context of older legal customs, and sometimes from the logic and justice that bind the law, as understood by the author of the treatise. Treatise authors work within a tradition to create a new source of law, like Sir Edward Coke said, “bringing new corn from old fields.” It is my great pleasure to work, not only with the authors of these books, but also with a world class staff of professionals in the English and North American offices of Oxford University Press, and with an outstanding editorial board. I am grateful to each of you for your care and persistence in developing this grand initiative. Stephen M. Sheppard Series Editor

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FOUNDATIONAL PRINCIPLES OF CONTRACT LAW Melvin A. Eisenberg

The Oxford Commentaries on American Law Stephen M. Sheppard Series Editor

1 Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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1 Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide. Oxford is a registered trademark of Oxford University Press in the UK and certain other countries. Published in the United States of America by Oxford University Press 198 Madison Avenue, New York, NY 10016, United States of America. © Melvin A. Eisenberg 2018 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, by license, or under terms agreed with the appropriate reproduction rights organization. Inquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above. You must not circulate this work in any other form and you must impose this same condition on any acquirer. Library of Congress Cataloging-​in-​Publication Data Names: Eisenberg, Melvin Aron, author. Title: Foundational principles of contract law/Melvin A. Eisenberg. Description: New York: Oxford University Press, 2018. | Series: The Oxford   commentaries on American law | Includes bibliographical references and index. Identifiers: LCCN 2018000342 | ISBN 9780199731404 ((hardback): alk. paper) Subjects: LCSH: Contracts—United States. | Contracts. Classification: LCC KF889.85 .E425 2018 | DDC 346.7302/2—dc23 LC record available at https://lccn.loc.gov/2018000342 1 3 5 7 9 8 6 4 2 Printed by Sheridan Books, Inc., United States of America Note to Readers This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is based upon sources believed to be accurate and reliable and is intended to be current as of the time it was written. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Also, to confirm that the information has not been affected or changed by recent developments, traditional legal research techniques should be used, including checking primary sources where appropriate. (Based on the Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.) You may order this or any other Oxford University Press publication by visiting the Oxford University Press website at www.oup.com.

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To Helen, Bronwyn, the memory of David, and Lia

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About the Author

Melvin A.  Eisenberg is the Jesse H.  Choper Professor of Law Emeritus at the University of California, Berkeley (Berkeley Law). After graduating from Harvard Law School summa cum laude, Eisenberg was with the New York firm of Kaye Scholer Fierman Hays & Handler. He also served as assistant counsel to the President’s commission on the assassination of President Kennedy (Warren Commission) and as assistant corporations counsel of New York City. He joined the Boalt faculty in 1966. Eisenberg is the author of The Nature of the Common Law (1991) and The Structure of the Corporation (1997) and has published casebooks on contracts and corporations. He was Chief Reporter of the American Law Institute’s Principles of Corporate Governance, an Adviser to the Institute’s Restatement Third of Agency, Restatement of Restitution and Unjust Enrichment, and a member of the American Bar Association’s Corporate Law Committee. He is presently an Adviser to the Institute’s Restatement of Consumer Contracts. From 1991 to 1993 he held the American Law Institute’s Justice R. Ami Cutter Chair. He was a Visiting Professor of Law at Harvard Law School in 1969, at the University of Tokyo in 1992, and at Columbia Law School from 1998 to 2009. He is a Fellow of the American Academy of Arts and Sciences and has been a Guggenheim Fellow and a Fulbright Senior Scholar. He holds honorary Doctor of Law degrees from Cologne University and the University of Milan In 1984 Eisenberg delivered the Cooley Lectures at the University of Michigan. He has also given lectures at a number of universities in the United States, Germany, Italy, England, Canada, Australia, New Zealand and Japan. In 1990 he was awarded the UC Berkeley Distinguished Teaching Award.

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Summary Table of Contents

About the Author

ix

Acknowledgments

xxxix

PART ONE • THE OBJECTIVE AND COVERAGE OF THIS BOOK, THEORIES OF CONTRACT LAW, FOUR UNDERLYING PRINCIPLES OF CONTRACT LAW, AND THE TRANSFORMATION OF CONTRACT LAW FROM CLASSICAL TO MODERN

1. Th  e Objective and Coverage of this Book; Doctrinal and Social Propositions; Social and Critical Morality; Terminology; and the Tenor of the Footnote Apparatus

3

2. Theories of Contract Law

9

3. F  our Underlying Principles of Contract Law and the Foundational Contract-​Law Standard

21

4. The Transformation of Contract Law from Classical to Modern

25

PART TWO • T  HE ENFORCEABILITY OF PROMISES

5. Bargain Promises and the Bargain Principle xi

31

xi

xii

Summary Table of Contents

6. The Theory of Efficient Breach

51

PART THREE • M  ORAL ELEMENTS IN CONTRACT LAW

7. The Unconscionability Principle

69

8. Donative Promises

97

9. The Duty to Rescue in Contract Law 10. The Mitigation Principle

133 149

PART FOUR • B  EHAVIORAL ECONOMICS AND CONTRACT LAW

11. Behavioral Economics and Contract Law

159

PART FIVE • T  HE ROLE OF FAULT IN CONTRACT LAW

12. The Role of Fault in Contract Law

173

PART SIX • EXPECTATION DAMAGES

13. The Building Blocks of Formulas to Measure Expectation Damages; the Indifference Principle

179

14. Formulas for Measuring Expectation Damages for Breach of a Contract for the Sale of Goods

189

15. Formulas for Measuring Expectation Damages for Breach of a Contract to Provide Services

201

16. Damages for a Purchaser’s Breach of a Contract for the Provision of an Off-​the-​Shelf Commodity

217

17. The Cover Principle

221

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Summary Table of Contents

xiii

18. The Certainty Principle

227

19. The Principle of Hadley v. Baxendale

239

20. O  ther Limitations on Expectation Damages: Litigation Costs, the Time Value of Forgone Gains, and the Risk of the Promisor’s Insolvency

255

21. The Theory of Overreliance

257

22. C  ritiques of the Expectation Measure, and Alternative Damage Regimes

269

PART SEVEN • LIQUIDATED DAMAGES

23. Liquidated Damages

283

PART EIGHT • SPECIFIC PERFORMANCE

24. Th  e Specific-​Performance Principle: Actual and Virtual Specific Performance

295

PART NINE • T  HE ROLE OF RESTITUTION IN CONTRACT LAW

25. The Role of Restitution in Contract Law (with Mark Gergen)

319

PART TEN • T  HE DISGORGEMENT INTEREST IN CONTRACT LAW

26. The Disgorgement Interest in Contract Law

335

PART ELEVEN • T  HE ELEMENTS OF A CONTRACT

27. Th  e Elements of a Contract: Expressions, Implications, Usages, Course of Dealing, Course of Performance, Context and Purpose

367

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Summary Table of Contents

PART TWELVE • I NTERPRETATION IN CONTRACT LAW

28. The General Principles of Contract Interpretation

373

29. Objective and Subjective Elements of Interpretation

397

30. Expression Rules

407

PART THIRTEEN • CONTRACT FORMATION

31. Offers

417

32. Modes of Acceptance

427

33. The Termination of an Offeree’s Power of Acceptance

457

34. Prizes and Rewards

485

35. Implied-​in-​Law and Implied-​in-​Fact Contracts

493

36. Incomplete Contracts

497

PART FOURTEEN • FORM CONTRACTS

37. Form Contracts

521

PART FIFTEEN • THE PAROL EVIDENCE RULE

38. The Parol Evidence Rule

533

PART SIXTEEN • M  ISTAKE, DISCLOSURE, AND UNEXPECTED CIRCUMSTANCES

39. Introduction to Mistake in Contract Law

551

40. Evaluative Mistakes

555

41. Mechanical Errors (“Unilateral Mistakes”)

557

42. Mistranscriptions

577

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Summary Table of Contents

xv

43. Shared Mistaken Factual Assumptions (“Mutual Mistakes”)

579

44. Disclosure in Contract Law

595

45. Th  e Effects of Unexpected Circumstances—Impossibility, Impracticability, and Frustration

625

PART SEVENTEEN • P  ROBLEMS OF PERFORMANCE

46. Introduction to Problems of Performance

667

47. The Order of Performance; Constructive Conditions

669

48. The Principle of Anticipatory Repudiation

673

49. The Principle of Adequate Assurance of Performance

683

50. A  ugmented Sanctions: Material Breach, Total Breach, and Opportunistic Breach; Cure; Suspension and Termination

687

51. The Principle of Substantial Performance

697

PART EIGHTEEN • T  HE PRINCIPLE OF GOOD FAITH IN CONTRACT LAW

52. Th  e Principle of Good Faith in Contract Law (with Mark Gergen)

707

PART NINETEEN • EXPRESS CONDITIONS

53. Express Conditions

715

PART TWENTY • RELATIONAL CONTRACTS

54. Relational Contracts

733

PART TWENTY-​O NE • T  HIRD-​PARTY BENEFICIARIES

55. Third-​Party Beneficiaries

741

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Summary Table of Contents

PART TWENTY-​T WO • R EQUIREMENTS OF A WRITING

56. The Statute of Frauds

783

57. No-​Oral-​Modification Clauses

813

Table of Cases

815

Table of Statutes, Regulations, and Restatements

835

Index

841

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Detailed Table of Contents

About the Author

ix

Acknowledgments

xxxix

PART ONE • THE OBJECTIVE AND COVERAGE OF THIS BOOK, THEORIES OF CONTRACT LAW, FOUR UNDERLYING PRINCIPLES OF CONTRACT LAW, AND THE TRANSFORMATION OF CONTRACT LAW FROM CLASSICAL TO MODERN

1. Th  e Objective and Coverage of this Book; Doctrinal and Social Propositions; Social and Critical Morality; Terminology; and the Tenor of the Footnote Apparatus I. Objective and Coverage

3 3

A. Objective B. Coverage

3 4

II. Terminology

4

A. Doctrinal Propositions B. Social Propositions C. Social and Critical Morality D. Principles and Rules E. Classical Contract Law

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Detailed Table of Contents

xviii

F. Williston G. Corbin H. Commodity I. Expression J. Pronouns III. The Tenor of the Footnote Apparatus

2. Theories of Contract Law I. Formalist Theories A. Creating New Exceptions B. Reconstruing C. Transformation D. Overruling E. The Status of Formalism II. Interpretive Theories III. Normative Theories

6 7 7 7 7 7 9 9 11 12 13 14 15 15 17

3. Four Underlying Principles of Contract Law and the Foundational Contract-Law Standard

21

4. The Transformation of Contract Law from Classical to Modern

25

PART TWO • T  HE ENFORCEABILITY OF PROMISES

5. Bargain Promises and the Bargain Principle I. An Introduction to Bargain Promises

31 31

II. Structural Agreements

32

III. Three Doctrinal Exceptions to the Bargain Principle

37

A. The Legal-Duty Rule 1. The Insignificant Hold-Up Issue B. Surrender of or Forbearance to Assert a Claim That Turns Out to Be Invalid  C. The Doctrine of Mutuality and the Illusory-Promise Rule

38 41 44 45

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Detailed Table of Contents

xix

6. The Theory of Efficient Breach

51

I. The Overbidder Paradigm

51

II. The Factual Predicates of the Theory A. Inefficiently Remaking Contracts B. Inefficiently Providing Disincentives for Planning C. Weakening the Contracting System

52 58 62 62

III. The Loss Paradigm

64

IV. Conclusion

66

PART THREE • M  ORAL ELEMENTS IN CONTRACT LAW

7. The Unconscionability Principle I. Introduction

69 69

II. The Role of Markets

71

III. The Role of Moral Fault

72

IV. Specific Unconscionability Norms

73

A. Distress B. Price-Gouging C. Transactional Incapacity D. Unfair Persuasion E. Unfair Surprise F. Sales at Above-Market Prices and the Exploitation of Price-Ignorance  1. One-Off Sellers 2. Door-to-Door Sellers 3. Extension of Credit G. Substantive Unconscionability H. Two Statutes

8. Donative Promises I. Simple Donative Promises II. Formal Donative Promises—Promises under Seal

73 78 79 82 84 85 85 87 89 89 95 97 97 109

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Detailed Table of Contents

xx

III. Promises Based on a Moral Obligation to Compensate for a Prior Benefit 

112

IV. Promises to Give to Social-Service Institutions

116

V. The Role of Reliance

117

VI. Measuring Reliance Damages in a Donative-Promise Context

121

VII. The Life of Reliance

124

9. The Duty to Rescue in Contract Law I. The No-Duty Rule II. Offer and Acceptance A. Silence as Acceptance B. Late Acceptance C. Unilateral Contracts III. Performance A. The Duty to Warn a Party That It May Be about to Breach B. The Duty to Warn of a Potential Loss C. The Duty to Cooperate IV. Summary

10. The Mitigation Principle

133 133 136 136 139 139 140 140 144 145 148 149

PART FOUR • B  EHAVIORAL ECONOMICS AND CONTRACT LAW

11. Behavioral Economics and Contract Law

159

I. Introduction

159

A. Invariance

160

II. Bounded Rationality

162

III. Irrational Disposition: Unrealistic Optimism

163

IV. Defective Capability

165

A. Availability B. Representativeness

166 167

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Detailed Table of Contents

C. Faulty Telescopic Faculties D. Faulty Risk-Estimation Faculties

xxi

167 168

PART FIVE • T  HE ROLE OF FAULT IN CONTRACT LAW

12. The Role of Fault in Contract Law

173

PART SIX • EXPECTATION DAMAGES

13. Th  e Building Blocks of Formulas to Measure Expectation Damages; the Indifference Principle I. Comparing Expectation and Reliance Damages A. Reliance Damages B. Expectation Damages II. Expectation Damages v. Reliance Damages in a Bargain Context A. The Efficient Rate of Performance B. The Efficient Rate of Precaution C. The Efficient Rate of Surplus-Enhancing Reliance Appendix

14. F  ormulas for Measuring Expectation Damages for Breach of a Contract for the Sale of Goods

179 180 180 181 182 183 184 184 186 189

I. Breach by a Buyer of Goods

189

II. Breach by a Seller of Goods

192

III. Cases in Which Market-Price Damages Exceed the Promisee’s Actual Loss 

194

15. F  ormulas for Measuring Expectation Damages for Breach of a Contract to Provide Services I. Breach by a Service-Purchaser A. The Core Formula: Lost Profit B. The Treatment of Fixed Costs (Overhead) C. Deductions from the Core Formula

201 201 201 202 204

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Detailed Table of Contents

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II. Breach by a Service-Provider A. Th  e Core Formulas: Cost-of-Completion and Diminished-Value Damages  B. When Diminished-Value Damages Should Be Used in Lieu of Cost-of-Completion Damages 

16. Damages for a Purchaser’s Breach of a Contract for the Provision of an Off-the-Shelf Commodity I. Off-the-Shelf Services

206 206 208 217 217

II. Off-the-Shelf Goods

219

III. Full Capacity

220

17. The Cover Principle

221

I. The Cover Principle and Positive Law II. Conclusion

223 225

18. The Certainty Principle

227

19. The Principle of Hadley v. Baxendale

239

I. Introduction

239

II. The Hadley Principle and General Principles of Law

241

III. The Modern Arguments for the Hadley Principle

244

IV. An Alternative Regime to the Hadley Principle

250

A. Contractual Allocations of Losses B. Proximate Cause C. Nature of the Break D. Limitations on Disproportionate Damages

250 251 252 253

V. Conclusion

254

20. Other Limitations on Expectation Damages: Litigation Costs, the Time Value of Forgone Gains, and the Risk of the Promisor’s Insolvency

255

21. The Theory of Overreliance

257

I. Introduction

257

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Detailed Table of Contents

xxiii

II. Preliminary Considerations

258

III. Cases Where Overreliance Is Normally Impossible

259

A. C  ases in Which Reliance Consists of Necessary Performance or Preparation Costs  259 B. Cases in Which Expectation Damages Are Invariant to Reliance 260 1. Liquidated Damages 2. Sellers’ Damages for Breach by a Buyer 3. Buyer’s Damages for Breach by a Seller IV. C  ases in Which Overreliance, Although Theoretically Possible, Is Very Unlikely to Occur  A. Reliance That Holds Its Value after Breach B. Cases Where It Would Be Inefficient for a Buyer to Take the Seller’s Probability of Breach into Account  1. Lumpy Reliance 2. Coordinated Contracts 3. Reliance on a Seller Who Has a Very Low Probability of Committing an Economically Significant Breach  V. A Flawed Tenet of the Theory of Overreliance A. Litigation Risks B. Litigation Costs VI. Th  e Costs of Modifying the Expectation Measure by Taking into Account the Probability of the Promisor’s Breach 

22. C  ritiques of the Expectation Measure, and Alternative Damage Regimes I. Introduction II. Enforcement-Error Regimes A. Background B. The Subjective Beliefs of Promisors C. Objective Probabilities and Evidence about Subjective Probabilities  D. The Elusiveness of Objective Probabilities, and of Objective Evidence about Subjective Probabilities, in Contracts Cases  E. Other Administrative Concerns Raised by Enforcement-Error Regimes 

260 260 261 262 262 262 263 263 264 265 265 266 266 269 269 269 269 270 271 272 273

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Detailed Table of Contents

xxiv

III. Regimes That Take into Account the Secrecy Interest

274

IV. Regimes That Have the Goal of Promoting Efficient Search

277

V. Conclusion

279

PART SEVEN • LIQUIDATED DAMAGES

23. Liquidated Damages

283

PART EIGHT • SPECIFIC PERFORMANCE

24. The Specific-Performance Principle: Actual and Virtual Specific Performance I. Th  ree Reasons in Favor of a Regime of Routine Specific Performance  A. The Indifference Principle B. The Bargain Principle C. Informational Effects II. Reasons against a Regime of Routine Specific Performance

295 296 296 297 297 298

A. The Enforcement Process

298

1. Social Norms 2. The Risk of Error

298 299

B. The Problem of Jury Trial C. The Problem of Mitigation D. Suits by a Seller E. The Problem of Opportunism

299 300 302 302

III. The Specific Performance Principle

304

IV. A  pplication of the Specific Performance Principle to Important Types of Contracts 

306

A. Contracts for the Sale of Goods 1. Seller’s Breach of a Contract for the Sale of Goods a. Homogeneous Goods to be Delivered in the Near Future b. Long-Term Supply Contracts c. Goods Not Readily Available in the Market

306 306 306 307 308

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2. Highly Differentiated Goods 3. Moderately Differentiated Goods 4. Breach by the Buyer

309 309 310

B. Contracts for the Sale of Real Property

310

1. Breach by the Seller 2. Breach by the Buyer

310 311

C. Contracts for the Provision of Services

312

1. Contracts for Personal Services

312

a. Breach by the Employee b. Breach by the Employer 2. Other Contracts for the Provision of Services V. Conclusion

312 313 313 316

PART NINE • T  HE ROLE OF RESTITUTION IN CONTRACT LAW

25. The Role of Restitution in Contract Law (with Mark Gergen) I. Restitutionary Damages When the Defendant is in Breach

319 321

II. Restitutionary Damages When the Plaintiff is in Breach

328

III. Restitutionary Damages in the Absence of an Enforceable Contract 

330

PART TEN • T  HE DISGORGEMENT INTEREST IN CONTRACT LAW

26. The Disgorgement Interest in Contract Law I. Introduction II. The Disgorgement Interest outside Contract Law

335 335 337

III. The Puzzle of Restatement Second

339

IV. Efficiency Arguments against Disgorgement

342

V. W  hy Contract Law Should and Does Protect the Disgorgement Interest 

343

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VI. C  ases in Which the Promisee Has Bargained for the Promisor’s Gain from Breach 

345

VII. Disgorgement in Lieu of Specific Performance

349

VIII. Disgorgement as a Surrogate for Expectation Damages

349

IX. Bargains Designed to Serve Interests Other than Profitmaking X. Externalities XI. Disgorgement of Costs Saved by Breach A. Skimped Services B. Diminished Value XII. The Causation Arguments against Disgorgement in Contract Law  A. Cause in Fact B. Joint Cause; Apportionment C. Remote Cause; Tracing

350 353 354 354 355 356 356 358 359

XIII. Why Don’t We See More Disgorgement in Contract Law?

360

XIV. The Problem of Apportionment

361

XV. Conclusion

363

PART ELEVEN • T  HE ELEMENTS OF A CONTRACT

27. The Elements of a Contract: Expressions, Implications, Usages, Course of Dealing, Course of Performance, Context and Purpose

367

I. Expressions

367

II. Implications

367

III. Usages

368

IV. Course of Dealing

369

V. Course of Performance VI. Context and Purpose A. Context B. Purpose

369 370 370 370

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Detailed Table of Contents

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PART TWELVE • I NTERPRETATION IN CONTRACT LAW

28. The General Principles of Contract Interpretation

373

I. Contextualism

373

II. Literalism

380

A. The Plain-Meaning Rule III. Extreme Literalism

380 385

29. Objective and Subjective Elements of Interpretation

397

30. Expression Rules

407

I. Background Considerations

407

II. The Forms of Expression Rules

410

III. The Justifications of Expression Rules

410

IV. Conclusion

413

PART THIRTEEN • CONTRACT FORMATION

31. Offers I. The Promissory Nature of an Offer II. What Constitutes an Offer? A. Advertisements B. Auctions

32. Modes of Acceptance I. Acceptance by Promise or by Act?

417 418 420 420 424 427 427

II. Acceptance of Offers for Unilateral Contracts

429

A. The Background B. Employment Manuals and the At-Will Rule

429 431

1. In General 2. Disclaimers 3. Modification

431 433 434

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xxviii

C. The Offeree’s Motivation D. The Offeree’s Lack of Knowledge of the Offer E. Requirement of Notice of Performance of the Offeree

436 438 439

III. Obligations of an Offeree Who Has Begun Performance

440

IV. Bilateral Contracts

440

A. Section 2-207(1) Contracts B. Section 2-207(3) Contracts

442 446

V. Subjective Acceptance

447

VI. Electronic Acceptance

449

VII. When an Acceptance Is Effective A. R  ecurring Scenarios in Which the Time-of-Effectiveness Issue Arises  VIII. New Modes of Transmission

33. The Termination of an Offeree’s Power of Acceptance I. Lapse A. The General Rule B. The Conversation Rule C. Failure to Notify an Offeree That His Acceptance Is Too Late II. Revocation of Offers for Bilateral Contracts III. Exceptions to the Firm-Offer Rule A. Nominal Consideration B. Effect of Writing C. Auctions D. Reliance IV. Revocation of Offers for Unilateral Contracts V. “Indirect Revocation” VI. The Withdrawal of General Offers VII. Death or Incapacity VIII. Rejection, Counter-offer, and Qualified Acceptance A. Rejection

450 451 455 457 457 457 458 460 460 464 464 464 465 465 466 470 472 474 477 477

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Detailed Table of Contents

B. Counter-offers C. Conditional Acceptances D. The Mirror-Image Rule

xxix

477 479 481

IX. A Look Back

482

34. Prizes and Rewards

485

I. Consideration

485

II. Remedies

487

A. Damages for an Unpaid Reward or Prize B. Lost Chances

487 489

35. Implied-in-Law and Implied-in-Fact Contracts

493

36. Incomplete Contracts

497

I. Indefiniteness and Gaps A. Indefiniteness B. Gaps II. Further-Instrument-to-Follow Provisions and Promises to Negotiate in Good Faith  A. C  ases Involving an Explicit or Virtually Explicit Bargained-For Promise to Negotiate in Good Faith  B. Cases in Which There Is an Implicit Bargained-For Promise to Negotiate in Good Faith  C. Remedy D. Cases in Which a Relied-Upon Promise to Negotiate in Good Faith Is Implied from Conduct and Words Amounting to Leading-On  III. Some Ramifications of the Tribune Regime: Indefiniteness and Gaps 

498 498 499 503 504 507 514 516 517

PART FOURTEEN • FORM CONTRACTS

37. Form Contracts

521

I. In General

521

II. Rolling Contracts

529

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Detailed Table of Contents

xxx

PART FIFTEEN • THE PAROL EVIDENCE RULE

38. The Parol Evidence Rule I. Introduction II. Three Formulations of the Parol Evidence Rule and the Concept of Integration  A. Restatement First and Williston B. Restatement Second and Corbin (and Modern Contract Law) C. UCC Section 2-202

533 533 534 534 535 536

III. The Might-Naturally-Be-Made-as-a-Separate-Agreement, or Would-Certainly-Have-Been-Included, Exception to the Parol Evidence Rule 

537

IV. Contradiction or Inconsistency

540

V. Partial Integration

542

VI. Merger Clauses

543

VII. Promissory Fraud

544

VIII. The Condition-to-Legal-Effectiveness Exception

546

IX. Conclusion

547

PART SIXTEEN • M  ISTAKE, DISCLOSURE, AND UNEXPECTED CIRCUMSTANCES

39. Introduction to Mistake in Contract Law

551

I. Efficiency

551

II. Morality

552

III. Experience

553

40. Evaluative Mistakes

555

41. Mechanical Errors (“Unilateral Mistakes”)

557

I. Introduction

557

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Detailed Table of Contents

II. Mistaken Payments A. The Paradigm Case B. Lack of Actual Knowledge by the Payee C. Reliance D. Administrability III. Computational Errors A. The Nonmistaken Party Knew of the Error B. The Nonmistaken Party Had Reason to Know of the Error C. The Nonmistaken Party Neither Knew nor Had Reason to Know of the Error  D. Offers That Are Too Good to Be True E. Retail Mispricing IV. The Modern Position

xxxi

560 560 563 563 565 565 565 566 567 569 570 571

42. Mistranscriptions

577

43. Shared Mistaken Factual Assumptions (“Mutual Mistakes”)

579

I. The General Principle II. Four Exceptions to the General Principle A. Th  e Adversely Affected Party Is Consciously Aware of the Risk That the Assumption Is Mistaken or Recklessly Disregards Facts That Put Her on Notice of That Risk  B. The Risk That the Assumption Is Mistaken Is Contractually Allocated to the Adversely Affected Party  C. One Contracting Party Is in a Position to Have Clearly Superior Information about the Risk That the Assumption Is Mistaken  D. Windfalls

44. Disclosure in Contract Law I. The Disclosure Principle II. Disclosure of Information That Was Adventitiously Acquired

580 584

585 587 590 591 595 595 599

III. Disclosure of Information That Is Only Foreknowledge

604

IV. Allocative Efficiency

607

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Detailed Table of Contents

xxxii

V. Regimes of Pure Exchange VI. Disclosure by Sellers A. Market Information B. Current Law and Practice

609 611 612 613

VII. Information Acquired through Improper Means

615

VIII. F  iduciary Relationships and Relationships of Trust and Confidence 

616

IX. Exceptions A. Th  e Risk That the Unknowing Party Was Mistaken Was Allocated to That Party  B. The Unknowing Party Was on Notice, Failed to Conduct a Reasonable Search, or Both  C. The Social Context in Which the Transaction Occurred Is a Game in Which Buyers Troll for Mistakes by Sellers  X. Summary Appendix: How Much Does a Nondisclosure Regime Contribute to Efficiency?

45. The Effects of Unexpected Circumstances—Impossibility, Impracticability, and Frustration I. Introduction II. The Shared-Tacit Assumption Test A. Tacit Assumptions B. Exceptions to the Shared-Tacit Assumptions Test 1. Th  e Possibility of the Occurrence of the Relevant Circumstance Was More than Negligible  2. C  ases in Which the Risk That the Unexpected Circumstance Would Occur Was Explicitly or Implicitly Allocated to the Adversely Affected Party  3. C  ustom and Trade Usage; Inference from the Circumstances  C. The Role of Fault and the Nature of Judicial Relief under the Shared-Assumption Test 

617 617 618 619 620 620 625 625 627 627 630 630 633 634 636

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Detailed Table of Contents

III. The Unbargained-For Risk Test A. The Test B. Comparison with Mutual Mistake C. Example D. Nature of Relief

xxxiii

643 643 644 647 651

IV. A Contrary View

653

V. The Role of Insurance Considerations

655

VI. The Role of Ex Post Considerations VII. Conclusion

659 662

PART SEVENTEEN • P  ROBLEMS OF PERFORMANCE

46. Introduction to Problems of Performance

667

47. The Order of Performance; Constructive Conditions

669

48. The Principle of Anticipatory Repudiation

673

I. The General Principle

673

II. What Constitutes an Anticipatory Repudiation

675

III. The Effect of an Anticipatory Repudiation Where the Promisee Had Fully Performed at the Time of the Repudiation 

675

IV. Withdrawal of an Anticipatory Repudiation

677

V. Disregard of an Anticipatory Repudiation

677

VI. Ability of Aggrieved Party to Perform

678

VII. Th  e Measurement of Damages for an Anticipatory Repudiation 

679

49. The Principle of Adequate Assurance of Performance

683

50. A  ugmented Sanctions: Material Breach, Total Breach, and Opportunistic Breach; Cure; Suspension and Termination

687

I. Terminology and Definitions

687

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Detailed Table of Contents

xxxiv

II. The Likelihood of Future Performance by the Promisor

689

III. The Economic Significance of the Breach

690

A. Economically Immaterial Breaches B. Economically Material Breaches C. Economically Significant Breaches

690 690 690

IV. Opportunistic Breach

691

V. Cure

691

VI. The Interest of the Promisor VII. Summary

51. The Principle of Substantial Performance I. Introduction

693 695 697 697

II. The Test for What Constitutes Substantial Performance

698

III. The Effect of Willfulness

698

IV. Contracts for the Sale of Goods

699

A. Common Law Background B. The UCC

699 700

PART EIGHTEEN • T  HE PRINCIPLE OF GOOD FAITH IN CONTRACT LAW

52. The Principle of Good Faith in Contract Law (with Mark Gergen)

707

PART NINETEEN • EXPRESS CONDITIONS

53. Express Conditions I. An Introduction to Express Conditions II. The Effect of Imperfect Fulfillment of an Express Condition III. Exceptions to the Perfect-Fulfillment Rule A. Forfeiture

715 715 716 719 719

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Detailed Table of Contents

B. Lack of Prejudice C. Cases in Which the Purpose of the Condition Was Achieved D. Impracticability E. Triviality IV. I nterpretation of a Contractual Provision as a Promise or as an Express Condition  A. Pay-When-Paid Provisions B. Conditions of Satisfaction V. Conditions Precedent and Conditions Subsequent

xxxv

720 721 722 723 723 724 725 728

PART TWENTY • RELATIONAL CONTRACTS

54. Relational Contracts

733

PART TWENTY-ONE • T  HIRD-PARTY BENEFICIARIES

55. Third-Party Beneficiaries

741

I. Th  e Development of the Law Governing the Enforceability of Contracts by Third-Party Beneficiaries 

741

A. Early English and American Law B. Lawrence v. Fox C. Classical Contract Law D. The Beginnings of Modern Third-Party Beneficiary Law

741 743 745 748

II. The Third-Party-Beneficiary Principle

750

A. Restatement First and the Intent-to-Benefit Test B. The Restatement Second Test C. The Third-Party-Beneficiary Principle

752 754 756

III. Some Recurring Third-Party-Beneficiary Categories

759

A. Donee Beneficiaries B. Creditor Beneficiaries C. Cases in Which the Parties Have Explicitly Provided That a Third-Party Beneficiary Should or Should Not Be Allowed to Enforce the Contract  D. Would-Be Legatees

759 760 761 761

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Detailed Table of Contents

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E. Suits by Subcontractors against the Sureties of Prime Contractors F. Multi-Prime Contracts G. Suits by Owners against Subcontractors H. Government Contracts IV. Defenses A. D  efenses the Promisor Can Raise against an Empowered Beneficiary That Are Based on Defenses the Promisor Would Have Had against the Promisee  B. Modification and Rescission V. D  efenses That the Promisor Would Have Had against the Promisee  VI. Conclusion

763 767 768 770 774

775 775 778 780

PART TWENTY-TWO • R  EQUIREMENTS OF A WRITING

56. The Statute of Frauds I. Introduction

783 783

II. Is the Statute of Frauds Justified?

786

III. The Legal Consequences of an Agreement That Is Unenforceable under the Statute of Frauds 

788

IV. Types of Contracts That Are within the Statute

790

A. Contracts for the Sale of an Interest in Land B. Contracts for the Sale of Goods; the UCC

790 791

1. Coverage 2. Exceptions a. Part Performance (Subsection (3)(c)) b. Goods Made Specially to Order (Subsection 3(a)) c. Receipt of Confirmation (Subsection (2)) d. Admissions (Subsection 3(b)) e. T  wo Problems of Interpretation Raised by UCC Section 2-201  C. Other UCC Provisions That Bear on the Requirement of a Writing 

791 792 792 792 793 793 794 795

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Detailed Table of Contents

D. Agreements Not To Be Performed within One Year from the Making Thereof  E. The Suretyship Section F. Promises Made by Executors and Administrators G. Contracts upon Consideration of Marriage

xxxvii

795 796 797 798

V. What Kind of Writing or Other Record Will Satisfy the Statute? 798 VI. Th  e Effect of Part Performance of, or Reliance Upon, an Oral Contract within the Statute  A. Introduction B. Restitution C. Reliance D. Expectation Damages VII. Oral Rescission VIII. Oral Modifications IX. Interaction of the Statute of Frauds with the Parol Evidence Rule and the Remedy of Reformation  X. P  leading and Procedural Problems in Connection with the Statute 

802 802 802 803 805 807 808 810 811

57. No-Oral-Modification Clauses

813

Table of Cases

815

Table of Statutes, Regulations, and Restatements

835

Index

841

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Acknowledgments

A b o ok like t h is can only be w ri t ten w i th the hel p of m a n y wonderful people. In particular, I thank my friends and colleagues Mark Gergen, who wrote the chapters on good faith and restitution; Shawn Bayern, who coauthored an article that became the basis of the chapter on critiques of the expectation measure; and Bob Cooter, who taught me economics and made valuable comments on the drafts of several chapters. Thanks also to my former Dean at Berkeley Law, Chris Edley, for his extremely generous support of this project; to Jennifer Beerline, Annie Lee, Elaine Meckenstock, and especially Derek Chipman for their great work as research assistanwts and critics; to Kathleen Vanden Huevel, Marci Hoffman, and Dean Rowan, who provided great librarianship and, in the case of Marci and Dean, often acted as super-​skilled de facto research assistants to find hard-​to-​get cases for me; to my wonderful assistants/​secretaries, Billie Beard, Stephanie Boram, Joanna Hooste, Steve Vercelloni, and Toni Mendicino, and to Erin Reynolds for providing me with their support; to Laura Ventura Moreno, Araly Majano, Mila Carsola, Mina Enrique, Mary Tan, and Paola Gorrostieta, for their loving and life-​sustaining caregiving; and to Montie Magree, for his terrific, always forthcoming, and indispensable assistance with my many computer issues.

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PA R T   O N E

THE OBJECTIVE AND COVERAGE OF THIS BOOK, THEORIES OF CONTRACT LAW, FOUR UNDERLYING PRINCIPLES OF CONTRACT LAW, AND THE TRANSFORMATION OF CONTRACT LAW FROM CLASSICAL TO MODERN

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The Objective and Coverage of this Book; Doctrinal and Social Propositions; Social and Critical Morality; Terminology; and the Tenor of the Footnote Apparatus I .   O B JE C T I V E A ND COVER A GE A. OBJECTIVE The objective of this book is to develop the foundational principles of contract law as they should be, with an emphasis on American contract law. Attention will also be given to describing contract law as it is, because what the principles of contract law should be cannot be developed in a vacuum. Accordingly, this book has two facets—​one normative or aspirational, one positive or descriptive. The two facets are related, because in a body of law, such as contracts, that is largely judge-​made the courts have an ongoing power to transform the law, so that what should be tends to become what is. At the same time, the facts and reasoning of actual cases give texture to legal rules and show how they play out on the ground. Legal systems in countries with developed economies are for the most part categorized as either civil law or common l​ aw systems. In civil law systems the law of obligations, including the law of contracts, is codified in a civil code. In common ​law systems the law of obligations is generally but not entirely established by the courts. Civil law systems dominate in Europe and Asia, and the term civil law is used in this book to refer to the many European Civil Codes that are modeled on the Codes of either France or Germany. Common law systems dominate in England and countries that began as English colonies, such as the United States, Australia, and Canada.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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Because the objective of this book is to develop the foundational principles of contract law as they should be, with an emphasis on American contract law, the analysis and citation apparatus in this book will for the most part be based on American common l​aw institutions, cases, and methods of legal reasoning. There are two major exceptions. First, under the Statute of Frauds certain types of contracts are enforceable against the party to be charged only if embodied in a writing, or other record, signed by that party. The Statute was adopted by Parliament in 1677. It has been legislatively enacted in every state except Maryland and New Mexico and has been put into effect by judicial decisions in those states. Although the Statute is legislative it is virtually a part of the common law and has a very heavy judicial overlay. The Statute will be considered in Chapter 56. Second, contracts for the sale of goods are governed by Articles 1 and 2 of the Uniform Commercial Code (UCC). The UCC is in force in every state except Louisiana, which for historical reasons is a civil code jurisdiction. Article 2 is largely the handiwork of Karl Llewellyn, a distinguished contracts scholar. For that reason the rules of Article 2 are by and large justified—​at least as good as the equivalent rules of the common law, and in many respects better.

B. COVERAGE Although this book covers most of contract law it omits coverage of some topics—​principally, illegal contracts, the law of assignment and delegation, promises in restraint of trade, promises that impair family relations, and interference with protected relationships, such as contracts with third persons. These topics are omitted partly for reasons of space and partly because although the topics are important, in my view they are not at the center of contract law, and in some cases are more appropriately considered to be part of another body of law, such as tort law or commercial law.

I I .   T E R MI N OL OGY The following terminology is used in this book:

A.  DOCTRINAL PROPOSITIONS The term doctrinal propositions is used in this book to mean propositions that purport to state legal rules and are found in or can be derived from sources that are generally regarded as authoritative by the legal profession. These sources include official texts that are regarded as binding on a deciding court, such as local statutes and precedents; official texts that are not binding on a deciding court but are nevertheless treated by the profession as authoritative, such as precedents in other jurisdictions; and unofficial texts that the profession treats as authoritative, such as Restatements and leading treatises.

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The Objective and Coverage of this Book

5

B.  SOCIAL PROPOSITIONS The term social propositions is used in this book to mean policies, which characterize states of affairs as good or bad, depending on whether they are conducive or adverse to the general welfare; moral norms, which characterize conduct as right or wrong; and experiential propositions, which describe the way in which the world works, and mediate between moral and policy propositions, on the one hand, and doctrinal propositions on the other, or both. For ease of exposition, when I refer to social propositions I mean social propositions that are relevant and meritorious and that can properly be taken into account by a court, such as statements concerning human behavior and institutional design; that describe aspects of the present world, such as statements concerning the existence of a trade usage; or that describe historical events, such as statements concerning how a trade usage developed.

C.  SOCIAL AND CRITICAL MORALITY When morality figures in establishing the content of a rule of contract law—​as it often does—​an issue arises whether the relevant values are those of critical morality or social morality. The term critical morality refers to moral standards whose validity does not depend on community beliefs and attitudes. The term social morality refers to moral standards that are rooted in social aspirations that apply to all members of the community, can fairly be said to have substantial support in the community, can be derived from norms that have such support, or fairly appear to have such support. Critical and social morality probably do not differ much in the area of contract law. To put this differently, in this area it is not easy to identify values that are part of social morality but are rejected by critical morality. Where there is such a difference, as a matter of critical morality common law courts normally should and do employ social morality. To begin with, social morality is much easier to determine than critical morality. For example, we can say with ease that as a matter of social morality there is a duty to keep a promise. In contrast, both philosophers and legal scholars have continuously argued about whether promises should be kept as a matter of critical morality, and if they should be, why. The comparative ease of determining social morality is important for two reasons. First, it facilitates the formulation of contract law. Second, legal rules should as far as possible be predictable, and rules based on social morality are predictable by social actors in a way that rules based on critical morality are not. Next, a basic function of courts is to conclusively resolve disputes deriving from a claim of right that is based on the application, meaning, and implications of the society’s existing standards. If courts were not obliged to employ social morality when moral norms are relevant in establishing the law there would be no place to which a member of the society could go to vindicate a claim based on the society’s standards. Obliging courts to employ the society’s standards also alleviates the retroactivity of judicial lawmaking by ensuring that decisions are rooted in standards that the disputants either knew or had reason to know at the time of their transaction, albeit standards that perhaps had not been officially translated into legal rules. And if a society’s standards are based on observable criteria, a process of judicial lawmaking that requires

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Theories of Contract Law

the courts to draw on those standards is replicable by the legal profession and thereby facilitates legal planning and dispute-​settlement. Finally, contract law is to a significant extent about the protection of reasonable expectations. One kind of expectation that surrounds a contract is that each party will conform to the basic moral norms of the society. Social morality is therefore relevant, in a way that critical morality is not, to determining reasonable expectations. Accordingly, the terms morality and moral norms, when used in this book, refer to social morality rather than critical morality.

D.  PRINCIPLES AND RULES The terms principles and rules are used interchangeably in this book because there is no logical distinction between the two terms.1 However, as a matter of usage the term principle is sometimes employed to mean a more general standard and the term rule is sometimes employed to mean a narrower standard. That usage will occasionally be followed in this book. So for example, Chapter  28 concerns the general principles of interpretation and Chapter  30 concerns rules about the meaning of certain contractual expressions.

E.  CLASSICAL CONTRACT LAW The term classical contract law refers to the school of thought that found its central inspiration in Langdell, Holmes, and Williston and its central expression in the Restatement (First) of Contracts. Classical contract law was a rigid instrument, which employed formal, axiomatic, and deductive, rather than normative reasoning (see Chapter 2).

F. WILLISTON Samuel Williston, a professor of law at Harvard, was a central figure in classical contract law and authored a monumental multivolume treatise on contract law, Williston on Contracts. The first edition of Williston on Contracts was published in the early 1920s. A second edition, known as the revised edition, was authored with George J. Thompson. A third edition was edited by Walter H.E. Jaeger. A fourth edition, edited by Richard A. Lord, is still in progress. Unless otherwise 1.  In his article Hard Cases, 88 Harv. L. Rev. 1057, 1060 (1975), Ronald Dworkin put forward what he called “the rights thesis,” that “judicial decisions in civil cases . . . characteristically are and should be generated by principle not policy.” This thesis is not easily defensible. A major function of the courts is to enrich the supply of legal rules, and consideration of policies is an important element in this function: if the courts are to establish legal rules to govern social conduct, it is desirable for them to consider whether those rules will be conducive to a good or a bad state of affairs. Moreover, the relationship between morality and policy is itself disputed. Many believe that rightness reasons ultimately depend on general-​welfare considerations, and even those who deny that dependence would usually agree that in judging whether conduct is right or wrong it is not irrelevant whether the conduct is conducive to the good or the bad.

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The Objective and Coverage of this Book

7

indicated, references in this book to Williston on Contracts are to the first edition of Williston’s treatise.

G. CORBIN Arthur Corbin, a professor of law at Yale Law School, is the other giant of contract law in the twentieth century. Like Williston, Corbin authored a monumental multivolume treatise on contracts. The first edition of Corbin’s treatise was published in 1993, that is, over seventy years after Williston’s treatise. Just as Williston was a central figure in classical contract law, Corbin was a central figure in modern contract law. The transformation of contract law from classical to modern is discussed in Chapter 4.

H. COMMODITY The term commodity is used in this book to mean anything that can be bought or sold, including goods, services, intangibles, and real estate.

I. EXPRESSION As used in this book, the term expression refers to a manifestation consisting of words, acts, or both, which is either communicated by an addressor to an addressee or jointly produced by two or sometimes more contracting parties.

J. PRONOUNS In this book a party who breaches a contract is referred to as a promisor and is described by a feminine pronoun and a party injured by a breach is referred to as a promisee and is described by a masculine pronoun.

I I I .   T H E T E NOR OF   T HE F O O T N O T E A PPA R AT US The tenor of the footnotes in this book follows the tenor of the text. Legal propositions in the text that are well established and normatively justified—​for example, the proposition that bargains are generally enforceable according to their terms—​are not footnoted in depth, and generally speaking, descriptive statements of law that are not controversial are footnoted very lightly. The task of showing the support for such propositions is accomplished by many excellent hornbooks and treatises, and repeating the work of these authorities would divert time and

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Theories of Contract Law

space from the work of this book. Accordingly, the major aim of the footnotes in this book is to elaborate and add support for the analysis in the text. Although this book covers most of contract law it omits coverage of some topics—​principally illegal contracts, contracts against public policy, and assignments—​partly for reasons of time and space and partly because although these topics are important, in my view they are not at the center of contract law.

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Theories of Contract Law W hat c on tract l aw sh ou ld be m u st rest on a theory of c on tr act

law. The enterprise involved in developing such a theory needs explication, because legal theory has many branches. One branch of legal theory concerns fundamental jurisprudential issues, such as what constitutes law. Another branch concerns institutional issues, such as the nature of adjudication. However, when we talk about the theory of a specific area of law, such as contracts, we mean a theory about the content of the rules in that area, and more specifically, a theory about how the rules in that body of law should be formulated. In this book the term theory of contract law is used in that way. Theories of contract law fall into three basic categories: formalist, interpretive, and normative. Central to each category is the method of legal reasoning that is utilized by theories in the category and the relative roles the theories assign to doctrinal and social propositions.

I .   F O R MA L I ST T HEOR I ES Formalist theories are characterized by a conceptual and a methodological aspect. In their conceptual aspect formalist theories treat doctrine as autonomous from policy and morality. Formalism found its fullest expression in the school of thought now known as classical contract law, which held sway from the middle of the nineteenth century until the early part of the twentieth, and was systematized by a core group of scholars—​in particular, Christopher Langdell in his Summary of Contract Law, published in 1880,1 and Samuel Williston in his magisterial treatise on contracts, published in 1920.2 The autonomy of doctrine in formalism is well-​illustrated

1.  The first version of a Summary of Contract Law was published in 1879 as an appendix to the second edition of Langdell’s contracts casebook. The first freestanding edition of the Summary, called the second edition, was published in 1880. 2.  That classical contract law held sway during this period doesn’t mean that every contract law-​law decision in this period applied the tenets of that school of law. By way of analogy, a baseball team that wins three World Series in a row may be characterized as a dynasty even if it loses some games. Furthermore, courts frequently did obeisance to the tenets of classical contract law and then found a way, often artificial, to distinguish the cases before them so as to avoid the force of those tenets.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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by a passage from Langdell’s Summary addressing the question whether an acceptance by mail is effective on acceptance or dispatch: The acceptance . . . must be communicated to the original offerer, and until such communication the contract is not made . . . It has been claimed that the purposes of substantial justice, and the interests of contracting parties as understood by themselves, will be best served by holding that the contract is complete the moment the letter of acceptance is mailed; and cases have been put to show that the contrary view would produce not only unjust but absurd results. The true answer to this argument is that it is irrelevant . . . 3

Methodologically, formalism proceeds by first purporting to identify a core set of rules that are justified on the ground that they are self-​evident axioms, and then purporting to derive the remaining rules by logical deduction from the axioms. As Holmes observed at the height of classical contract law, “I sometimes tell students that the law schools pursue an inspirational combined with a logical method, that is, the postulates are taken for granted upon authority without inquiry into their worth, and then logic is used as the only tool to develop the results.”4 (Formalism has also been characterized in other ways.5) The first step in formalist methodology, the identification of self-​evident axioms, is untenable, because doctrinal propositions are never self-​evident and can only be justified by social propositions. A distinction must be drawn between the justification for following a doctrine and the justification of a doctrine. For example, although a common-​law court may justify a result on the basis of the rule stated in precedent, that rule can always be traced back to a point where precedential justification is unavailable and only a social justification will do. In short, once a doctrine has been adopted it may be justifiably followed because of the social interest in stability and predictability of law, the social reasons for adhering to rules that have been adopted through certain institutional processes, or both. However, those elements only justify following a doctrine, not the doctrine itself. A doctrine itself is justified only if it rests on social propositions that are appropriate factors for the generation of doctrine. The second step in formalist methodology, deduction from axioms, is no more sustainable than the identification of self-​evident axioms. While doctrines may serve as prima facie major 3. C.C. Langdell, Summary of the Law of Contracts 15, 20–​21 (2d ed. 1880) (emphasis added). 4.  Oliver Wendell Holmes, Law in Science and Science in Law, 12 Harv. L. Rev. 443 (1899) reprinted in Collected Legal Papers 210, 238 (1920). 5. In Forms of Formalism, 66 U. Chi. L. Rev. 607 (1999), published as part of a symposium, Richard Pildes summarized the way in which three of the symposium articles characterized formalism: (1) formalism as anticonsequential morality in law, (2) formalism as apurposive rule following, and (3) formalism as a regulatory tool for producing optimally efficient mixes of law and norms in contract enforcement regimes. Id. at 607. See also, e.g., Ernest J. Weinrib, Legal Formalism: On the Immanent Rationality of the Law, 97 Yale L. J. 949, 951–​53, 955–​57 (1988) (“Formalism postulates that law is intelligible as an internally coherent phenomenon. . . . Nothing is more senseless than to attempt to understand law from a vantage point entirely extrinsic to it. Formalism takes the internal standpoint to its extreme and makes it decisive for the understanding of juridical relationships. . . . Formalist doctrine is characterized by the working out of the implications of law from a standpoint internal to law. . . . The dominant tendency today is to look upon the content of law from the standpoint of some external ideal that the law is to enforce or make authoritative. . . . In the formalist conception, law has a content that is not imported from without but elaborated from within. Law is not so much an instrument in the service of foreign ideals as an end in itself constituting, as it were, its own ideal. . . . Form is the bedrock on which formalism rests.”). Weinrib’s view has little following. See infra text at note 16.

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premises in legal reasoning they cannot conclusively serve as major premises, because especially in the common law a court can legitimately reformulate a rule stated in precedent by creating new exceptions; reconstruing the precedent to stand for a new rule based on the facts and result of the precedent rather than on the rule it states; transforming the rule; or overruling the precedent. Whether and how one of these processes is utilized depends largely on social propositions.

A.  CREATING NEW EXCEPTIONS A rule stated in precedent is always subject to reconstruction through the creation of new exceptions, typically by employing the process of distinguishing. In that process a court begins with a rule stated in precedent that is literally applicable to the case at hand, and then determines that the rule should be reformulated by carving out an exception for cases like that at hand. Such an exception may be made either because the social propositions that support the existing rule do not extend to a new fact-​pattern that is within the rule’s literal scope or because a new fact-​pattern that is within the existing rule’s literal scope brings into play social propositions other than those upon which the rule originally rested. To put this differently, a rule stated in precedent should and normally will be reformulated by an exception where the reformulated rule is justified by applicable policy and moral propositions while the original rule would not be justified if it were applied to the newly arising case. For example, suppose that precedent in a jurisdiction has adopted the rule that bargains are enforceable in the absence of fraud, duress, or the like. The jurisdiction has not yet established whether age-​based incapacity is a defense to a bargain. Now an actor who made a bargain with a fourteen-​year-​old seeks to enforce the bargain. If common​law rules were fixed, then as a matter of deduction the minor would be liable. The major premise would be that bargains are enforceable in the absence of fraud, duress, or the like. The minor premise would be that the fourteen-​ year-​old made a bargain. The conclusion would be that the fourteen-​year-​old is liable. But this conclusion should not and will not be drawn, because the social propositions that support the rule that bargains are enforceable do not support the application of that rule to persons whom society considers underage. One social reason for the bargain rule is that actors are normally the best judges of their own interests. Based on experience this reason does not apply to persons society considers underage. Therefore, the rule should be reformulated by creating an exception for underage persons. Similarly, suppose that precedents in a jurisdiction have adopted the rule that donative promises (promises to make gifts) are unenforceable. A case now arises in which a donative promisee incurs costs in reasonable reliance on the promise. If common law rules were fixed, then as a matter of deduction the promisor would not be liable. The major premise would be that donative promises are unenforceable. The minor premise would be that the promise was donative. The conclusion would be that the promise is unenforceable. But this conclusion should not and will not be drawn, because a social proposition other than those that support the donative-​promise principle applies to the case: When one person, A, uses words or actions that he knows or should know would induce another, B, to reasonably believe that A is committed to take a certain course of action, and A knows or should know that B will incur costs if A does not take the action, A should take steps to ensure that if he does not take the action

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B will not suffer a loss.6 This proposition is weightier than the propositions that support the donative-​promise principle in the absence of reliance. Therefore, the donative-​promise principle should be reformulated by adding an exception where a donative promisee has been reasonably relied upon the promise. In contrast, suppose a court was asked to hold that a bargain made by a clergyman is unenforceable against the clergyman even though the bargain was not religious in nature (that is, did not concern issues of dogma, the allocation of authority within a church, or the like). This exception should not be engrafted onto the rule because no applicable social proposition supports a special status for clergymen in this regard. It is easy to imagine social propositions that would support a special status for clergymen for other purposes or in another society or time. For example, in the Middle Ages there was a clergyman exception in the criminal law—​clergymen could be prosecuted for felony only in ecclesiastical courts and therefore were not subject to capital punishment because ecclesiastical courts did not employ that sanction.7 Even today religious bargains made by clergymen might well be unenforceable. But applicable social propositions in contemporary society would not support a broad clergyman exception to the bargain rule. In short, any common l​aw rule may be reformulated at any time by the processes of distinguishing and drawing exceptions. Whether and how a given rule should be reformulated in these ways depends in whole or significant part on social propositions.

B. RECONSTRUING Under well-​accepted principles of common-​law reasoning the rule of a precedent can either be construed to be the rule that the precedent states or to be a very different rule based on the facts and result of the precedent. As a result, often a number of different rules can be constructed from a precedent. This is well illustrated by a famous British case, Donoghue v. Stevenson.8 There the plaintiff and a friend were together in a café and the friend purchased a bottle of ginger beer for the plaintiff. The bottle was opaque. After the plaintiff drank part of the ginger beer she discovered a decomposed snail in the bottle. She suffered shock and severe gastroenteritis, and sued the manufacturer. Before Donoghue it was a well-​established rule of law that the manufacturer of a product was liable only to its immediate buyers for injuries caused by its negligence in producing the product. In Donoghue, however, the House of Lords ruled in the plaintiff ’s favor. Lord Atkin stated that “a manufacturer of products, which he sells in such a form as to show that he intends them to reach the ultimate consumer in the form in which they left him with no reasonable possibility of intermediate examination, and with the knowledge that the absence of reasonable care in the preparation or putting up of the products will result in an injury to the consumer’s life or property, owes a duty to the consumer to take that reasonable care.”9

6.  See Thomas Scanlon, Promises and Practices, 19 Phil. & Pub. Affairs 199, 202–​03 (1990). 7.  See 1 Frederick Pollock & Fredrick William Maitland, The History of English Law 441–​45 (2d ed. 1898). 8.  M’Alister (or Donoghue) v. Stevenson, [1932] AC 562 (HL) (appeal taken from Scot.). 9.  Id. at 599.

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It is clear that Donoghue abandoned the existing rule, because the manufacturer was held liable to a plaintiff who was not the manufacturer’s immediate buyer. However, it was far from clear what rule Donoghue stood for, because, as Julius Stone pointed out,10 the facts in Donoghue could be characterized at vastly different levels of generality. For example, the agent of harm could be characterized as a thing, a food product, or a food product in an opaque container; the defendant could be characterized as a manufacturer, a manufacturer of nationally distributed goods, or a food manufacturer; and the injury could be characterized as a physical injury, an emotional injury, or simply an injury. Therefore, Donoghue could stand for any one of numerous possible rules constructed from permutations of the facts at various levels of generality—​for example, a rule that if a manufacturer of nationally distributed goods intended for human consumption produces the goods in a negligent manner it is liable for resulting physical injury, or a rule that if a food manufacturer is negligent it is liable for any resulting injury if it packaged the food in such a way that the defect was concealed. In such cases—​and many cases fall in this category—​which of the possible rules should and will be adopted cannot be determined by doctrine, because the very problem is that various doctrinal propositions can be extracted from the facts and result of a precedent. Instead, which rule should and will be adopted depends on social propositions, that is, on which possible rule is normatively best.

C. TRANSFORMATION Not only can a precedent be construed to stand for more than one rule, it can also be transformed to stand for a completely different rule than the precedent states. Judge Cardozo’s famous opinion in MacPherson v. Buick Motor Co.11 provides a classic illustration. This case grew out of injuries suffered by MacPherson as a result of the sudden collapse of a new Buick he had purchased from a dealer. One of the car’s wheels had been made of defective wood, and the car collapsed because the spokes of the wheel crumbled into fragments. Buick had purchased the wheel from another manufacturer, but there was evidence that a reasonable inspection by Buick could have discovered the defects. MacPherson won a jury verdict and Buick appealed. The established rule in New York, like the established rule in England prior to Donoghue, was that a manufacturer was liable only to its immediate buyer (there, the dealer) for injury caused by the manufacturer’s negligence in producing a product. However, the New York courts had developed an exception for cases in which an injury was caused by a product of a kind that is “imminently” or “inherently” dangerous, such as poison. Although a car doesn’t seem much like poison, Cardozo held for MacPherson by creating a new rule, which he purported to base on the facts and results of the precedents as opposed to the rule stated in the precedents. “We hold,” Cardozo said, that the existing rule “is not limited to poisons, explosives, and things of like nature, to things which in their normal operation are implements of destruction. If the nature of a thing is such that it is reasonably certain to place life and limb in peril when negligently made, it is then a thing of danger. . . . If to the element

10.  Julius Stone, The Ratio of the Ratio Decidendi, 22 Mod. L. Rev. 597, 603–​04 (1959). See also A.W.B. Simpson, Note, The Ratio Decidendi of a Case, 22 Mod. L. Rev. 413 (1958), 21 Mod. L. Rev. 155 (1959), 22 Mod. L. Rev. 453 (1959). 11.  MacPherson v. Buick Motor Co., 111 N.E. 1050 (N.Y. 1916).

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of danger there is added knowledge that the thing will be used by persons other than the purchaser, and used without new tests, then, irrespective of contract, the manufacturer of this thing of danger is under a duty to make it carefully.”12 This formulation adopted the cloak of the old rule insofar as it made the manufacturer’s liability turn on whether the product was “a thing of danger.” However, the formulation completely changed the substance of the old rule. Under the MacPherson formulation the issue became not whether a product is of a type that is inherently or imminently dangerous, but whether a product is dangerous if negligently made, and any product can be dangerous if negligently made. In substance, therefore, MacPherson adopted a straightforward negligence rule under which the manufacturer of any negligently made defective product is liable to any person who would foreseeably be injured as a result of the manufacturer’s negligence, even if the person is not the manufacturer’s immediate buyer. In transforming the pre-​MacPherson rule Cardozo dealt with five cases. All of those cases seemed inconsistent with the rule Cardozo adopted. However, Cardozo asserted that three of the cases supported the rule he adopted because they imposed liability on a negligent manufacturer—​never mind that they did not do so on a negligence theory.13 The other two cases actually held in favor of the manufacturer but Cardozo distinguished these cases on the ground that on their facts the manufacturers were insulated from liability by standard negligence defenses—​ never mind that those defenses were not the basis of the decisions.14 In short, Cardozo did not transform the old rule for formalist reasons, based on doctrine. On the contrary, he disregarded doctrine, threw out the existing rule because it was not normatively justified, and adopted a normatively justified rule in its place.

D. OVERRULING Common law rules are also not fixed because a court can simply overrule precedent. Generally speaking, doctrines should be and over time normally will be overruled where the social value of replacing an unjustified rule exceeds the social value of doctrinal stability.15 Of course, in many cases the courts will simply apply a rule stated in precedent rather than distinguishing, reconstruing, transforming, or overruling the rule. That is to be expected, because courts are unlikely to formulate normatively unjustified rules in the first place, and even if a rule was unjustified when adopted, eventually most unjustified rules will have been distinguished, reconstrued, transformed, or overruled. In any event, the point is not the extent to which at any given time the rules of the common law are for the most part normatively justified. Rather, the point is that few or no common law rules are fixed. Therefore, a common law rule cannot serve as a conclusive major premise without regard to whether the rule is normatively

12.  Id. at 1053. 13.  Id. at 1052–​54 citing Statler v. George A. Ray Mfg. Co., 88 N.E. 1063 (N.Y. 1909); Devlin v. Smith, 89 N.Y. 470 (1882); Thomas v. Winchester, 6 N.Y. 397 (1852). 14.  Losee v. Clute, 51 N.Y. 494 (1873); Loop v. Litchfield, 42 N.Y. 351 (1870). 15.  For discussion of this point see Melvin A. Eisenberg, The Nature of The Common Law 105–​27 (1988).

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justified, and accordingly there is no room in the common law for conclusive reasoning based solely on deduction from doctrinal propositions.

E.  THE STATUS OF FORMALISM To summarize, no doctrinal proposition is self-​evident; axiomatic legal reasoning is untenable, as is conclusive reasoning by deduction; and doctrinal rules are dependent on, not autonomous of, policy and morality. As a result, formalism is untenable. Its current status has been accurately described as follows by Stephen Perry: In a series of important and provocative articles Professor Ernest Weinrib has argued in favor of formalism, a position in legal theory that conventional wisdom has for some time pronounced dead. In his present paper, Weinrib tells us that his defense of formalism is a voice from the empty sepulchre. While there is certainly no doubting the ingenuity and inherent interest of Weinrib’s efforts to raise the dead, in the final analysis his attempt at revivification must be judged a failure. He may have induced the corpse to twitch a little, but despite all his skillful arguments formalism remains . . . as dead as it ever was.16

Some commentators on contract law have nevertheless reported, often with alarm, that there has been a rebirth of formalism in contract law, which they call neoformalism. To paraphrase Mark Twain, the reports of the birth of neoformalism in contract law have been greatly exaggerated. The commentators who file these reports usually point to the work of only three scholars—​Alan Schwartz and Robert Scott, writing together, and Lisa Bernstein. Much although not all of the work of these scholars concerns only contract interpretation, and Bernstein’s work turns heavily on whether incorporating trade usage, course of dealing, and course of performance into interpretation leads to inefficient incentives, misreading of party intentions, or both.

I I .   I N T E R P R E TI VE T HEOR I ES Interpretive theories proceed by describing some area of contract law and then determining the social propositions that are to be found in the most fundamental doctrines in the area, or that meet some standard of fit with and best justify or rationalize doctrine in the area. These social propositions are then used to explain the law governing that area, or to reinterpret, reformulate, critique, or reject doctrines in the area that the social propositions do not justify or rationalize. As stated by Nathan Oman, the purpose of interpretive theories of contract law “is not to provide us first with an ideal normative framework and only then offer concrete rules of law that flow from that framework. Rather, one takes contract law as it currently exists and seeks

16.  Stephen R. Perry, Professor Weinrib’s Formalism:  The Not-​So-​Empty Sepulchre,16 Harv. J.L. & Pub. Policy 597, 597 (1993).

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an explanation that renders it as coherent and intelligible as possible.”17 Interpretive theories suffer a fundamental flaw in their application: the application of such theories will often produce a body of law that is normatively undesirable. Stephen Smith and Peter Benson are leading proponents of interpretive theories of contracts. Smith describes the core of his theory as follows: Interpretive theories aim to enhance understanding of the law by highlighting its significance or meaning. . . . [T]‌his is achieved by explaining why certain features of the law are important or unimportant and by identifying connections between those features—​in other words, by revealing an intelligent order in the law, so far as such an order exists.18

The application of this theory will often result in an undesirable body of contract law because the aim of the theory is not to produce the best possible contract law but only an intelligible order in the law. Accordingly, the theory does not and cannot differentiate between making a good body of contract law intelligible and making a bad body of contract law intelligible. For example, classical contract law was a collection of mostly bad rules, such as the rule that reliance does not make a donative promise enforceable,19 the rule that if an offer and a response that purports to be an acceptance conflict in even the slightest way no contract is formed,20 and the rule that an offer for a unilateral contract can be revoked even after the offeree had begun performance.21 It would be easy to make classical contract law intelligible, but the only result would be to make a bad body of law even worse. Benson calls his theory a public basis of justification.22 A “public basis of justification,” he says, “draws on basic normative ideas that are explicitly or implicitly present in the public legal culture, and more specifically, in its principles and doctrines of contract law.”23 Benson’s interpretive theory is subject to the same problems as Smith’s and one more. Benson assumes that a set of clearly defined and harmonious normative ideas can be found in contract law. It can’t. Contract law is and should be based on all applicable and meritorious policies and moral norms. Many or most of these policies and norms will conflict over parts of their range. When that occurs, prudential judgment must be exercised to craft a rule that properly reflects the conflict. (It is important to keep in mind that a conflict between two norms in a part of their applications does not mean that the two norms are inconsistent. This issue will be discussed at greater length below.) Because of partial conflicts among the norms that underlie contract law, a fully nonconflicting set of norms cannot be found in the body of contract law. To put this differently, contract-​law rules can be made nonconflicting but the policies and moral norms that underlie those rules often are not and cannot be made nonconflicting over the full range of their applications. 17.  Nathan B. Oman, Unity and Pluralism in Contract Law, 103 Mich. L. Rev. 1483, 1489 (2005) (reviewing Stephen A. Smith, Contract Theory). 18.  Smith, supra note 17, at 5. 19.  See Chapter 8, infra. 20.  See Chapter 32, infra. 21.  See Chapter 33, infra. 22.  Peter Benson, The Idea of a Public Basis of Justification for Contract, 33 Osgoode Hall L.J. 273 (1995). 23.  Id. at 305.

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All this is illustrated by Benson’s own scholarship. For example, one of the basic normative ideas that Benson finds in contract law is that contract law is strictly objective and therefore rejects a purely subjective test of interpretation. That is incorrect. Both objective and subjective norms have roles to play in interpretation, and as a result the body of rules that govern interpretation combines objective ideas and rules, subjective ideas and rules, and ideas and rules that combine objective and subjective elements. Thus Restatement Second Section 201(1) provides that “[w]‌here the parties have attached the same [subjective] meaning to a promise or agreement or a term thereof, it is interpreted in accordance with that meaning.” Similarly, Restatement Second Section 201(2) provides that if A and B attach different subjective meanings, M and N, to an expression, and A knows that B attaches meaning N, but B does not know that A attaches meaning M, then B’s subjective meaning will trump A’s meaning even if A’s meaning is objectively more reasonable than B’s. Another basic normative idea that Benson finds in contract law is that when a contract is formed each party has a legal right to possession of the performance promised by the other.24 That is not the case. If it were, a party to a contract would be entitled not merely to damages for breach but to specific performance—​just as if A withholds from B possession of property that B has a right to possess B is entitled to replevin, not merely damages. But here too, different and partially conflicting policies and moral norms are applicable—​for example, the policy in favor of minimal state intrusion into private conduct, which argues against a general right to specific performance, and the policy in favor of putting a promisee where he would have been if the contract had been performed which argues in its favor. As a result, under the rules that govern specific performance, that remedy is available in some kinds of cases but not others, depending on how the applicable policies and moral norms are best weighted and reconciled.25

I I I .   N O R MAT I VE T HEOR I ES Under a normative theory of contract law the content of contract law should depend on the rules that are generated by properly weighted and reconciled policy, moral, and empirical propositions. Unlike the objectives of formalist and interpretive theories the objective of normative theories is to formulate the best possible rules of contract law. Normative theories of contract law fall into two basic categories: monistic and pluralistic. Monistic theories are based on a single value, such as the moral value of autonomy or communitarianism or the policy value of efficiency. In contrast, under pluralistic theories all applicable and meritorious policy and moral values should be taken into account. The attractions of monistic theories are obvious: because they turn on a single value these theories appear to be capable of producing determinate results and avoiding the dissonance caused by sometimes conflicting policies and moral norms. However, these advantages are only apparent, not real. Part of the human moral condition is that we hold many meritorious moral values, some of

24.  Id. at 317, 319, 320–​24. Still a third basic normative idea that Benson finds in existing contract doctrine is that there can be no liability for nonfeasance. Id. at 302. In fact, however, contract law provides various examples of a duty to bestir oneself. See Chapters 9 & 10, infra. 25.  See Chapter 24, infra.

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which will conflict in given cases. Similarly, part of the human social condition is that many meritorious policy goals are relevant to the creation of a good world, some of which will conflict in given cases. As said by Isaiah Berlin: . . . [S]‌ince some values may conflict intrinsically, the very notion that a pattern must in principle be discoverable in which they are all rendered harmonious is founded on a false a priori view of what the world is like. . . . [E]‌nds collide. . . . The need to choose, to sacrifice some ultimate values to others, turns out to be a permanent characteristic of the human predicament.26 *** If, as I believe, the ends of men are many, and not all of them are in principle compatible with each other, then the possibility of conflict . . . can never wholly be eliminated from human life, either personal or social. The necessity of choosing between absolute claims is then an inescapable characteristic of the human condition.27

Elizabeth Anderson has written to the same effect: Our evaluative experiences, and the judgments based on them, are deeply pluralistic. . . . To adopt a monistic theory of value is to hopelessly impoverish our responsive capacities to a monolithic “pro” or “con” attitude or to mere desire and aversion. . . . Pluralists deny that it makes sense to reason about the good and the right independent of thick evaluative concepts. When monists try to do so, they either abolish discursive reasoning about values altogether, or confine it to an arbitrarily narrow set of considerations. This has disastrous implications. In adopting a theory of value, we adopt a way of understanding and appreciating what is worthwhile in life and of exploring new possibilities for living. Monism drastically impoverishes these possibilities. It disables us from appreciating many authentic values. It suppresses the parallel evolution of evaluative distinctions and sensibilities that make us capable of caring about a rich variety of things in different ways. . . . It cuts off fruitful avenues of exploration and criticism available on a pluralistic self-​understanding.28

Contract law cannot escape these moral and social conditions. Monistic theories fail because they deny the complexity of life. In contract law, as in life, all applicable meritorious policy goals and moral values should be taken into account, even if those values and goals may sometimes conflict, even if one value or goal trumps another in given cases, and even at the expense of complete determinacy. Michael Trebilcock has made a comparable point: Both as individuals and as a community, we do not operate within a one-​value view of the world. Any such view is likely to prove self-​defeating. For economists to claim that they are interested only in maximizing the total value of social resources, without being concerned about how gains

26.  Isaiah Berlin, Four Essays on Liberty li (1969). 27.  Isaiah Berlin, Two Concepts of Liberty, reprinted in Four Essays on Liberty 118, 169. 28.  Elizabeth Anderson, Value in Ethics and Economics 1, 5, 118 (1993).

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in the value of social resources are to be distributed and whether these gains are in fact making the lives of individuals better, and whose lives, or while ignoring the impact of economic change on the lives of individuals or on the integrity or viability of long-​standing communities, reflects a highly impoverished view of the world. Alternatively, theorists committed only to concepts of distributive justice, who proceed in their analysis by inviting us to assume a given stock of wealth, or a given increase in the stock of wealth, and then asking what a just distribution of that wealth might entail, are largely engaging in idle chatter as long as the wealth creation function is simply assumed. Creating wealth is a necessary pre-​condition to distributing it. Similarly, communitarians who stress values of solidarity and interconnectedness and discount values of individual autonomy and freedom risk pushing this perspective to an extreme, where communitarian values become exclusionary, authoritarian, or repressive.29

In short, the best theory of contract law is normative and pluralistic.

29.  Michael J. Trebilcock, The Limits of Freedom of Contract 248 (1993). See also, e.g., Steven J. Burton, Normative Legal Theories: The Case for Pluralism and Balancing, 98 Iowa L. Rev. 535 (2013); Martha Minow & Joseph William Singer, In Favor of Foxes:  Pluralism as Fact and Aid to the Pursuit of Justice, 90 B.U. L. Rev. 903 (2010); Leon Trakman, Pluralism in Contract Law, 58 Buff. L. Rev. 1031 (2010).

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three

Four Underlying Principles of Contract Law and the Foundational Contract-​Law Standard This c hap t er devel ops f ou r u nderly i n g pri n ci pl es of c on tr act

law and the foundational contract law standard. The four principles may govern contractual conduct; may mediate between normative theories of contract law, on the one hand, and specific rules of contract law, on the other; or may do both. The principles involve economic, moral, empirical, and administrative criteria; the first two principles also center on what kinds of promises should be legally enforceable. The four principles are as follows: 1. The aim of contract law should be to effectuate the objectives of parties to promissory transactions, provided appropriate policy and moral conditions, such as freedom from duress and fraud, are satisfied, and subject to appropriate constraints, such as capacity and legality.

This is the first and most basic underlying principle of contract law. 2. The conditions to and the constraints on effectuating the objectives of parties to promissory transactions, and the way in which those objectives are to be ascertained, should consist of those rules that best take into account all applicable and meritorious policy, moral, and empirical propositions. When more than one such proposition is applicable a court should exercise good judgment to give each proposition appropriate weight considering the issue at hand and, based on those weights, should either subordinate some propositions to others or formulate a rule that is the best vector of the applicable propositions, given their relative weights and the extent to which an accommodation can be fashioned that reflects those weights. 3. Where contracting parties have not explicitly or implicitly addressed an issue, the issue should be governed by a default rule whose content is determined in the same way that the conditions to and the constraints on effectuating the parties’ objectives should be determined.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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Theories of Contract Law 4. The remaining rules of contract law—​such as those that govern the enforceability of promises, remedies for breach of promise, excuse for nonperformance of enforceable promises, the effect of nonfulfillment of conditions, the rights of persons who are not parties to a contract but would benefit by its performance—​should also be determined in the same way.

The normative theory of contract law, taken together with these four underlying principles, comprise the foundational standard of contract law (hereafter the foundational standard). Rules that are supported by the foundational standard are justified. Rules that are not so supported are unjustified. An objection that might be made to the foundational standard is that the body of contract law generated by the standard will be internally inconsistent because the standard depends on social propositions, and social propositions often conflict. In fact, in many applications all relevant social propositions will point in the same direction. For example, all social propositions point toward a rule that fraud should be a defense in a suit for breach of contract. But even where social propositions conflict in some applications they are not for that reason inconsistent. If each of two conflicting moral norms has established its credentials in independent territories, we do not want to walk away from either norm just because there are territories where they conflict. For example, the moral norm “don’t lie” is not inconsistent with the moral norm “venerate human life” even though under certain circumstances venerating human life might require lying—​as in lying to an assassin about a victim’s whereabouts. Similarly, it does not lessen our commitment to truth-​telling that we believe that sometimes it is morally permissible or even morally required to lie, as in the case of therapeutic lies. Goals too are not inconsistent just because they conflict in certain applications. For example, the goal of developing a fruitful and rewarding career is not inconsistent with the goal of being a nurturing parent, although pressures of time may lead to a conflict between the two goals in particular cases. A related objection that might be made to the foundational standard is that it provides no metric for giving proper weights and roles to social propositions that conflict in specific applications. The premise of that objection is accurate. The standard is pluralistic and therefore does not provide such a metric. Instead, under that standard when social propositions conflict in establishing a rule, good judgment must be used concerning the weight and role to be given to each proposition—​just as when values or goals conflict in life, actors must use good judgment concerning the weight and role to be given to each value or goal that is relevant to the issue at hand. However, the requirement of good judgment does not confer unrestricted discretion. When conflicting social propositions are relevant to establishing a given rule, the rule should be adopted that takes appropriate account of each proposition. At one time two leading contract law scholars, Alan Schwartz and Robert Scott, objected to pluralist theories based on the lack of a metric. In Contract Theory and the Limits of Contract Law1 they argued that Pluralist theories . . . need, but so far lack, a meta-​principle that tells which of these goals should be decisive when they conflict . . . The problems that pluralist theories without meta-​norms pose are nicely illustrated in Melvin Eisenberg’s effort, which purports to solve the broad-​scope-​of-​contract problem by proposing overlapping sets of norms. . . . [Eisenberg] recognizes that this multivalue

1. 113 Yale L.J. 541, 543 & 543–​44 n.2 (2003).

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approach can generate conflicting social propositions. When conflicts actually occur, “the lawmaker must make a legal rule that gives a proper weight and role to each of the conflicting values or goals in the context at hand.” . . . Further, “when social propositions conflict the [lawmaker] must exercise good judgment concerning the weight and role to be given to each proposition in the issue at hand.” Eisenberg recognizes that his theory lacks a metric that would tell the lawmaker just how to give the proper “weight and role” to each social proposition or value when conflicts occur. Since courts or legislatures are likely to be involved when the relevant social propositions or values arguably favor more than one type of litigant or interest group, pluralist theories such as Eisenberg’s tend to be least helpful when they are most needed.

Later, however, Schwartz and Scott implicitly recanted in Market Damages, Efficient Contracting and the Economic Waste Fallacy.2 There they defended a damages rule they proposed on the pluralist ground that the rule was preferable to the alternative “on both efficiency and fairness grounds,”;3 that “there is a corrective justice argument against” the alternative damages rule and that their proposal was supported by “conventional moral notions.”4 So too, they said, “[w]‌hen the buyer has prepaid for [a] contract service, both efficiency and fairness justify awarding cost-​of-​completion damages even when these would much exceed the market delta.”5 And again, “With regard to fairness, it is not inequitable to require the seller to pay cost-​of-​completion damages though they significantly exceed the major alternative.”6

2. 108 Colum. L. Rev. 1610 (2008). 3.  Id. at 1647. 4.  Id. at 1649. 5.  Id. at 1651 (emphasis in original). 6.  Id. at 1664 n.139.

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The Transformation of Contract Law from Classical to Modern Fro m the middle of th e ninet een th cen tu ry u n ti l the fi r st pa rt

of the twentieth century contract law was dominated by a school of thought now known as classical contract law, which found its central inspiration in Christopher Columbus Langdell, Oliver Wendell Holmes Jr., and Samuel Williston, and its central expression in Restatement First. Classical contract law was a rigid instrument, which purported to employ formal, axiomatic, and deductive rather than normative reasoning. Its rules were often responsive to neither the actual objectives of the parties, the actual facts and circumstances of the parties’ contract, nor the dynamic character of contracts. Instead, the rules of classical contract law were centered on a single abstraction—​the reasonable person; on a single kind of promise—​the bargain promise; and on a single moment in time—​the moment of contract-​formation. Over the last seventy or eighty years, contract law has been transformed from classical to modern. One area of transformation concerns the nature of contract-​law reasoning. Reasoning in classical contract law was formal; that is, it began with axioms that were taken for granted and proceeded to rules derived through deduction from those axioms. Social propositions (that is, propositions of policy, morality, and experience) played little or no role. In contrast, the objective of modern contract law is to craft rules that are justified by social propositions and that, to put it differently, are normatively desirable. Doctrines have an important role to play even in modern legal reasoning because of the social value of doctrinal stability, but that value must always be weighed against the value of normative justification. In general, the algorithm that describes modern contract-​law reasoning is as follows: if a rule stated in applicable precedents is substantially congruent with what the court believes would be the rule that is best justified by policy, morality, and experience, the rule normally should and will be followed even though it falls short of the best rule. Small differences between the best possible rule and a reasonably good rule are likely to be highly debatable, difficult to perceive, or both. Therefore, if the courts failed to follow a doctrinal rule just because the rule was modestly less desirable than a competing alternative it would be difficult to rely on doctrine. To put it differently, at least over the short term the value of making minor improvements in legal rules

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is normally outweighed by the value of doctrinal stability. In contrast, the value of major normative improvements in legal rules normally outweighs the value of doctrinal stability. Accordingly, if a stated rule lacks substantial congruence with the normatively best rule the courts normally should and will create exceptions to the rule—​if need be, exceptions that are inconsistent with the rule, create distinctions to the rule, or overrule the rule. As a result, in modern times many of the most firmly rooted doctrines of classical contract law have been either radically transformed or wholly uprooted because the courts have come to perceive the doctrines as not normatively justified. This is true, for example, of the rule that only bargain promises are enforceable and the rule that an offer for a unilateral contract (that is, a contract formed by a promise on one side and an act on the other) is revocable before performance has been completed even if the offeree had begun to perform. Other examples will be discussed throughout this book. The transformation from classical to modern contract law can also be observed through examination of the spectra along which contract-​law doctrines can be ranged. One spectrum of contract-​law doctrines runs from the pole of objectivity to the pole of subjectivity. A  contract-​law doctrine lies at the objective pole if its application depends on a directly observable state of the world, and at the subjective pole if its application depends on a mental state. For example, application of the plain-​meaning rule of interpretation depends on observable meanings attached to words by established communities. In contrast, application of the modern rule that if both parties attach the same meaning to an expression that meaning prevails depends on a determination of the parties’ mental states. Classical contract law carried objectivism so far that it overrode the actual shared intentions of the parties. Thus, Williston: It is even conceivable that a contract shall be formed which is in accordance with the intention of neither party. If a written contract is entered into, the meaning and effect of the contract depends on the construction given the written language by the court, and the court will give that language its natural and appropriate meaning; and, if it is unambiguous, will not even admit evidence of what the parties may have thought the meaning to be.1

And Learned Hand: A contract has, strictly speaking, nothing to do with the personal, or individual, intent of the parties. A contract is an obligation attached by the mere force of law to certain acts of the parties, usually words, which ordinarily accompany and represent a known intent. If, however, it were proved by twenty bishops that either party, when he used the words, intended something else than the usual meaning which the law imposes upon them, he would still be held, unless there were some mutual mistake, or something else of the sort. . . . [W]‌hatever was the understanding in fact of the banks [in this case] . . . of the legal effect of this practice between them, it is of not the slightest consequence, unless it took form in some acts or words, which being reasonably interpreted, would have such meaning to ordinary men.2

1. 1 Samuel Williston, A Treatise on the Law of Contracts § 95 (1st ed. 1920). 2.  Hotchkiss v. Nat’l City Bank. 200 F. 287, 293–​94 (S.D.N.Y. 1911), aff ’d, 201 F. 664 (2d Cir. 1912), aff ’d, 231 U.S. 50 (1913).

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A second spectrum runs from the pole of standardization to the pole of individualization. A contract-​law doctrine lies at the standardized pole if its application depends on a single variable that is unrelated to the actual intentions of the parties or the particular circumstances of their contract. A contract-​law doctrine lies at the individualized pole if its application depends on situation-​specific variables that relate to intentions and circumstances. For example, application of the doctrine that adequacy of consideration will not be reviewed depends on a single variable—​the presence of a bargain—​that is designed to screen out all information concerning intentions and circumstances. In contrast, application of the modern doctrine of unconscionability depends on situation-​specific variables that are wholly concerned with that sort of information. A third spectrum runs from the static to the dynamic. A contract-​law doctrine lies at the static pole if its application turns entirely on what occurred at the moment in time when a contract was formed. A contract-​law doctrine lies at the dynamic pole if its application turns in significant part on a moving stream of events that precedes, follows, or constitutes the formation of a contract. For example, the plain-​meaning rule is not only objective but static, because it limits interpretation to what occurred at the moment in time when a written contract was formed. In contrast, the position taken by many modern courts is that the context in which a contract was made should be taken into account in interpretation is dynamic, because it turns in significant part on the stream of events before the moment of contract-​formation. A fourth spectrum runs from the binary to the multifaceted. Contract-​law doctrines are binary if they organize the experience within their scope into only two categories. Contract-​ law doctrines are multifaceted if they organize the experience within their scope into several categories. For example, Williston famously argued that when it came to damages for breach of contract the only choice was between no damages and expectation damages.3 In contrast, modern contract law provides a multifaceted menu of no damages, expectation damages, reliance damages, restitutionary damages, and disgorgement damages. Another area of transformation concerns the deep structure of contract-​law rules. Classical contract law gave an overriding priority to objective, standardized, static, and binary rules, often responsive to neither the actual objectives of the parties, the actual facts and circumstances of the parties’ transaction, nor the dynamic character of contracts. In contrast, modern contact law pervasively, although not completely, consists of principles that are individualized, dynamic, multifaceted, and, in appropriate cases, subjective. In addition to these large-​scale movements in contract law, there have been numerous shifts in particular doctrines. These shifts will be discussed throughout this book. Three examples: (1) Classical contract law gave no role to reliance. In contrast, in modern contract law the role of reliance is pervasive: it figures in consideration, damages, offer and acceptance, mistake, unexpected circumstances, the Statute of Frauds, and on and on. (2) Classical contract law was extremely grudging in enabling third-​party beneficiaries to bring suit. In contrast, modern contract law allows third-​party beneficiaries to bring suit in a number of contexts. (3) In the area of interpretation the plain-​meaning rule of classical contract law, which limited interpretive elements to what occurred at the moment in time when a written contract was executed, and was both static and objective, is now often displaced by rules that give primacy to the parties’

3.  Proceedings April 29, 1926, 4 App’x A.L.I. Proc. 6, 88–​89, 91–​92, 95–​96, 98–​99.

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mutual subjective interpretation, if one exists; put a heavy emphasis on the context in which a contract was made; and conceive of contracts as developing through time; and recognize a variety of roles for subjective elements in interpretation. In short, as will be shown throughout this book, no area of contract law has been left unaffected by the shift from classical to modern contract law.

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PA R T   T W O

THE ENFORCEABILITY OF PROMISES Under all common law systems, and most if not all civil law systems, a promise as such is not legally enforceable. Under the common law the first great question of contract law therefore is what kinds of promises should be enforceable. The answer to that question has traditionally been subsumed under the heading consideration. Under this terminology a type of promise that is enforceable is said to have consideration, while a type of promise that is unenforceable is said to lack consideration. The concept of consideration, in turn, may be conceived in two very different ways, one narrow and one broad. Under the narrow conception, consideration is equated with bargain. This conception—​the “bargain theory of consideration”—​was adopted in classical contract law and in Restatement First and Restatement Second. In Restatement Second this conception is embodied in section 71(1): “. . . . To constitute consideration, a performance or a return promise must be bargained for.” The bargain theory of consideration can produce two kinds of distortion. The first concerns terminology. As will be seen in succeeding chapters, a number of elements other than bargain should and do make promises legally enforceable. Restatement Second recognizes these elements, but only under the topic-​heading “Contracts Without Consideration.” The ludicrous result is that under Restatement Second a promise needs consideration to be enforceable unless it does not need consideration to be enforceable. The second distortion produced by the bargain theory of consideration is substantive. If consideration means the set of elements that make promises enforceable, the meaning of the term will be continually adjusted as it becomes socially desirable to add new elements or drop old ones. In contrast, the bargain theory of consideration suggests a closed system in which all nonbargain promises are presumptively unenforceable. If taken seriously, such an approach not only tends to stifle judicial creativity and reconceptualization but conduces to the formulation of particularized rules rather than general standards, to govern nonbargain promises. The bargain theory of consideration is not mandated by contract doctrine. On the contrary, the theory cannot account for many basic contract doctrines except by clumsily relegating them to the purgatory of “Contracts [Enforceable] Without Consideration.” Nor is the theory mandated by judicial decisions. A number of courts have adopted the bargain theory of consideration, but many others use the term consideration in its broader sense, to embrace nonbargain elements. Under the broad conception of consideration, that term includes the various elements that make a promise legally enforceable. Bargain is one such element. As will be seen in subsequent chapters, there are others, such as reliance. In this book the term consideration is used in its broad sense.

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five

Bargain Promises and the Bargain Principle I .   A N I N T R ODUCT I ON T O   B A R G A I N PR OM I S ES In his classic article “Consideration and Form,”1 Lon Fuller described two criteria that should govern the enforceability of promises. Fuller called these criteria considerations of form and of substance. Today, we might say criteria of process and substance. Bargains are the paradigm case for a type of promise that should be enforceable. The substantive reasons for enforcing bargain promises are extremely strong. A bargain is an exchange in which each party views what he gives as the price of what he gets. Bargains between actors who are voluntary, capable, and fully informed increase wealth by producing gains through trade, because normally each party to a bargain values what he gets more highly than what he gives. For example, if Consumer C purchases a Sony TV from Best Buy for $500, C almost certainly values the TV more than he values $500 and Best Buy almost certainly values $500 more than it values the TV, so that the contract creates surplus for both parties. Perhaps more important, a modern free-​enterprise system depends heavily on private planning, and enforcing bargains enables parties to reliably engage in various kinds of planning, such as the coordination of inputs and outputs; to shift risks from an actor who is less willing or able to bear given risks to an actor who is more willing or able; and to engage in exchanges over time, such as present transfers for future payments. More generally, to paraphrase John Rawls, bargains set up and stabilize small-​scale schemes of cooperation.2 Enforcing bargains also facilitates investment in surplus-​enhancing reliance, such as advertising that will increase the value of a contract. Bargain promises also present few problems of process. To begin with, such promises are typically self-​regarding and therefore are likely to be deliberatively made and finely calculated. Next, bargain promises are usually made in a commercial context, and an alleged bargain that does not cohere with that context is unlikely to be deemed credible. For example, a claim that a steel producer had agreed to sell steel to a party who was not either a steel user, a steel distributor, or a steel speculator would usually be implausible. So would be a claim that a steel 1.  Lon Fuller, Consideration and Form, 41 Colum. L. Rev. 799 (1941). 2.  Cf. John Rawls, A Theory of Justice 304–​05 (rev. ed. 1999).

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producer had agreed to sell steel at less than market price. Moreover, bargain promises are usually supported by some kind of objective evidence, such as an invoice, a receipt, or an email, and the absence of any such evidence is telling. It is true that reasons of morality and reputation would provide incentives for keeping bargain promises even if such promises were unenforceable. However, moral incentives operate unevenly, and data concerning reputation is difficult and costly to assemble and evaluate. A commercial regime that was dependent solely on morality and reputation therefore would almost certainly be less efficient than a regime that also depended on legal enforceability. Accordingly, under the bargain principle in contract law a bargain promise is enforceable according to its terms in the absence of a defense such as fraud, duress, or unconscionability. Two more difficult issues are whether bargain-​like structural agreements should be enforceable, and whether certain types of bargain promises should be unenforceable even if they are not subject to a conventional defense. These two issues will be considered in Sections B and C of this chapter. A third, even more difficult issue is, what should be the remedy for breach of a bargain promise: reliance damages, expectation damages, restitution, disgorgement, or specific performance? This issue, and those remedies, is considered in Chapter 13 and other chapters in this book. In short, whether bargain promises should be enforceable is not a difficult issue. It is a rule of contract law that for a promise to be enforceable it must have consideration. Under classical contract law, and still today to a significant extent,3 the term consideration was more or less equivalent to the term bargain. That usage is incorrect (and is not universally followed), because the term consideration refers, or should refer, to types of promises that are enforceable and as will be shown in this section several important types of nonbargain promises are legally enforceable. In this book, the term consideration is used in that way.

I I.   S T R U C T U R A L A GR EEM ENT S The world faced by a potential contracting party can be divided into four realms, which will be referred in this book to as the realms of choice, predictability, probability, and chance. The realm of choice is comprised of states of the world (states) whose occurrence is within a party’s control. The realm of predictability is comprised of states that are not within a party’s control but are almost certain to occur. The realm of probability is comprised of states that are neither within a party’s control nor almost certain to occur but are likely to occur. The realm of chance is comprised of states that are outside a party’s control and are neither highly predictable nor likely to occur. It would be surprising if contract law did not turn on predictability, probability, and chance as well as choice. After all, firms make massive investments on the basis of predictability and probability and recognize that chance will often play a role in whether an investment will yield a profit, and a bargain is just a special type of investment. Generally speaking, legal consequences in contract law do not turn directly on whether a relevant contract is in one of these realms rather than another. However, these realms provide

3.  See, e.g., Restatement (Second) of Contracts § 71(1) (Am. Law Inst. 1981) [hereinafter Restatement Second].

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a conceptual apparatus that enables us to better understand the experience that underlies contracting. This understanding, in turn, facilitates the development of legal principles that are responsive to that experience and do have direct legal consequences. For example, the concept of the realm of choice illuminates what it means to make a promise. A promise is a commitment to take some action.4 Therefore, by virtue of a promise the promisor shrinks the boundaries of her realm of choice. Whatever were the boundaries of that realm before the promisor made the promise the realm is smaller thereafter, because some actions that she was morally free to choose before making the promise are actions that she is no longer morally free to choose. Courts have not always understood the ramifications of a promisor’s narrowing its realm of choice. For example, in a common type of contract, known as a requirements contract, a buyer agrees to purchase all of its requirements of a specified commodity from a given seller at a specified price. In the era of classical contract law the courts often refused to enforce requirements contracts against the seller if the buyer could choose to have no requirements, as if such a buyer had not made a real promise. (Examples were cases in which the buyer had no established business,5 or was a middleman,6 or required the commodity only in a part of its operations that it could easily abandon.7) However, even where a requirements-​contract buyer may choose to have no requirements it shrinks its realm of choice: Before a buyer enters into a requirements contract it is morally free to purchase the specified commodity from anyone it chooses. After the buyer enters into a requirements contract, if it requires the commodity during the contract period it is morally obliged to purchase it from the seller at the contract price. Since the seller on his part has promised to fill the buyer’s requirements at the contract price, both parties have made real promises—​have shrunk their realms of choice. And since each party has exchanged its promise as the price of the other’s, courts that refused to enforce requirements contracts because the buyer might have no requirements violated the bargain principle. That the buyer in a requirements contract may choose in good faith to have no requirements is a risk the seller knowingly takes and thinks it worthwhile to take.8 The realms of choice, predictability, probability, and chance also illuminate four paradigms into which most bargains fall. Two of the paradigms are well recognized in contract law. In these paradigms an actor, A, for whom a given state is within the realm of chance, wishes to use the instrumentality of contract to move the state into the realm of choice, predictability, or probability. In one of the paradigms B, for whom the relevant state is within the realm of choice, 4.  See Restatement Second § 1. For ease of exposition, commitments not to take a given action will be subsumed under commitments to take a given action. 5.  See, e.g., Pessin v. Fox Head Waukeshaw Corp., 282 N.W. 582, 585 (Wis. 1938). 6.  See, e.g., Oscar Schlegel Mfg. Co. v. Peter Cooper’s Glue Factory, 132 N.E. 148, 150 (N.Y. 1921). 7.  See, e.g., G. Loewus & Co. v. Vischia, 65 A.2d 604 (N.J. 1949). 8.  U.C.C. § 2-​306(1) now provides that “A term which measures the quantity by the output of the seller or the requirements of the buyer means such actual output or requirements as may occur in good faith, except that no quantity unreasonably disproportionate to any stated estimate or in the absence of a stated estimate to any normal or otherwise comparable prior output or requirements may be tendered or demanded.” The Official Comment adds that “Under this article, a contract for output or requirements . . . [does not] lack mutuality of obligation since, under this section, the party who will determine quantity is required to operate his plant or conduct his business in good faith and according to commercial standards of fair dealing in the trade so that his output or requirements will approximate a reasonably foreseeable figure.” Although UCC § 2-​306(1) applies only to the sale of goods, most requirements contracts fall into that category. In any event, a modern court would almost certainly hold that all requirements contracts have consideration.

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enters into a bargain with A under which B promises that the state will occur. For example, A, a computer manufacturer who will need large quantities of a certain chip in the future, may obtain a contractual commitment from B, the chip’s manufacturer, to supply the chips when needed. In the second paradigm a given state is within the realm of chance for both A and B, and A and B enter into a bargain under which the risk that the state will or will not occur is assumed by B even though the relevant state is not within her realm of choice. B may be more willing than A to take on the risk for a variety of reasons: B may be less risk-​averse than A, or may believe she can assess and price the risk better than A, or may have the capacity to aggregate comparable risks in such a way that although any given risk is within the realm of chance the outcomes of the risks as a class will fall within the realm of predictability. For example, homeowner A, for whom the risk of fire is in the realm of chance, may shift that risk to insurance company B, which can aggregate unpredictable single risks into a predictable class of risks. Both of these paradigms involve simple binary shifts between realms, and both are well recognized in contract law. In a third paradigm, which has received only limited legal recognition, the parties do not shift the risk of an occurrence of a given state from the realm of chance to the realm of choice, predictability, or probability. Instead, the parties create a dynamic promissory structure involving a promise by one of them that is designed to increase the probability of exchange, but the promise is not exchanged for either a counter-​promise or a bargained-​for act. In this book these promissory structures, whose terms are normally bargained out, will be called structural agreements. Structural agreements provide a direct link between transaction-​ cost economics and contract-​law doctrine. A major concern of transaction-​cost economics is the manner in which various forms of governance structures can maximize the likelihood that economic transactions will be seen to completion. A structural agreement is just such a governance structure. It is designed and intended to promote completed economic transactions. Although structural agreements do not involve a commitment by the promisee, they are often designed to give the promisor some assurance that exchange will occur. One such type of structural agreement, explicated by Oliver Williamson, consists of hostage agreements.9 These are transactions in which B is willing to make a commitment to A even without a reciprocal promise, because A can benefit from B’s commitment only by continuing to transact with B, and may take a loss if he stops transacting with B. Typically, hostage agreements involve an investment by A in assets whose value is highly specific to the transaction with B and will be forfeited if exchange with B fails to occur or continue. Such transaction-​specific investments serve as a hostage for A’s continued willingness to exchange, and therefore increase the probability of bargained-​for exchange between A and B.10 Laclede Gas Co. v. Amoco Oil Co.11 is a good example. In 1970 Amoco and Laclede entered into a master agreement under which Amoco would sell propane gas to Laclede for use in 9.  See Oliver E. Williamson, Credible Commitments: Using Hostages to Support Exchange, 73 Am. Econ. Rev. 519 (1983). 10.  A hostage theory of consideration has old legal roots. In ancient times, hostages were often given in settlement of blood feuds. In Germanic Europe in the Middle Ages, hostages came gradually to be used for other purposes, and eventually it became possible for a debtor to offer himself as a hostage or surety for his own obligation. On the Continent, this notion of self-​pledge was the source of a formality that became in time a general means of making promises binding. See Lon L. Fuller & Melvin Aron Eisenberg, Basic Contract Law 1079 (8th ed. 2006). 11.  522 F.2d 33 (8th Cir. 1975).

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gas-​distribution systems that Laclede chose to install in new residential developments. Under the master agreement, if Laclede decided to install a distribution system in a given development it could request Amoco to supply propane for the development. If Amoco decided to supply the propane it would bind itself to do so by signing a supplemental agreement in a prescribed form. Under the terms of each supplemental agreement Amoco was required to sell propane to Laclede for a given development at a defined price and to install storage and vaporization facilities at the development that were capable of delivering propane to the development. Laclede, for its part, agreed to install and operate distribution facilities that would connect the homes in the development to the outlet of Amoco’s header piping. However, Laclede did not promise to purchase propane from Amoco under either the master agreement or the supplemental agreements. In 1973 Amoco declined to deliver any more propane to Laclede under the supplemental agreements. Laclede sued for specific performance. Amoco defended on the ground that the supplemental agreements lacked mutuality because Laclede did not promise to purchase any propane. The court held for Laclede pursuant to “an intelligent, practical reading of the agreement.”12 Under the structure crafted by the parties, in order to obtain the benefit of a supplemental agreement Laclede had to construct distribution facilities for a given development that connected to the outlet of Amoco’s header piping. As a practical matter, once Laclede had invested in a distribution system that connected to an Amoco header outlet it could not switch to a different propane supplier without either substantially altering the supply route to its distribution system or making a substantial investment in new storage equipment. Accordingly, Laclede’s construction of distribution facilities for a given development would serve as a hostage to provide a high likelihood that it would continue to purchase propane for that development from Amoco. Another example of a hostage agreement—​this time involving a classical bargain rather than a structural agreement—​is provided by Lindner v. Mid-​Continent.13 Linder leased a service station for three years to Mid-Continent, who had an option to renew for two more years and could terminate on ten days’ notice. On the surface this seems to have been a foolish bargain by Lindner. However, the bargain is easy to explain through the hostage perspective. There was a strong prospect that as the lease continued Mid-​Continent would invest in improvements and develop locational goodwill. (The agreement was made when self-​service stations were uncommon, so customers often developed a personal relationship with the employees at a given service station.) These investments would serve as hostages to make it likely that Mid-​Continent would remain a tenant, because the investments would be sacrificed if Mid-​ Continent terminated the lease. Of course, Mid-​Continent could have decided at any time that it would make more profit by sacrificing its investments than by continuing to transact with Lindner. Giving a hostage provides some assurance but not a guarantee that a contracting party will continue to perform. Despite Mid-​Continent’s investment, therefore, Lindner was taking a risk that Mid-​Continent might terminate the lease (in fact, it did not: Lindner, not Mid-​Continent, tried to terminate), just as in Laclede Amoco was taking a risk that Laclede would terminate (in fact, it too did not: Amoco, not Laclede, tried to terminate). However, Lindner and Amoco deliberately took

12.  Id. at 38. 13.  252 S.W.2d 631 (Ark. 1952).

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these risks to advance their own interests by increasing the probability of exchange, and the resulting agreements should have been enforceable on that basis, and were indeed enforced. In the case of hostage agreements the parties increase the probability of exchange by creating a promissory structure under which a party will incur costs if he does not continue to exchange. In another type of structural agreement the parties increase the probability of exchange by creating a promissory structure that aligns the interests of the parties. Such agreements will be referred to in this book as interest-​aligning agreements. Interest-​aligning agreements often take the form of classical bargains, in which the parties’ interests are aligned by providing that they will share the revenues that the agreement produces. For example, in sharecropping contracts a farm owner and a tenant farmer agree to share the revenues the farm produces; in publishing contracts an author and a publisher agree to share the revenues that a book produces. The alignment of interests in these and other such contracts is not perfect. For example, when one party must incur post-​contract expenses to produce the revenue (the tenant farmer or the publisher), while the other may not (the farm owner or the author), the latter will prefer that the former’s expenses are maximized so as to maximize revenues while the former will prefer that expenses are incurred only to the point at which an extra dollar of expenses brings it an extra dollar of revenue. Similarly, one or both parties to such an agreement may have an incentive to cheat by concealing revenues or in other ways. However, that the parties’ interests are not perfectly aligned should not lead us to lose sight of the fact that they are generally aligned; that cheating and comparable misconduct will be at least partially deterred by internalized morality, concern with reputation, and contractual mechanisms such as monitoring and bonding; and that the parties know what they are doing. Sometimes an interest-​aligning agreement may be interpreted as either a structural agreement or a classical bargain. An example is presented by the famous case of Wood v. Lucy, Lady Duff-​Gordon.14 Lady Lucy was in the business of designing fashions and endorsing the designs of others. She and Wood made an agreement under which Wood had the exclusive right, subject to Lucy’s approval, to sell her designs, place her endorsements on others’ designs, and license others to market her designs. In return, Lucy would receive half of all profits and revenues derived from any such arrangements. Wood’s exclusive right was to last for one year, and thereafter to run from year to year unless terminated on ninety days’ notice. In violation of the agreement Lucy placed endorsements secretly and withheld from Wood his share of the resulting profits. When Wood learned of this he brought suit. Lucy defended on the ground that her promise was not enforceable because there was no bargain: although she had made a promise, Wood had not. The court, in an opinion by Judge Cardozo, held for Wood on the ground that Wood had made a promise—​an implied promise to use reasonable efforts on Lucy’s behalf. Perhaps Cardozo’s analysis was correct; essentially the same approach was later embodied in the Uniform Commercial Code.15 It must be wondered, however, why Wood made no express promise to make reasonable efforts on Lucy’s behalf and whether he would in fact have been willing to expressly make the promise that Cardozo inferred. It was easy for Cardozo to infer that promise without worrying about whether he was saddling Wood with an onerous and involuntary obligation, because Lucy was not claiming that Wood had failed to use reasonable efforts. 14.  118 N.E. 214 (N.Y. 1917). 15.  U.C.C. § 2-​306(2) provides that “A lawful agreement by either the seller or the buyer for exclusive dealing in the kind of goods concerned imposes unless otherwise agreed an obligation by the seller to use best efforts to supply the goods and by the buyer to use best efforts to promote their sale.”

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However, the case could have been dealt with in a simpler and more direct way by holding that Lucy’s promise was enforceable because it was part of a structural agreement: in all likelihood Lucy believed that she could forgo an express commitment from Wood because the contract was structured to align Wood’s interests with hers. In substance, Lucy gave Wood an option to place her endorsement and sell and license her designs. Wood had an incentive to exercise this option because that was the only way he could profit under the agreement. The resulting alignment of interests better explains Lucy’s motivation for making the agreement than does the implication of a promise by Wood, and provides a sounder basis for enforcement. Hostage and interest-​aligning agreements are only two examples of structural agreements. Other examples will be considered in subsequent chapters. The basic principle that should govern all types of structural agreements is the same:  the reasons that support the enforceability of bargains also support the enforceability of structural agreements.16 Just as bargained-​for exchanges between capable and fully informed actors are desirable, so too, and for the same reasons, are agreements that facilitate and promote the probability of bargained-​for exchanges. Bargained-​for exchanges are enforceable because they increase wealth by producing gains through trade and facilitate planning, surplus-enhancing reliance, coordination, efficient risk-​ shifting, and transactions over time. Structural agreements between capable and fully informed actors are designed to achieve the same ends by increasing the probability of a bargained-​for exchange and should be enforceable for the same reasons. Treating the promise in a structural agreement as unenforceable would frustrate these ends.

III .   T H R E E D O C T R I NA L EXCEPT I ONS T O   T H E B A R G A I N PR I NCI PL E The bargain principle is based in large part on the idea that voluntary, capable, and well-​ informed actors are the best judges of their own utility. Accordingly, where one or more of those conditions are absent or diluted the bargain principle loses some, most, or all of its vitality. So, for example, if a promisee makes false statements about the subject-​matter of a bargain he has wrongfully interfered with the promisor’s being fully informed, and the promisor has a defense of fraud. If the promisee wrongfully threatens the promisor in a way that leaves her with no good alternative he has improperly interfered with the promisor’s voluntariness, and the promisor has a defense of duress. If the promisor lacks capacity, that will also be a defense. These defenses are quality-​of-​consent defenses. They differ radically from defenses based on lack of consideration, because a promise that lacks consideration is unenforceable even if the bargaining process and the price were fair and the promisor was fully informed, capable, and acted voluntarily. This difference is exemplified by three doctrinal exceptions to the bargain principle under which certain kinds of bargains are unenforceable on the ground of lack of consideration even though the quality of consent is not at issue and the bargain is fair. These exceptions concern bargains in which a party only does or promises to do what he was already legally obliged to do, bargains in which a party only surrenders or forbears from asserting an invalid claim, and bargains that lack mutuality, or more particularly, involve illusory promises. 16.  See Melvin Aron Eisenberg, The Bargain Principle and Its Limits, 95 Harv. L. Rev. 741 (1982).

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A.  THE LEGAL-​DUTY RULE Suppose that Steady and Vary enter into a contract that they later agree to modify. Imagine two Patterns. In Pattern A, at Time 1 Steady and Vary enter into a contract under which Vary agrees to render performance P and Steady agrees to pay $20,000 for the performance. Then at Time 2 the parties enter into a modification under which Vary re-agrees to render performance P and Steady agrees to pay $23,000 instead of $20,000 for that performance. In Pattern B, at Time 1 Vary owes Steady $23,000. Then at Time 2 the parties enter into a modification under which Vary will pay Steady $20,000 and Steady will accept that amount in full satisfaction of Vary’s debt. Under a central doctrine of classical contract law, known as the legal-​duty rule, neither type of modification was enforceable against Steady even though the modification was a bargain. Under this rule if in Pattern A Vary renders performance he cannot collect the extra $3,000 that Steady promised to pay, on the ground that Vary only did what he was already legally obliged to do. Correspondingly, if in Pattern B Vary pays $20,000 pursuant to the modification, Steady can bring suit for $3,000 despite her promise not to do so. For the most part the two patterns raise the same issues, and for ease of exposition only Pattern A will be discussed in this section. (A word on nomenclature. Suppose Contractor agrees to build a two-​bedroom house for Homeowner for $350,000 and Homeowner and Contractor later agree that Contractor will build the house with three bedrooms and Homeowner will pay $425,000. The new contract is a modification of the old one in the normal sense of that term. In contract law, however, the term modification conventionally refers to contracts that fall within Patterns A or B. The second contract between Contractor and Homeowner doesn’t fall within these Patterns, because both Homeowner and Contractor agreed to render performances they were not legally obliged to render.) In the view of classical contract law the legal-​duty rule needed no moral or policy justification, because it was self-​evident on axiomate grounds. Frederick Pollock, for example, said that “[i]‌t seems obvious that an express promise by A to B to do something which B can already call on him to do can in contemplation of law produce no fresh advantage to B or detriment to A [and therefore will not be good consideration].”17 However, no legal rule can be justified on axiomatic grounds, least of all the legal-​duty rule, which violates the bargain principle. In modern times, therefore, attempts have been made to justify the legal-​duty rule on normative grounds. The conventional justification—​advanced, for example, in Restatement Second—​is based in large part on the premise that A probably agreed to the modification only because B put A  under duress,18 which is conventionally defined as an improper threat that leaves the threatened party with no real alternative.19 Of course, if a party obtains a modification by use of duress the contract should be and is unenforceable on that ground. But that rationale is not sufficient to justify the legal-​duty rule. Duress is always a defense to a contract, so a modification made under duress would be unenforceable even in the absence of the legal-​duty rule. Accordingly, a duress justification for the rule would need to rest on a second justification, also advanced in Restatement Second, that the proportion of modifications that are made under duress is so high, and a determination whether duress actually occurred is so difficult, that it 17.  Frederick Pollock, Principles of Contract:  A Treatise on the General Principles concerning the Validity of Agreements in the Law of England 181 (10th ed. 1936). 18.  See Restatement Second § 73 cmt. a. 19. Restatement Second § 175.

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would be a waste of judicial resources to determine whether any particular modification was made under duress.20 That seems highly unlikely. Often, perhaps typically, a party who seeks a modification makes a proposal or a request, rather than an improper threat. Furthermore, whether a modification was made under duress is usually not difficult to determine. The issues, therefore, are whether the promisee demanded rather than proposed or requested the modification, whether the demand was accomplished by a wrongful threat, and whether the promisor lacked practical freedom to reject the demand. Courts can easily deal with these issues—​indeed, they frequently do so.21 There is no evidence that an extremely high or even significant proportion of modifications are made under duress. In fact, the opposite is more likely to be true.22 In an elegant article on the legal-​duty rule, Aivazian, Penny, and Trebilock ask, “[W]‌hy would any party to a contract agree, by way of modification, to pay more or accept less than originally contracted for, without an appropriate quid pro quo (consideration), unless the other party had obtained bargaining power in the course of the relationship that he did not possess at the time of the contract formation and that he now seeks to exploit?”23 The tone of the question, and the article itself, suggest that the authors believe that usually there is no reason why a contracting party would so agree unless the other party had increased its bargaining power or exerted duress. In fact, however, there are strong reasons why a party might agree to a modification even without a contemporaneous quid pro quo, a significant shift in bargaining power after the contract was made, or duress. One reason centers on concepts of fair dealing. Most modifications probably are not motivated by B’s desire to grab more of the contract surplus because a shift in bargaining power allows him to do so. Instead, most modifications probably are motivated by the fact that when the time comes to perform the contract, the world looks significantly different than the parties expected it to look at the time they made the contract. This may occur either because the parties were under a misapprehension when the contract was made or because after the contract was made events unfolded in a significantly different way than the parties expected. In some cases, a misapprehension or unexpected circumstance could give a party a defense to performance under the doctrines governing mistake, impossibility, impracticability, or frustration. If one of those doctrines is applicable there will be no legal-​duty-​rule problem, because if B agrees to render a contracted-​for performance despite the fact that he has a defense to performance, he is agreeing to do something that he is not legally obliged to do. However, these doctrines have relatively narrow ambits, partly because if the doctrines were unduly encompassing, legitimate expectations might be improperly upset. Why then does a party like A agree to a modification even where B has no legal excuse for nonperformance of the original contract and does not exert duress on A? One reason is that A is willing to modify a contract with B because A believes that as a matter of fair dealing a readjustment should be made to reflect either the original purpose of the contractual enterprise or the equities as they now stand.24 A second, and probably more powerful and prevalent reason, is reciprocity or the hope 20.  Id. 21.  See, e.g., Angel v. Murray, 322 A.2d 630, 636–​37 (R.I. 1974). 22.  See B.J. Reiter, Courts, Consideration, and Common Sense, 27 U. Toronto L.J. 439, 466 (1977). 23.  Varouj A. Aivazian et al., The Law of Contract Modifications: The Uncertain Quest for a Bench Mark of Enforceability, 22 Osgoode Hall L.J. 173, 174 (1984). 24.  Cf. B.J. Reiter, supra note 22, at 465 (“[T]‌he basic assumption that a businessman will insist upon the strict fulfilment of his legal rights however dramatically circumstances have changed for the other party

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of reciprocity.25 A modification that appears to be one-​sided if examined in isolation may be reciprocal when account is taken of the dynamic ebb and flow of the contractual stream in which the modification is located. For example, A may agree to a modification that favors B to reciprocate for past modifications, of either the same or other contracts, that favored A. Or A may believe that her agreement to the modification will increase the probability that B will agree to modifications in A’s favor when A is in B’s shoes. It is true that under a regime without a legal-​duty rule a contracting party who agrees to a modification in the expectation of future reciprocity takes the chance that when her turn comes reciprocity will not be forthcoming. However, whether to take that chance should be the party’s call. The fair-​dealing and reciprocity reasons for agreeing to modifications reinforce each other. For example, if A agrees to a modification now because B agreed to a modification in the past, A’s action can be described as based on either fair dealing or reciprocity. Indeed, the idea of reciprocity itself is partly rooted in the concept of fair dealing, although it also has roots in self-​seeking. The important point is not whether A’s agreement to a modification is motivated by fair dealing or by self-​seeking. Rather, the important point is that in most modifications A is probably motivated by one or both of these factors rather than by an increase in B’s bargaining power or duress by B. Indeed, as an empirical matter, modifications normally appear to be viewed by firms as almost routine transactions. In 1988 Russell Weintraub sent a questionnaire to the general counsels of 182 corporations asking for their views on certain contracts issues.26 One of the questions was:  “If, because of a shift in market prices, one of your suppliers or customers requested a modification of the contracted-​for price, would your company always insist on compliance with the contract?” Ninety-​five percent of the respondents said their companies would not always insist on compliance with the contract. A follow-​up question asked those respondents to list the factors they deemed relevant in deciding whether to grant a request for a modification. In response, 80 percent said they would consider whether relations with the company making the request had been long and satisfactory, and 76 percent would take into account whether the request was reasonable under trade practice. A parallel question asked: “How frequently has your company asked relief from or modification of its contractual obligations?” Only 17 percent of the respondents said that their companies never made such requests. In contrast, 22 percent said that their companies made such requests an average of one to five times a year and 18 percent said that their companies made such requests even more frequently. In most cases, the respondents reported, the problem was amicably worked out either by a modification of the contract in question or by adjustments in future contracts. In short, from the perspective of consideration a bargain promise to perform an action that the promisor is under a duty to perform is normally no different than any other bargain promise and should be enforceable, subject to the usual free-​standing defenses such as duress. and that only pressure will force him to yield to suggestions that he ought to help absorb unforeseen and onerous changes suffered by his obligee, reflects an unrealistic and unduly pernicious view of modern business ethics.”). 25.  See id. at 465–​66; Mark B. Wessman, Retaining the Gatekeeper: Further Reflections on the Doctrine of Consideration, 29 Loy. L.A. L. Rev. 713, 720–​23 (1996). 26.  Russell J. Weintraub, A Survey of Contract Practice and Policy, 1992 Wis. L. Rev. 1, 1–​2. The survey had a response rate of 46 percent. Id. at 1, n.1.

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It has been suggested by Aivazian, Trebilock, and Penny that an enforceability regime would be based only on static considerations whereas the legal-​duty rule (or more precisely, a rule under which modifications were presumptively unenforceable) would reflect dynamic considerations. There is a tension in this area, they say, . . . between two competing sets of efficiency considerations . . . Static efficiency considerations will generally require that contract modifications be enforced on the grounds that the immediate contracting parties perceive mutual gains from recontracting that cannot, at the time modification is proposed, be realized as fully by any alternative strategy. On the other hand, dynamic efficiency considerations focus on the long-​run incentives for contracting parties at large. . . . In the modification context, these dynamic efficiency considerations adopt an ex ante perspective, rather than the ex post perspective implicit in the static efficiency considerations. Adopting the former perspective, rules that impose no constraints on recontracting may increase the over-​all costs of contracting by creating incentives for opportunistic behaviour in cases where “holdup” possibilities arise during contract performance. . . . Thus, what is in the best interests of two particular contracting parties ex post contract formation when a modification is proposed and what is in the interests ex ante of contracting parties generally in terms of legally ordained incentives and constraints that minimize the over-​all costs of contracting may lead to divergent policy perspectives.27

In fact, however, the matter is the other way around: it is the legal-​duty rule that is based on a static view of contract whereas a regime in which promises to perform a legal duty are enforceable is based upon and furthers a dynamic view of contract. The legal-​duty rule conceives of contracts as static transactions whose terms are fully determined at the moment of contract formation, whereas an enforceability regime conceives of contracts as evolving processes. The legal-​duty rule conceives of modifications as individual events that occur in isolation, whereas an enforceability regime recognizes that modifications are often ripples in an ongoing stream of reciprocity between contracting parties. The legal-​duty rule ignores the values of ongoing dynamic cooperation and accommodation between parties, whereas an enforceability regime takes account of those values.28 Accordingly, the legal-​duty rule inhibits both the dynamic evolution of contracts and dynamic reciprocity between contracting parties, whereas an enforceability regime efficiently encourages both dynamic reciprocity and dynamic evolution as circumstances unfold. An enforceability regime also makes the contracting process more efficient, because it allows parties to enter into contracts without negotiating every possible contingency on a static ex ante basis, since the parties know that misapprehensions or unexpected circumstances that do not rise to the level of a free-​standing defense can be dealt with by a modification.

1.  The Insignificant Hold-​U p Issue A reason often given for the legal-​duty rule is the fear of hold-​ups, that is, the fear that once A  has made a transaction-​specific investment in order to perform a contract with B, B will

27.  Aivazian, et al., supra note 3, at 175. 28.  See Hugh Collins, The Law of Contract 30 (2d ed. 1993).

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demand an increased price, backed by a threat to not perform, which if carried out would result in a sacrifice of A’s investment. The hold-​up problem has an especially strong grip on many law-​and-​economists, who often explain much of contracting as a way to deal with this problem. However, there is little or no evidence that hold-​ups are a frequent occurrence. On the contrary, it seems likely that the hold-​up problem has been blown way out of proportion. Omri Ben-​Shahar and James J.  White conducted an exhaustive empirical inquiry into this issue in the context of contracts between automobile manufacturers, known as Original Equipment Manufacturers, or OEMs, and their suppliers.29 This industry was particularly apt for studying the hold-​up problem because scholars who place great weight on the role of hold-​ups often cite a merger between GM and a major supplier, Fisher Body, which these scholars conclude was entered into to ensure that GM would not be subject to a hold-​up by Fisher. Ben-​Shahar and White concluded that in the automotive industry (and by implication, in every other industry) the hold-​up problem was a myth: If an OEM who abandons a supplier would suffer prohibitive costs in finding and qualifying a replacement, it may be conjectured that the original supplier has some economic power over the OEM for the contracted goods or services for some period—​perhaps even to the end of the model run of the vehicle in which the part or assembly is installed. This power, we should expect, would be at its height shortly after production commences when the supplier looks forward to five years of work and the competing bidders have turned to other things. In fact, this conjecture—​ that a . . . supplier can exert hold-​up power against an OEM after production begins—​is widely recognized as the benchmark example in economic theory for the general problem of contractual hold up. The standard account of the hold-​up problem was developed and generically illustrated in the context of the very same [OEM-​supplier] contracts. . . . It suggests that in the 1920s, Fisher Body . . . had a ten-​year requirements contract with General Motors. When GM’s requirements increased due to the greater demand for closed-​body cars, Fisher Body enjoyed an “intolerable” position to hold up General Motors and to refuse to make adjustments that were overall efficient, and was therefore acquired and vertically integrated into GM. It is not clear how much evidence substantiates the GM-​Fisher Body hold-​up story. . . . Our own findings suggest that, at least in the automotive business, this bargaining position-​ hold-​up account is misguided. . . . If the seller uses its power to engage in explicit hold up (for instance, “Give me an increase in price or I  won’t ship”) it knows it will lose in the long run. One OEM representative emphasized that the buyers “have long memories” and assured us that a successful threat by a seller would surely count against it in the award of new contracts. Even more threatening, the representative told us, is that a major disruption at one OEM is likely to become known to the others and to be considered by other OEMs when bids are being evaluated. Representatives of suppliers concurred with this skeptical view. If a supplier puts a gun to the head of the OEM, it would be “suicide,” they claim; the short-​term benefit from extracting some concession will be more than offset by the long-​term reputation sanction. The myth that suppliers can engage in hold up overlooks a very basic fact. Suppliers trying to hold up OEMs must threaten to halt production of a part that is necessary to keep the assembly line working. Such a threat, if carried out, would lead to enormous losses, constituting an

29.  James White & Omri Ben-​Shahar, Boilerplate and Economic Power in Auto Manufacturing Contracts, 104 Mich. L. Rev. 953 (2006).

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entire meltdown in the industry. The . . . supplier who commits such a hold up would therefore be subjected to potentially bankrupting damages, some of which can be setoff by the OEM against the supplier’s account as a matter of self-​help. Moreover, the OEM would likely be able to get injunctive relief, thus barring such a threat from being carried out in the first place. In other words, the hold-​up account assumes lethargic contractual obligation and legal enforcement, which is probably far from reality.30

Given the fairness and efficiency advantages of an enforceability regime it is to be expected that modern contract law would move toward that regime. That is just what has occurred. Although the legal-​duty rule still has some bite, even courts that believe themselves obliged to follow the rule as a matter of stare decisis characterize the rule as “technical,” regard it with “disfavor,” and find it to be supported by “neither rhyme nor reason.”31 The rule has been riddled with inconsistent exceptions,32 repudiated by judicial decisions in several states,33 and repudiated as to written modifications by statutes in several major jurisdictions.34 The UCC provides that a modification of a contract for the sale of goods is enforceable if it is made in good faith.35 More generally, Restatement Second Section 89 provides that a modification of a contract that has not been fully performed on either side is binding “if the modification is fair and equitable in view of circumstances not anticipated by the parties when the contract was made.”36 The principle embodied in Section 89, which has been widely followed,37 carves away most although not quite all of the remaining carcass of the legal-​duty rule.

30.  Id. at 974–​75. 31.  See, e.g., Chicago, Milwaukee, & St. Paul Ry. Co. v. Clark, 178 U.S. 353, 365 (1900); Brooks v. White, 43 Mass. (2 Met.) 283, 285–​86 (1841); Kellogg v. Richards, 14 Wend. 116, 119 (N.Y. Sup. Ct. 1835); Harper v. Graham, 20 Ohio 105, 115 (1851); Brown v. Kern, 57 P. 798, 799 (Wash. 1899); Herman v. Schlesinger, 90 N.W. 460, 466 (Wis. 1902). 32.  See, e.g., Morrison Flying Serv. v. Deming Nat’l Bank, 404 F.2d 856 (10th Cir. 1968) (the legal-​duty rule is inapplicable when the preexisting contractual duty is owed to a third person); Schwartzreich v. Bauman-​ Basch, Inc., 131 N.E. 887 (N.Y. 1921) (the rule is inapplicable when the prior contract is mutually rescinded at the time the new contract is made); Cohen v. Sabin, 307 A.2d 845 (Pa. 1973) (the payment of part of an unliquidated obligation that is admittedly due is consideration for the surrender of the balance of the claim); Angel v. Murray, 322 A.2d 630 (R.I. 1974) (the rule is inapplicable if the new contract is fair and equitable in light of circumstances not anticipated when the contract was made). 33.  See Dreyfus & Co. v. Roberts, 87 S.W. 641, 642 (Ark. 1905); Clayton v. Clark, 21 So. 565, 568 (Miss. 1897); Frye v. Hubbell, 68 A. 325, 328 (N.H. 1907). 34.  See Cal. Civ. Code §§ 1524 (1872) (“Part performance of an obligation, either before or after a breach thereof, when expressly accepted by the writing for that purpose, though without any new consideration, extinguishes the obligation”), 1541, 1697; Mich. Comp. Laws Ann. § 566.1 (West 2007); N.Y. Gen. Oblig. § 5–​1103 (1936​). 35.  See U.C.C. § 2-​209 & cmt. 1 (Am. Law Inst. & Unif. Law Comm’n 1977). 36.  Restatement Second § 89(a). 37.  See, e.g., United States v. Sears Roebuck & Co., 778 F.2d 810, 813 (D.C. Cir. 1985); Coyer v. Watt, 720 F.2d 626, 629 (10th Cir. 1983); Lowey v. Watt, 684 F.2d 957, 969–​70 (D.C. Cir. 1982); Univ. of the Virgin Islands v. Petersen-​Springer, 232 F. Supp. 2d 462, 470 (D.V.I. 2002); Acton v. Fullmer, 323 B.R. 287, 297 n.4 (Bank. Ct. D. Nev. 2005); Greenberg v. Mallick Mgmt., Inc., 527 N.E.2d 943, 949 (Ill. App. Ct. 1988); F.S. Credit Corp. v. Shear Elevator, Inc., 377 N.W.2d 227, 231 (Iowa 1985); Angel v. Murray, 322 A.2d 630, 636 (R.I. 1974).

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B.  SURRENDER OF OR FORBEARANCE TO ASSERT A CLAIM THAT TURNS OUT TO BE INVALID Suppose B has a claim against A; the parties make a bargain under which B agrees to surrender the claim, or forbear from asserting it, in exchange for a payment by A; and it turns out later that the claim was invalid. Under classical contract law such a bargain was deemed not to have consideration—​deemed unenforceable—​unless the claim was asserted in subjective good faith and had a significant degree of objective merit. For example, Restatement First Section 76 imposed a conjunctive test under which “The surrender of, or forbearance to assert an invalid claim or defense by one who has not an honest and reasonable belief in its possible validity” was not consideration.38 Requiring a claimant to have an honest belief in the validity of his claim is appropriate, because if the claimant does not have such a belief his assertion of the claim amounts to extortion. However, this requirement, properly understood, does not raise an issue of consideration, since by hypothesis the parties have made a bargain. Rather, it raises an issue of unconscionability. (See Chapter 7.) Moreover, a requirement that the claim have some degree of merit is inappropriate as a test of either consideration or unconscionability. It is inappropriate as a test of consideration, because a bargain for the surrender of or forbearance to assert a claim is as much a bargain as any other. It is inappropriate as a test of unconscionability because if the claimholder has a good-​faith belief that his claim is valid, normally it is not unconscionable for him to assert the claim. Modern contract law is evolving in just this direction. In contrast to the conjunctive test of Restatement First Section 76, which required both an honest and a reasonable belief in the possible validity of the claim, Restatement Second Section 74 uses a disjunctive test, under which forbearance to assert or the surrender of a claim is consideration even though the claim later proves to be invalid if “the claim or defense is in fact doubtful because of uncertainty as to the facts or the law, or . . . the forbearing or surrendering party believes that the claim or defense may be fairly determined to be valid.”39

38.  Restatement (First) of Contracts § 76(b) (Am. Law Inst. 1932)  (emphasis added). Generally speaking, over time the courts gradually whittled down the degree of merit a claim must have to constitute consideration. One court stated: . . . [T]‌he claim must have some foundation. . . . As to this . . . consideration we find the courts using varying language. The claim cannot be “utterly baseless.” It has been said that it must have a “tenable ground” or a “reasonable, tenable ground.” It must be based on a “colorable right,” or on some “legal foundation.” It must have at least an appearance of right sufficient to raise a “possible doubt” in favor of the party asserting it. We think we had best leave definitions alone, confident that, as applied to each individual case, the facts will make the thing apparent. But if we should make further effort to distinguish we would say that if the claimant, in good faith, makes a mountain out of a mole hill the claim is “doubtful.” But if there is no discernible mole hill in the beginning, then the claim has no substance.

Duncan v. Black, 324 S.W.2d 483, 486–​87 (Mo. Ct. App. 1959) (emphasis in original). See also Springstead v. Nees, 109 N.Y.S. 148 (App. Div. 1908) (claim must be at least doubtful or colorable). 39.  Restatement Second § 74 (emphasis added). See also, e.g., Tower Inv’rs v. 111 E. Chestnut Consultants, Inc., 864 N.E.2d 927, 938 (Ill. App. Ct. 2007) (“Where a party’s compromise of its claim is made in good faith, even if that claim is ultimately shown to be invalid, the forbearance is nevertheless sufficient consideration to support a contract.”); Dyer v. Nat’l By-​Prods., Inc., 380 N.W.2d 732 (Iowa 1986); Denburg v. Parker Chapin Flattau & Klimpl, 624 N.E.2d 995, 1000 (N.Y. 1993) (“To constitute sufficient consideration . . . a party need only have a good-​faith belief in the merit of its position. That the party’s view of the law might ultimately prove meritless does not undermine the validity of the agreement (Restatement

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However, although the rule embodied in Restatement Second is a major improvement over the rule embodied in Restatement First, even Restatement Second does not adopt the best possible rule, because it continues to frame the issue in consideration terms. The real issue in this area, as in the area of modifications, is unconscionability. A rule that all promises of a designated class lack consideration renders all bargains in the class unenforceable even if they are not unfair or otherwise unconscionable. In contrast, unconscionability must be applied case by case, requires a review of all the facts and circumstances, and renders only unfair contracts unenforceable. Consideration is too blunt an instrument to deal with fairness issues because it screens out from judicial review the circumstances of a particular transaction and knocks out both fair and unfair bargains.

C.  THE DOCTRINE OF MUTUALITY AND THE ILLUSORY-​PROMISE RULE A third classical c​ ontract ​law exception to the bargain principle is the doctrine of mutuality. Under this doctrine unless both parties to a contract are bound neither is bound. This doctrine needs more qualification than it sometimes receives. One important qualification is that the doctrine is inapplicable to unilateral contracts. In a bilateral contract the parties exchange a promise for a promise. For example, B promises to mow A’s lawn in exchange for A’s promise to pay B $100. In a unilateral contract the parties exchange a promise for an act. For example, A tells B, “I will pay you $100 to mow my lawn. I don’t want your promise to mow the lawn—​you have made those promises before, and you did not keep them. If you actually mow the lawn, I will pay you $100; if you don’t, I won’t.” In such cases, normally the promisee, B, is never bound. He is not bound to do anything before he does the act, and normally he is not bound to do anything after he does the act. Nevertheless, if B does the act, or even begins to do the act, the mutuality doctrine does not apply and A is bound. A second major qualification is that the mutuality doctrine is inapplicable to bargains in which both parties have made real promises but one party is not bound by his promise under a legal rule other than the mutuality doctrine. For example, suppose that A fraudulently induces B to agree to buy Blackacre. Because A has acted fraudulently he cannot enforce B’s promise. Nevertheless, if B chooses to enforce the contract A is bound notwithstanding the lack of mutuality.40 Once the necessary qualifications to the mutuality doctrine have been made, that doctrine is for most practical purposes a nom de plume for the illusory-​promise rule. This rule is stated as follows in Restatement Second Section 77: “A promise or apparent promise is not consideration if by its terms the promisor or purported promisor reserves a choice of alternative performances unless . . . each of the alternative performances would have been consideration if it alone had been bargained for. . . .” The rule is exemplified by Illustrations 1 and 2 to that Section: 1. A offers to deliver to B at $2 a bushel as many bushels of wheat, not exceeding 5,000, as B may choose to order within the next thirty days. B accepts, agreeing to buy at that price as much as

[Second] of Contracts § 74, comment b). Indeed, if the rule were otherwise, there would be little incentive to enter into a compromise.”). 40.  See 3 Williston on Contracts § 7.13 (Richard A. Lord ed., 4th ed. 1992).

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The Enforceability of Promises he shall order from A within that time. B’s acceptance involves no promise by him, and is not consideration. 2. A promises B to act as B’s agent for three years from a future date on certain terms; B agrees that A may so act, but reserves the power to terminate the agreement at any time. B’s agreement is not consideration, since it involves no promise by him.

As these Illustrations suggest, the illusory-​promise rule applies to apparent bargains in which one party, A, makes a real promise while the other party, B, uses an expression that seems to be a real promise but when closely analyzed is only the illusion of a promise. Where the rule is applicable B is not bound because he did not make a real promise. A is also not bound, despite the fact that she did make a real promise, on the ground that B made only an illusory promise in return. Illustrations 1 and 2 exemplify the two basic scenarios in which the illusory-​promise rule is applied. In the first scenario, exemplified in Illustration 1, B does not make a real promise because he only agrees to do whatever he may choose to do. In the second scenario, exemplified in Illustration 2, B does not make a real promise because he reserves the right to terminate at any time any obligation that he might otherwise be under. The illusory-​promise rule is unjustified for two reasons. First, transactions involving illusory promises are usually structural agreements, and the real promise should be enforceable on that ground. Call the person who makes the real promise A, and the person who makes the illusory promise B.  In illusory-​promise cases, such as Illustrations 1 and 2, A does not make a promise to B for other-​regarding reasons, as a gift. She makes it for self-​regarding reasons. Specifically, A makes the promise to advance her own interests by increasing the probability of exchange. Choosing to exchange with one trading partner rather than another is not cost-​free. A  makes her promise because she believes that B’s incentives to exchange with her rather than with others would be insufficient unless the promise is made. In effect there is a disparity of information and incentives between A and B. A has a degree of confidence in the attractiveness of her performance that she believes B does not share. To increase the probability of exchange with B, A makes a promise that is intended to change B’s incentives to exchange with A by giving A a chance to show that her performance is attractive, either by sampling A’s commodity or by giving more serious consideration to purchasing A’s commodity than he would otherwise be likely to do. The second reason the illusory-​promise rule is unsound is that in most of its applications the rule violates the bargain principle. It is true that in illusory-​promise cases there is no bilateral bargain, because there is no exchange of promises. Properly understood, however, most of these cases do involve a unilateral bargain, because A exchanges her promise for B’s bargained-​for act—​the act of giving A a chance. The value of a chance to increase the probability of exchange is widely evidenced. Book clubs give potential customers free books now for the opportunity to sell them books later; developers give free vacations for the opportunity to present a sales pitch; retailers offer free prizes in promotional contests to induce customers to shop; direct sellers pay substantial amounts for mailing lists. In most illusory-​promise transactions, A makes the promise to get B to give her a chance. If B gives A the chance, A gets just what she bargained for. B’s illusory promise may not conclude a bargain, but B’s act of giving A  a bargained-​for chance does.

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Transactions involving illusory promises are also illuminated by the option perspective. One teaching of financial economics is that economic structures that are not options in form are often options in substance. So in the case of transactions involving illusory promises, in substance the party who makes the real promise gives the party who makes the illusory promise an option to acquire a given commodity at a defined price. For example, recall that in Illustration 1 to Restatement Second Section 77, A offered to deliver to B, at $2 a bushel, as many bushels of wheat, not exceeding 5,000, as B might choose to order within the next thirty days, and that B accepted, “agreeing to buy at that price as much as he shall order from A within that time.” In substance, therefore, A gave B a thirty-​day option to buy up to 5,000 bushels of wheat at $2 a bushel. Similarly, in Illustration 2, A promised B that he would act as B’s agent for three years on designated terms, and B accepted, reserving the power to terminate at any time. In substance, therefore, A gave B an option on A’s services as an agent for up to three years on designated terms. If in such cases B had paid A a small (but more than nominal) amount of cash for the option, there would be no question that the option would be enforceable. Similarly, there would also be no question of enforceability if in Illustration 1, B had promised to order at least ten bushels of wheat or if in Illustration 2, B had promised to employ A as an agent for at least ten days. B’s act of giving A a chance that will increase the probability of exchange will often be far more valuable to A than a small amount of cash or a small initial commitment. Whether the chance is objectively valuable is not relevant; what is relevant is that A thought the chance was valuable to him and therefore bargained for it. By making the bargain A revealed that the value she put on the chance equaled or exceeded her cost for making the promise. If B gave A the chance there is a bargain, and since the parties made a bargain there is consideration. The option perspective also brings into focus a doctrinal reason for the enforcement of transactions involving illusory promises. As discussed in Chapter 2, for the most part Restatement Second Section 87 rejects the doctrine of nominal consideration.41 However, Subsection 87(a) (1), and many cases, makes an exception for options. Under the rule of that Subsection nominal consideration—​the form of a bargain—​normally does suffice to make an option binding: “An offer is binding as an option contract if it . . . is in writing and signed by the offeror, recites a purported consideration for the making of the offer, and proposes an exchange on fair terms within a reasonable time. . . .”42 In real-​world terms, the illusory-​promise rule is inconsistent with Subsection 87(1)(a), because in practice almost every illusory-​promise transaction is an option that falls within the rule. There is always a recital of “a purported consideration,” namely, the illusory promise, and typically the real promise is in writing and proposes an exchange on fair terms within a reasonable time. Accordingly, the doctrine that transactions involving illusory promises are unenforceable normally violates not only the general bargain principle but the specific rule embodied in Subsection 87(1)(a). The mutuality doctrine and the illusory-​promise rule are creatures of classical contract law. Although the doctrine and the rule are still on the books, under modern contract law they are being whittled away. To begin with, the rule is inapplicable if the promisee gives any bargained-​ for promise at all, no matter how minimal. For example, in Lindner v. Mid-​Continent Petroleum

41.  See Restatement Second § 71, cmt. b, illus. 4 & 5. 42.  Id. § 87(1)(a).

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Corp.,43 Lindner gave Mid-​Continent a three-​year lease on a filling station with an option to renew for two additional years—​in all, a five-​year commitment. In exchange, Mid-​Continent agreed to lease the filling station, but with the right to terminate its obligations at any time on ten days’ notice—​in all, a ten-​day commitment. Subsequently, Lindner sought to cancel the lease on the ground that it lacked mutuality. The court held for Mid-​Continent: [T]‌he requirement of mutuality does not mean that the promisor’s obligation must be exactly coextensive with that of the promisee. It is enough that the duty unconditionally undertaken by each party be regarded by the law as a sufficient consideration for the other’s promise. . . . This is not an option by which the lessee may terminate the lease at pleasure and without notice; at the very least the lessee bound itself to pay rent for ten days.44

In Lindner, ten days were enough to constitute consideration. In Gurfein v. Werbelovsky,45 a nanosecond sufficed. Seller and Buyer contracted for the sale of five cases of plate glass “to be shipped within 3 months from date.”46 The contract provided that Buyer had the option to cancel the order before shipment. During the three months following the date on which the contract was made, Buyer repeatedly requested performance, but Seller never shipped. Eventually, Buyer brought suit for breach of contract. Seller argued that the agreement lacked mutuality by virtue of Buyer’s right to cancel the order before shipment. The court disagreed, on the ground that Seller had “one clear opportunity to enforce the entire contract” by shipping as soon as he received the order.47 “This is all that is necessary to constitute a legal consideration and to bring the contract into existence. If the defendant voluntarily limited his absolute opportunity of enforcing the contract to the shortest possible time, the contract may have been improvident, but it was not void for want of consideration.”48 Cases such as Lindner and Gurfein undermine rather than explicitly repudiate the illusory-​ promise rule. In Harris v. Time, Inc.,49 the court took the final step and explicitly held that the provision of a bargained-​for chance is consideration. Joshua Gnaizda received a letter from Time, Inc. The front of the envelope included a window that revealed a picture of a calculator watch, and the statement, “JOSHUA A. GNAIZDA, I’LL GIVE YOU THIS VERSATILE NEW CALCULATOR WATCH FREE Just for Opening this Envelope Before Feb. 15, 1985.”50 When the envelope was opened, but not until then, an additional clause in the letter was revealed: “AND MAILING THIS CERTIFICATE [to buy a subscription to Fortune Magazine] TODAY!”51

43.  252 S.W.2d 631 (Ark. 1952). 44.  Id. at 632; see also, e.g., Hancock Bank & Trust Co. v. Shell Oil Co., 309 N.E.2d 482 (Mass. 1974) (a gas-​station lease was not invalid for lack of mutuality where the lessor was obligated for thirty years and the lessee obligated for only ninety days). 45.  118 A. 32 (Conn. 1922). 46.  Id. 47.  Id. at 33. 48.  Id. 49.  237 Cal. Rptr. 584 (Ct. App. 1987). 50.  Id. at 586. 51.  Id.

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Joshua, having opened the envelope, demanded the calculator watch even without mailing the certificate, based on the promise in the window. Time refused. Joshua then brought a class action against Time for breach of contract. Time argued that there was no contract because the mere act of opening the envelope was valueless and therefore did not constitute consideration. The court rejected this argument on the ground that Time had bargained for Joshua’s opening the envelope—​that is, giving Time a chance: [T]‌he act at issue here—​the opening of the envelope, with consequent exposure to Time’s sales pitch—​may have been relatively insignificant to the plaintiffs, but it was of great value to Time. At a time when our homes are bombarded daily by direct mail advertisements and solicitations, the name of the game for the advertiser or solicitor is to get the recipient to open the envelope. . . . From Time’s perspective, the opening of the envelope was “valuable consideration” in every sense of that phrase.52

In short, although courts continue to give at least lip service to the mutuality and illusory-​ promise doctrines, and some courts still apply them, the trend of modern contract law is in the other direction. As stated in Helle v. Landmark, Inc.,53 “ ‘The modern decisional tendency is against lending the aid of courts to defeat contracts on technical grounds of want of mutuality.’ . . . As a contract defense, the mutuality doctrine has become a faltering rampart to which a litigant retreats at his own peril.”

52.  Id. at 587–​88. However, the court dismissed Joshua’s suit on the ground that Joshua could not maintain the suit as a class action, and his individual claim was barred by the principle of de minimis. See id. at 589–​90. 53.  472 N.E.2d 765, 776 (Ohio Ct. App. 1984).

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The Theory of Efficient Breach The the ory of ef f icient breach as serts that b reach of c on tr act

is efficient, and therefore desirable, if the promisor’s gain from breach, after payment of the promisee’s expectation damages, will exceed the promisee’s loss. The theory was developed by law-​and-​economists. It has significant currency among contracts scholars and is sometimes referred to by courts. Richard Posner gives the best-​known exposition of the theory in his book, Economic Analysis of Law.1 This exposition has changed somewhat over the various editions of that book. Here is the core of the exposition in the first edition: [I]‌n some cases a party [to a contract] would be tempted to breach the contract simply because his profit from breach would exceed his expected profit from completion of the contract. If his profit from breach would also exceed the expected profit to the other party from completion of the contract, and if damages are limited to loss of expected profit, there will be an incentive to commit a breach. There should be.2

Although the theory of efficient breach is usually presented in very generalized terms, the theory can be properly understood and evaluated only in the context of paradigm cases to which it may be applied. Two paradigm cases are especially salient: the Overbidder Paradigm and the Loss Paradigm.

I .   T H E O V E R B I DDER PA R A DI GM In the Overbidder Paradigm a seller who has contracted to sell a commodity breaches the contract in order to resell the commodity to a third party—​the overbidder—​who comes along later 1.  See Richard A. Posner, Economic Analysis of Law (1st ed. 1972). The theory was originated by Robert Birmingham in his article Breach of Contract, Damage Measures, and Economic Efficiency, 24 Rutgers L. Rev. 273, 284 (1970) (“Repudiation of obligations should be encouraged where the promisor is able to profit from his default after placing his promisee in as good a position as he would have occupied had performance been rendered”). 2.  Posner, supra note 1, at 57 (emphasis added).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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and offers a higher price. The Overbidder Paradigm is the poster child of the theory of efficient breach. Proponents of the theory, including Posner, typically include an illustration that exemplifies this Paradigm as part of their argument. Here is the centerpiece illustration of the theory in the first edition of Posner’s Economic Analysis of Law: I sign a contract to deliver 100,000 custom-​ground widgets at $.10 apiece to A, for use in his boiler factory. After I have delivered 10,000, B comes to me, explains that he desperately needs 25,000 custom-​ground widgets at once since otherwise he will be forced to close his pianola factory at great cost, and offers me $.15 apiece for 25,000 widgets. I sell him the widgets and as a result do not complete timely delivery to A, who sustains $1000 in damages from my breach. Having obtained an additional profit of $1250 on the sale to B, I am better off even after reimbursing A for his loss. Society is also better off. Since B was willing to pay me $.15 per widget, it must mean that each widget was worth at least $.15 to him. But it was worth only $.14 to A—​$.10, what he paid, plus $.04 ($1000 divided by 25,000), his expected profit. Thus the breach resulted in a transfer of the 25,000 widgets from a lower valued to a higher valued use.3

Proponents of the theory of efficient breach seldom articulate the manner in which the theory would affect the rules that govern contract-​law remedies. The theory does not put the expectation measure into question; on the contrary, the theory takes expectation damages as a given. However, there are two other remedies that would be impacted by the theory: specific performance, because if the buyer is awarded specific performance the seller will be unable to breach, and disgorgement of the seller’s gain from breach, because if the buyer is awarded disgorgement the seller cannot profit from breach. For ease of exposition, in this Section the theory of efficient breach is contrasted only with a rule under which specific performance is freely awarded. A  comparable analysis applies to disgorgement.

II .   T H E FA C T U A L PR EDI CAT ES O F   T H E   T HEORY The theory of efficient breach rests on two factual predicates: the expectation measure makes the promisee indifferent between performance and damages, and the promisor knows the value that the promisee places on the promisor’s performance and therefore can make the calculation that the theory requires. Posner states those predicates as follows: “[I]‌f the profit that [the breaching party] would make from a breach . . . is greater than his profit from completion, then completion will involve a loss to him. If that loss is greater than the gain to the other party from completion, it is clear that commission of the breach would be value maximizing and should be encouraged. And because the victim of the breach is made whole for his loss, he is indifferent between performance and damages.”4 Both predicates are incorrect. 3.  Posner, supra note 1, at 57. 4.  Id.

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The first predicate, that expectation damages makes a victim of breach indifferent between performance and breach, is incorrect because, as shown in Chapter 13, the expectation measure systematically fails to achieve that objective. To take just one example, if the promisor performs the promisee gets all the gains to be derived by him under the contract, but if the promissee breaches the promisor gets those gains minus his attorneys’ fees. The second predicate, that at the time of the perform-​or-​breach decision the promisor knows what the promisee’s gain from performance of the contract would be, is also incorrect for the following reasons: As applied to the Overbidder Paradigm the theory of efficient breach normally has no bearing on contracts for the sale of homogenous commodities that are in abundant supply, because in the case of such commodities the amount by which the overbidder’s price exceeds the contract price normally is also the measure of the buyer’s damages, so that the seller will not profit by a sale to an overbidder. For example, suppose that on January 2, Seller agrees to sell to Buyer 1,000 bushels of No. 2 Hard Red Wheat (“No. 2 wheat”) for $4.00/​bushel, delivery on March 1. On February 15, Seller sets aside 1,000 bushels and identifies them to Buyer’s contract. On March 1, the market price of No. 2 wheat for immediate delivery is $4.50/​bushel. That day, Overbidder offers to buy 1,000 bushels of No. 2 wheat from Seller, and Seller sells to Overbidder the 1,000 bushels she had identified to Buyer’s contract. Because No. 2 wheat is a homogeneous commodity Overbidder will pay Seller the market price of $4.50/​bushel for the wheat, a total of $500 more than Buyer’s contract price. But correspondingly, Buyer will be entitled to damages of $500, based on the difference between the $4.50 market price and $4.00 contract price. As a result, Seller’s gain from breach will equal Buyer’s damages. At least in principle, therefore, Seller will have no incentive to breach—​and indeed, under the theory of efficient breach she should not breach, because her gain will not exceed Buyer’s loss. (Of course, experience suggests that sellers of homogeneous commodities sometimes do breach. Such breaches, however, are not motivated by efficiency and are not explained by the theory of efficient breach. Instead, they are typically motivated by the limits of expectation damages, which, as the seller knows, dampen a buyer’s incentives to bring suit.) Accordingly, if the theory of efficient breach was valid, in the Overbidder Paradigm the theory normally would apply only to contracts for differentiated commodities. In the case of such contracts, however, a seller will have only very limited information about the buyer’s potential gains from performance. At the time the contract is made the seller will know that the buyer values the commodity at more than the contract price; otherwise, he would not agree to pay the contract price. Often, the seller will also know the general nature of the buyer’s intended use for the commodity. However, rarely if ever will a buyer quantify for the seller the gain he expects to make from a contract, because the price of a differentiated commodity is usually bargained out within a range and knowledge of the buyer’s expected gain would give the seller a lever to extract a price higher in the range. Furthermore, the seller’s lack of information concerning the buyer’s expected gain tends to intensify as time passes. After the contract is made the value of the differentiated commodity to the buyer may increase because the buyer either creates or discovers a more valuable use for the commodity than he had when the contract was made; may make surplus-​enhancing investments, such as advertising, that will increase his gain if the seller performs; or both. This informational flaw in the theory of efficient breach is thrown into sharp relief by a competing theory, which may be called the theory of efficient termination. This theory simply holds that it is often more efficient to terminate a contract than to perform it. As stated by Paul Mahoney, “Efficient termination is possible when the amount of money, Y, that [the promisor]

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would pay to escape performance at a particular point in time is greater than the amount of money, Z, that the promisee . . . would accept in lieu of performance. In that situation there is a potential gain of Y–​Z from terminating the contract.”5 The difference between the two theories is as follows. At the risk of oversimplification a contract normally can be terminated nonjudicially in two very different ways—​mutually, by rescission, or unilaterally, by breach. The theory of efficient breach contemplates only unilateral termination, by breach, and incorrectly assumes that a seller will have full information about the value the buyer places on performance. In contrast, the theory of efficient termination contemplates termination by mutual consent, because it is only through mutual consent that the parties can establish the amount the promisee will accept in lieu of performance.6 This theory therefore contemplates termination through a process that involves a much richer mix of information than the theory of efficient breach. The theory of efficient termination also has a moral dimension, because it requires the promisor to accord to the promisee the respect that a promisee is due, by seeking to obtain the promisee’s consent to nonperformance. In short, as compared with the theory of efficient breach the theory of efficient termination contemplates that termination of a contract will occur through a process that is voluntary on both sides, involves a much richer mix of information, and helps ensure that promisees are treated with due respect. This point is nicely illustrated by Walgreen Co. v. Sara Creek Property Co.,7 decided by Judge Posner. Walgreen operated a pharmacy in a mall owned by Sara Creek. Under Walgreen’s lease Sara Creek promised not to rent space in the mall to anyone else who wanted to operate a pharmacy. Well into the term of the lease Sara Creek informed Walgreen that it intended to buy out the anchor tenant in the mall and install a Phar-​Mor discount store in its place. The Phar-​Mor store would include a pharmacy the same size as Walgreen’s store and would be within 200 feet of Walgreen’s store. Moreover, Phar-​Mor probably would sell pharmaceuticals at lower prices than Walgreen. Walgreen sought an injunction against the new lease. (Injunctive relief is often equivalent to specific performance, particularly where, as in Walgreen, the promise is to not do a certain act.) Judge Posner began by pointing out that issuing an injunction could entail transaction costs: if the injunction was granted, Sara Creek and Walgreen might enter into costly negotiations looking toward Walgreen’s surrender of its right to enforce the injunction in exchange for a payment equal to Walgreen’s prospective lost profits from Phar-​Mor’s competition. Judge Posner nevertheless granted the injunction, on the ground that post-​injunction negotiation would produce better information concerning Walgreen’s expected loss than would the adjudicative process: The benefits for substituting an injunction for damages are twofold. First, it shifts the burden of determining the cost of the defendant’s conduct from the court to the parties. If it is true that Walgreen’s damages are smaller than the gain to Sara Creek from allowing a second pharmacy into

5.  Paul G. Mahoney, Contract Remedies and Option Pricing, 24 J. Legal Stud. 139, 141 (1995). 6.  As Sidney DeLong has put it, “[T]‌he promisee’s consent to a reallocation of performance resources is the only certain proof of the efficiency” of termination. Sidney W. DeLong, The Efficiency of a Disgorgement as a Remedy for Breach of Contract, 22 Ind. L. Rev. 737, 754 (1989). 7.  966 F.2d 273 (7th Cir. 1992).

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the shopping mall, then there must be a price for dissolving the injunction that will make both parties better off. . . . [A]‌premise of our free-​market system, and the lesson of experience here and abroad as well, is that prices and costs are more accurately determined by the market than by government. A battle of experts is a less reliable method of determining the actual cost to Walgreen of facing new competition than negotiations between Walgreen and Sara Creek over the price at which Walgreen would feel adequately compensated for having to face that competition.8

It is true that requiring the promisor to perform her contract with the promisee, rather than allowing her to render the performance to an overbidder, may sometimes do more than produce information. If the promisor’s gain from dealing with the overbidder exceeds the promisee’s loss from breach, requiring the promisor to perform will also give the promisee a lever to extract part of the promissor’s gain. Indeed, this could have been the effect of the decree in Walgreen. But surely Judge Posner recognized that possibility. Presumably, his decision to uphold the injunction anyway was based on one or more of three reasons: (1) Over the long run (and perhaps even in Walgreen), the social gain from forcing information to the surface exceeds the possible social loss from giving the promisee undue leverage. (2) Cases in which it is apparent that the promisee seeks specific performance for the purpose of opportunistically appropriating part of the promisor’s gain can be singled out for special treatment. (3) In any event, in the typical overbidder case the promisor, by making her contract, has bargained away the potential for gains from overbidders. The promisor therefore cannot justly complain if she must give up to the promisee part of such a gain. In short, the theory of efficient breach is based on the predicates that expectation damages makes a promisee indifferent between performance and damages and that at the time of breach the promisor knows what value the promisee places on the promisor’s performance. In the context of the Overbidder Paradigm both predicates are incorrect. As discussed further in Chapter 19 a buyer will never be indifferent between performance and damages, because of the cost of litigation, the way in which market-​price damages are calculated, the way in which the certainty rule is administered, the principle of Hadley v.  Baxendale, the limitations on prejudgment interest, and the risk of promisor insolvency after performance was due. Similarly, at the time of the perform-​or-​breach decision the seller will seldom know whether the overbidder values the commodity more highly than does the buyer. Instead, she will know only that the overbidder is willing to pay more now than the buyer agreed to pay at an earlier time. This reality is masked by the form of the illustrations used by proponents of the theory of efficient breach. In real life a perform-​or-​breach decision must be made by a seller who will have highly imperfect information about both the buyer’s value and the overbidder’s value. In contrast, proponents of the theory support it with illustrations that feature an omniscient narrator who looks down from academic heaven, has perfect information, and knows everyone’s value. So, for example, the omniscient narrator of Posner’s custom-​ground-​widgets illustration—​that is, Posner—​knows to the penny how much profit the buyer would make if the seller performed rather than breached.9 Accordingly, in the context of the Overbidder Paradigm the theory of efficient breach cannot be sustained because the predicates on which it rests are incorrect. 8.  Walgreen, 966 F.2d at 275–​76. 9.  See Posner, supra note 1, at 57.

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Furthermore, even assuming, counterfactually, that the predicates of the theory were correct, in the context of the Overbidder Paradigm the theory not only lacks an efficiency justification but would promote inefficiency. In the context of the Overbidder Paradigm the standard efficiency justification for the theory is that if a seller’s gain on sale to an overbidder exceeds the buyer’s loss, breach is an instrument for transferring a commodity to a higher-​valued use. This justification, however, cannot be sustained. Consider first a resale to an overbidder in a world in which there are no transaction costs. In such a world the higher-​valued-​use rationale would clearly be incorrect. Under the Coase Theorem, in the absence of transaction costs the efficient outcome will occur without regard to the content of legal rules, and commodities will always flow to higher-​valued uses. Therefore, if a third party values the commodity more than the buyer he will end up with the commodity even under a regime that freely grants specific performance to buyers. Indeed, as Daniel Farber dramatically puts it, in a world without transaction costs if a third party has a higher-​valued use for a commodity than the buyer he will end up with the commodity even if breach is a capital offense and sellers therefore never breach: [Assume that] B (a buyer) and S (a seller) contract for the production of unique goods. Before the delivery date, X (a third party) offers to buy the goods from S. Assum[e]‌zero transaction costs. . . . To take the most extreme case, suppose that breach of contract were a capital offense. S would not be willing to breach even if X offered to pay far more than the goods are worth to B. X would still ultimately receive the goods, however, as X would either pay B to assign him the contract or buy the goods from B after delivery. Absent transaction costs, no assignment of liability will prevent the parties from achieving this distribution of goods.10

Commodities will also normally flow to higher-​valued uses even in a world with transaction costs. In such a world if a third party values the commodity more than the buyer, and knows the buyer’s identity, he will purchase from the buyer either an assignment of the contract or the contracted-​for commodity itself. If the third party does not know the buyer’s identity a rational seller will either negotiate with the buyer for a release from the contract or sell the third party’s identity to the buyer or the buyer’s identity to the third party. In the third edition of Economic Analysis of Law Posner changed the rhetoric of his efficiency justification from higher-​valued use to Pareto superiority: Having obtained an additional profit of $1,250 on the sale [of the widgets to B, the seller is] better off even after reimbursing A [the buyer] for his loss, and B is no worse off. The breach is Pareto superior, assuming that A is fully compensated and no one else is hurt by the breach.11

In the context of the Overbidder Paradigm, however, the Pareto-​superiority justification is no more persuasive than—​and indeed just a variant of—​the higher-​valued-​use justification. Posner’s conclusion explicitly turns on the assumption of full compensation. That assumption does not hold if compensation means the amount required to make a promisee indifferent

10.  Daniel A. Farber, Reassessing the Economic Efficiency of Compensatory Damages for Breach of Contract, 66 Va. L. Rev. 1443, 1449–​50 (1980). 11.  Richard A. Posner, Economic Analysis of Law 107 (3d ed. 1986) (emphasis added).

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between performance and breach, because expectation damages do not make a promisee indifferent in this manner. Because the assumption does not hold, the buyer will be worse off from breach. Indeed, breach would not be Pareto superior even if Posner’s full-​compensation assumption did hold. Even with full compensation for his losses the buyer is worse off in the breach state than in the performance state because in the breach state he loses the possibility of himself reselling the widgets to the third party for a higher price. Furthermore, there is little or no reason to believe that an overbidder usually has a higher-​ valued use for the commodity than does the buyer. It is true that the amount the overbidder offers to pay now is, by hypothesis, greater than the amount that the buyer agreed to pay earlier. However, this tells us little or nothing about the parties’ respective valuations at the time of breach. Accordingly, even in a world without transaction costs the theory of efficient breach cannot be justified in the context of the Overbidder Paradigm on the ground that breach will move commodities to higher-​valued uses. Posner implicitly recognized this problem, and fell back on an argument that the transaction costs of moving commodities to higher-​valued uses will be less under an efficient-​breach regime than under a regime that freely allows specific performance. Choices among competing legal regimes that purport to be based on differences in transaction costs usually rest on very shaky foundations. Often transaction costs are trivial, and as Paul Mahoney observes, “[t]‌he transaction costs approach yields . . . no persuasive conclusion when transaction costs are low (unless we can measure them with extreme precision).”12 Moreover, even where transaction costs are more than trivial it is frequently impossible to reliably identify and quantify all the transaction costs of alternative legal regimes. Ian Macneil points out that “it is extremely easy to introduce selected transaction costs to show that the model ‘proves’ what the modeler wants it to prove, while ignoring countless other transaction costs of equal or greater pertinence in the real world—​costs yielding different conclusions.”13 Therefore, transaction-​ costs arguments often adorn rather than control a preference for one legal regime over another. In short, transaction-​costs arguments are often or even usually suspect. In the context of the Overbidder Paradigm, the transaction-​costs argument is worse than suspect; it is almost certainly wrong. Posner’s argument is that if an overbidder has a higher-​valued use for the commodity than the buyer, and the law allowed the buyer to obtain specific performance, then there would be a transaction cost for negotiating a sale of the buyer’s rights to the overbidder. However, a seller’s breach and resale also entail transaction costs—​and heavy ones. To begin with, a sale of a contracted-​for commodity by a seller to an overbidder will involve the same kinds of negotiation costs as a sale of the commodity to the original buyer.14 Furthermore, if the seller breaches she must pay damages to the buyer. Because the buyer’s damages will normally be both uncertain and contested, determining damages will normally require costly negotiation and costly legal fees. As Ian Macneil and Daniel Friedmann have shown, it is impossible to definitively establish whether the transaction costs of moving commodities to higher-​valued uses would be greater under an efficient-​breach regime or a regime in which specific performance

12.  Mahoney, supra note 5, at 142. 13.  Ian R. Macneil, Efficient Breach of Contract: Circles in the Sky, 68 Va. L. Rev. 947, 961 (1982). 14.  See James Gordley, A Perennial Misstep: From Cajetan to Fuller and Perdue to “Efficient Breach,” Issues in Legal Scholarship, Article 4, at 12–​14 (2001).

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was routinely available.15 Nevertheless, the transaction costs of breach are likely to be significantly greater, on average, than the transaction costs of performance. Presumably under the impetus of critiques such as those of Friedmann and Macneil, in later editions of Economic Analysis of Law, Posner reworked his transaction-​costs passage to concede that breach, as well as performance, entailed transaction costs: True, if I  [the seller] had refused to sell to B [the overbidder], he could have gone to A  [the buyer] and negotiated an assignment to him of part of A’s contract with me. But this would have introduced an additional step, with additional transaction costs—​and high ones, because it would be a bilateral-​monopoly negotiation. On the other hand, litigation costs would be reduced.16

The grudging nature of this concession is evidenced by the defects in the argument and the imbalanced nature of the rhetoric. For example, Posner characterizes the costs of negotiation between the seller and the buyer as high, but says nothing about the magnitude of litigation costs in an efficient-​breach regime. Similarly, Posner persists in failing to point out that in an efficient-​ breach regime there will be negotiation costs between the seller and the overbidder. Accordingly, in the context of the Overbidder Paradigm there is no convincing efficiency justification for the theory of efficient breach. But there is more. If the theory were widely followed it would lead to three kinds of inefficiency: it would inefficiently remake contracts, it would inefficiently provide disincentives for planning, and it would decrease the efficiency of the contracting system.

A.  INEFFICIENTLY REMAKING CONTRACTS One way to measure the efficiency of a contract rule is to ask what rule well-​informed contracting parties would be likely to agree upon if bargaining were cost-​free. This is not the only way to measure the efficiency of a contract rule, nor would this question necessarily be easy to answer. Nevertheless, parties normally are the best judges of their own utility, so that if well-​informed contracting parties would normally favor a given rule, that rule is probably the most efficient and should be implied in the contract where the contract does not explicitly speak to the issue. There is an easy way to determine whether the theory of efficient breach corresponds to the rule that contracting parties in the Overbidder Paradigm would normally agree upon if they addressed the issue at the time the contract is made. Suppose that Seller and Buyer have negotiated a contract under which Seller agrees to sell a differentiated commodity to Buyer—​for example, a home to live in, custom-​made widgets that Buyer will use as an input in production, or a used die press that Buyer will employ as a factor of production. As the parties are about to sign a written contract, Seller says to Buyer, “In all honesty, I should tell you that although I have no present intention to breach this contract, neither do I have a present intention to perform. If a better offer comes along I will take it and pay you expectation damages. In fact, I will begin

15.  See Daniel Friedmann, The Efficient Breach Fallacy, 18 J. Legal Stud. 1 (1989); Macneil, supra note 13, at 950–​51. 16.  Richard A. Posner, Economic Analysis of Law 119 (4th ed. 1992).

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actively looking for a better offer right after we sign this contract. Let’s insert a provision that recognizes I will do just that.” What would be Buyer’s likely response? Under the theory of efficient breach, Buyer would respond, “Of course, I expect no more.” However, experience strongly suggests that in real life most buyers would be shocked by such a statement and would either walk away, insist on an explicit contractual provision stating that the seller has a present intent to perform and that any profit on breach and resale will go to buyer, or demand a payment, in the form of a lower price, for the seller’s right to resell. Buyers will react this way because, as Ian Ayres and Gregory Klass conclude, normally one point of a bargain promise is to convince the promisee that the promisor has an intent to perform: [T]‌here are good reasons why promisors want to implicitly say that they intend to perform simpliciter, rather than that they intend to perform or pay damages, or that they do not intend not to perform, or nothing at all about their intent. Promisees care about promisor intent because they care deeply about whether or not the promisor will perform. If a promisee thinks that the promisor does not intend to perform and is seriously considering the option of paying damages instead, he is much less likely to rely on her promise, be it by entering into a binding contract or by otherwise ordering his behavior as if performance were going to happen. But the whole point of promising is to convince others to rely on one’s future actions. Thus promisors have a natural incentive to communicate with their promisees an intent to perform. This fact explains why most promises represent an intent to perform and why the law should adopt a default interpretation that recognizes this fact.17

To put this differently, as stated in the official Comment to the Uniform Commercial Code, “the essential purpose of a contract between commercial [actors] is actual performance and they do not bargain merely for a promise, or for a promise plus the right to win a lawsuit.”18 Accordingly, “a continuing sense of reliance and security that the promised performance will be forthcoming when due . . . is an important feature of the bargain.”19 Why is it that a promisee bargains for actual performance, not for a promise plus the right to win a lawsuit if the promise is not kept, and promisors implicitly represent that they intend to perform? One reason is that expectation damages will almost never make a promisee indifferent between performance and damages, so that promisees will almost never bargain for a promise plus the right to win a lawsuit if the promise is not kept.20 But there is an even stronger reason. When buyers contract for the purchase of a differentiated commodity they are typically motivated in significant part by a desire to coordinate and stabilize planning, production, and distribution by locking in the supply and prices of inputs, factors of production, and factors of distribution. This lock-​in allows buyers to confidently engage in long-​term production projects and to make expenditures on surplus-​enhancing reliance, such as advertising or the acquisition of control over complementary inputs. Indeed, even where the allocation of the risk of price changes is an important purpose of a contract the buyer’s desire to acquire control over inputs 17.  Ian Ayres & Gregory Klass, Promissory Fraud without Breach, 2004 Wisc. L. Rev. 507, 513–​14. 18.  U.C.C. § 2-​609 cmt. 1 (Am. Law Inst. & Unif. Law Comm’n 1977). 19.  Id. 20. See supra Chapter 5.

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and factors of production and distribution is often equally or more critical. An example is a contract for just-​in-​time delivery of manufacturing components, where delays in delivery would often be much more adverse to the buyer than increased prices. Furthermore, even if, counterfactually, expectation damages made a promisee indifferent between performance and damages if damages are awarded, because of the vagaries of litigation a promisee cannot be sure whether damages will be awarded. Buyers do not contract for the expensive, emotionally draining, hassling game of chance that litigation constitutes. Instead, buyers contract for goods or services to be delivered when they are supposed to be delivered, and they want to know that those goods or services will be delivered, and delivered on time. That is why, as the UCC Comments state, a continuing sense of reliance and security that the promised performance will be forthcoming when due is an important feature of a bargain. Survey evidence also supports the conclusion that a promisee normally expects that a promisor is committed to performance. David Baumer and Patricia Marschall surveyed 119 North Carolina corporations about their attitudes toward willful breach. One question was, “If a trading partner deliberately breaches a contract because a better deal can be had elsewhere, is such behavior unethical?” One hundred and five respondents said yes and eighty-​six said that they would always or almost always withhold future business from a party who had willfully breached.21 In her study of the cotton industry Lisa Bernstein reported that “As one transactor explained, ‘[y]‌ou want performance, not payment for nonperformance. [Payment] is not fulfilling your deal.’ And as another transactor put it, ‘you do not just breach and pay. This is not done.’ ”22 These responses make sense only if buyers understand a contract of sale to be a commitment by the seller to perform, not a commitment to perform or pay damages at the seller’s option. Not only does a buyer expect a seller to perform, a buyer pays an implicit premium for his seller’s implied promise not to seek or sell to an overbidder. At the time a contract for the sale of a differentiated commodity is made the buyer and the seller both know that an overbid might be made later. Because the buyer and the seller know this, the buyer will need to pay the seller an implicit premium for taking the risk of forgoing an overbid. The amount of this premium will be the expected value of an overbid based on a probability-​weighted average of potential overbid prices. Having been paid this premium the seller should not be allowed to abrogate the insurance she has sold to the buyer. To put it differently, making a forward contract for the sale of a differentiated commodity reflects a decision by the seller, embodied in a binding commitment, that her best bet is to take the buyer’s present offer rather than to wait for a possible higher offer in the future. If the seller keeps searching for or accepts a higher offer, she is reneging on her bet. The point that a contract for the sale of differentiated commodities implicitly prohibits a seller from searching for an overbidder or accepting an overbid is forcefully made in Greer Properties, Inc. v. LaSalle National Bank,23 a Seventh Circuit opinion that Judge Posner joined. In February 1987 Sellers contracted to sell a parcel of real estate to Searle Chemicals for approximately $1,100,000. Searle had the right to terminate the contract if the soil was contaminated

21.  David Baumer & Patricia Marschall, Willful Breach of Contract for the Sale of Goods: Can the Bane of Business Be an Economic Bonanza?, 65 Temp. L. Rev. 159, 165 (1992). 22.  Lisa Bernstein, Private Commercial Law in the Cotton Industry: Creating Cooperation through Rules, Norms, and Institutions, 99 Mich. L. Rev. 1724, 1755 (2001). 23.  874 F.2d 457 (7th Cir. 1989).

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by environmental waste. The deal fell through because an environmental consulting firm that Searle hired reported that the site was contaminated and that cleanup would cost more than $500,000. Sellers then contracted to sell the parcel to Greer Properties for $1,250,000. Under this contract Sellers were required to remove the environmental contamination at their own expense but were allowed to terminate the contract if the cost of the cleanup became economically impracticable. Sellers then retained a soil consultant, who estimated that the cleanup would cost only $100,000–​200,000. At that point, Sellers went back to Searle and entered into a new round of negotiations. A  purchase price of $1,455,000 was proposed in these negotiations and embodied in a draft contract prepared by Searle. Sellers then terminated the contract with Greer, purportedly under the cleanup provision, but obviously to enable a resale to Searle. Greer brought an action for specific performance and damages. The district court held for Sellers on the ground that, under the cleanup provision, upon receipt of the soil consultant’s study Sellers had broad discretion to terminate the contracts. The Seventh Circuit reversed on the ground that by making the contract with Greer Sellers had given up their right to look for a better price: Under Illinois law, “every contract implies good faith and fair dealing between the parties to it.” . . . This implied obligation of good faith and fair dealing in the performance of contracts acts as a limit on the discretion possessed by the parties. . . . With this limitation on the discretion of the Sellers in mind, their decision to terminate the contract must be analyzed to determine if they acted in good faith. If the Sellers terminated the contract to obtain a better price from Searle, their action would have been in bad faith. When the Sellers entered the contract with Greer and Greer agreed to pay them a specific price for the property, the Sellers gave up their opportunity to shop around for a better price. By using the termination clause to recapture that opportunity, the Sellers would have acted in bad faith.24

In short, in a contract for the sale of a differentiated commodity the buyer agrees to purchase the commodity and to take the negative risk that prices may fall. The seller agrees to deliver the commodity and to forgo the positive risk that an overbidder may come along. Whether that positive risk materializes before or after delivery is not relevant. Just as the buyer assumes the negative risk that the value of the commodity may fall before or after delivery, so the seller forgoes the positive risk that the value of the commodity may rise before or after delivery, that an overbidder may be found, or both. Accordingly, the theory of efficient breach, which approves and indeed encourages searching for and accepting overbids, would inefficiently remake contracts. Of course, there may be cases where at the time the contract is made the buyer is willing to allow the seller to resell to an overbidder and keep the gain in exchange for a reduction in the buyer’s price. These cases are easy to deal with. If a seller wants the right to resell in exchange for a reduction in the buyer’s price, and the buyer finds this deal attractive, the parties can use explicit contract language that gives the seller that right and waives any right the buyer would otherwise have to seek specific performance.

24.  Id. at 460–​61 (emphasis added).

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B.  INEFFICIENTLY PROVIDING DISINCENTIVES FOR PLANNING The theory of efficient breach also provides inefficient disincentives for planning. There are two basic reasons that an overbidder may be willing to pay more than the market price. First, in the case of relatively differentiated commodities market price is not a real price, but a construct based on extrapolations from comparable transactions (see Chapter 19), and the overbidder may be willing to pay a price above that construct. In that case the theory has no positive efficiency implication: there is no reason to believe that the overbidder values the commodity more highly than the buyer, because the buyer may also have been willing to pay a price above the construct. Second, the commodity may have a strategic value to the overbidder that is higher than its value to anyone else, and the constructed market price may not impound that strategic value. However, if the overbidder had a special strategic need for the commodity when he made his overbid, he probably had a prospect of the strategic need when the original contract was made. The question then arises: Why didn’t the overbidder make a contract with the seller at that time? The answer to this question is likely to involve issues of foresight and investment. For example, it may be that the commodity takes time to produce, the buyer foresaw that it would have a future need for the commodity, and the buyer was willing to invest in a contract for future production of the commodity at a time when the overbidder lacked the foresight to do so, was unwilling to make the investment, or both. Or it may be that the commodity essentially consists of productive capacity, the buyer foresaw a future need for that capacity, and the buyer was willing to invest in a contract to lock up that capacity at a time when the overbidder lacked the foresight to do so, was unwilling to make the investment, or both. Providing the seller with an incentive to sell the commodity to the overbidder would deny the buyer the benefit of his foresight and investment. Efficient incentives should be just the other way around. The law should reward the ant, not the grasshopper. It is the buyer who has earned the opportunity to acquire the commodity by having foresight and investing when the overbidder was either not smart enough or willing enough to do so. Accordingly, the theory of efficient breach would also have efficiency costs in such cases, because it would diminish the incentives for developing foresight and investing. As stated by Doug Laycock: It is common ground that one economic function of contract is to allocate risk. One of the risks that is allocated by contracts is the risk of doing without in time of shortage. Those who plan ahead when shortage is merely a risk should reap the benefits when shortage comes to pass. . . . [B]‌reaching sellers should not be able to reallocate the risk after the fact by . . . keeping the specific thing and paying damages that cannot be used to replace it.25

C.  WEAKENING THE CONTRACTING SYSTEM There is a third way in which the theory of efficient breach, if widely followed, would reduce efficiency. The theory is based on a static and short-​run approach to the issue of breach,

25.  Douglas Laycock, The Death of the Irreparable Injury Rule 253–​54 (1991).

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because it addresses only the efficiency of performing or breaching an individual contract. In contrast, a dynamic long-​run approach to the issue of breach addresses the efficiency of the contracting system as a whole. From that perspective, the theory of efficient breach is inefficient because if widely followed it would diminish the efficiency of that system. The efficiency of the contracting system does not rest, as the theory of efficient breach implies, solely on legal remedies. Rather, the efficiency of the contracting system rests on a tripod whose legs are legal remedies, reputational effects, and the internalization of social norms—​in particular, the moral norm of promise-​keeping. These three legs are mutually supportive. Legal rules rest in significant part on social norms, reputational effects rest in significant part on social norms, and social norms are reinforced by legal rules and supported by reputational effects. All three of these legs are necessary to ensure the reliability of the contracting system. Legal rules are not alone sufficient because dispute-​settlement under law is expensive and risky. The moral norm of promise-​keeping is not alone sufficient because not all actors fully internalize moral norms. Reputational effects are not alone sufficient because reputations are fully effective only if third parties have reliable information concerning a promisor’s history—​and this kind of information is hard to come by, both because many breaches do not become widely known and because promisors will often claim that they had a valid excuse for not performing. Because all three legs are necessary to support the efficiency of the contracting system, any­ thing that weakens one leg will seriously threaten the efficiency of the system. The theory of efficient breach, if widely adopted, would do precisely that, because the effect of the theory would be to remove the moral force of promising in a bargain context. The moral meaning of a promise is to commit yourself to take a given action in the future even if when the action is due to be taken, all things considered you no longer wish to take it. The theory of efficient breach turns this upside down. Under that theory if you don’t wish to take a promised action when it is due because your gain from breach would exceed the promisee’s loss from breach, you shouldn’t keep the promise. Indeed, removing the moral force of promises in a bargain context is not only an effect of the theory of efficient breach, it is a purpose of the theory. Robert Birmingham, who originated the theory, was explicit on this point: [P]‌rotection of the expectation interest . . . encourages optimal reallocation of factors of production and goods without causing material instability of expectations. More rigorous adherence to this standard would promote proper functioning of the market mechanism. Encouragement of repudiation where profitable through elimination of moral content from the contract promise might also be socially desirable.26

To the same effect, recall Posner’s conclusion that if the seller’s gain from breach will exceed the buyer’s loss, then “if damages are limited to loss of expected profit, there will be an incentive to commit breach. There should be.”27 Given the dilution or elimination of the moral force of bargain promises under the theory of efficient breach, the theory, if widely adopted, would decrease the efficiency of the contracting system in three ways. First, it would increase the need to resort to litigation, which is very expensive, as opposed to achieving performance through the internalization of moral norms, which

26. Birmingham, supra note 1, at 292 (emphasis added). 27. Posner, supra note 1, at 57 (emphasis added).

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is very inexpensive. Second, it would lead contracting parties to make greater use of costly noncontractual measures, such as security deposits, to ensure performance. Third, it would diminish the force of reputational constraints, because such constraints rest in significant part on moral norms. To summarize, in the context of the Overbidder Paradigm the theory of efficient breach is inefficient in three major respects. First, the theory would inefficiently remake the parties’ contract by converting a contract to sell a commodity and to not search for or sell to an overbidder into a contract that allowed and indeed encouraged sellers to search for and sell to overbidders. Second, the theory would provide a disincentive to plan and invest by encouraging sellers to transfer commodities away from buyers who have planned and invested to overbidders who have done neither. Third, the theory would reduce the efficiency of the contracting system by seriously weakening one of the three legs upon which that efficiency rests. In light of the failure of the predicates of the theory of efficient breach in the context of the Overbidder Paradigm, and the inefficiency to which the theory would lead if it was widely followed, at least in that context the theory is invalid.

I I I .   T H E L O S S PA R A DI GM Consider now the theory of efficient breach in the context of a second paradigm, the Loss Paradigm. In this Paradigm a seller who has contracted to render a performance to a buyer breaches the contract because she determines that the cost of the performance would exceed the value that the buyer places on performance. It is not clear how often this kind of case occurs. To begin with, most contracts, even for production, are short term, and costs of performance are unlikely to drastically increase over the short term. If a contract is long term there is a greater likelihood that the seller’s cost of performance will come to exceed the buyer’s value. However, many long-​term contracts are not likely susceptible to a situation in which the seller’s cost of performance would significantly outweigh the value the buyer places on the contact, since many such contracts either are cost-​plus, include escalator provisions, or are pegged to market price because the main purpose of the contract is to ensure supply, not to shift the risk of price changes, and as a result a rise in the cost of performing the contract will be compensated by a rise in prices. Moreover, if the seller’s costs of performance increase usually the buyer’s value will increase in tandem, because usually the costs of a given seller for producing a certain kind of commodity are likely to be pretty much the same as the costs of other sellers for producing that commodity. Therefore, if the seller’s costs increase so will those of all other sellers. But if the costs of all sellers increase the price of the commodity will increase, and if the price of the commodity increases so will the buyer’s value. For example, suppose that Seller S agrees to build a house for buyer B. If S’s costs increase so in all likelihood will those of all other homebuilders, and therefore the price of houses. If the price of houses increases, B’s value for the house will also increase. Therefore, in the normal case an increase in a seller’s cost of production will not cause that cost to exceed the buyer’s value, because the buyer’s value will rise with the seller’s costs. Undoubtedly it sometimes happens that a seller’s cost of performance does exceed the value that the buyer places on the performance. The question then is whether the theory of efficient

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breach has a bite in this context. In the context of the Overbidder Paradigm there is no reason to believe there will be an efficiency gain from breach; on the contrary, in that context the theory, if widely followed, would lead to an efficiency loss. In contrast, an efficiency gain might be possible in the Loss Paradigm, because if the seller’s cost of performance exceeds the value the buyer places on performance the performance may involve a social loss. Accordingly, in a hypothetical world in which buyers were indifferent between performance and breach with damages, and there was perfect cost-​free information, so that the seller would always know the value that the buyer placed on the contracted-​for commodity, it might well be undesirable to freely award specific performance in cases that fall within the Loss Paradigm. In the real world, however, specific performance normally should not be withheld simply because a case falls within the Loss Paradigm. To begin with, even if the seller’s cost of performance exceeds the buyer’s value for the performance, because of the limits of expectation damages the buyer may be worse off from breach and damages than from performance. For example, assume that a seller agrees to manufacture a machine for a buyer for $50,000. At the time the contract is made the buyer values the machine at $53,000 and the seller’s anticipated cost of production is $47,000. Suppose that prior to the time performance is due the seller’s costs rise to $57,000 and the buyer’s value for the machine rises to $55,000. Although the buyer values the machine at less than the cost to produce it, if the contract is performed the buyer will have a surplus of $5,000 ($55,000 value to the buyer minus the $50,000 contract price). In contrast, if the contract is breached the buyer’s gain from damages will be much less than $5,000, after deducting, from his recovery attorney’s fees, the unreimbursed time value of money, and the lost gains not awarded because of the certainty principle, the principle of Hadley v. Baxendale, and the like. Next, in practice the seller usually will not know the value that the buyer places on the seller’s performance. Accordingly, the seller can rarely make an informed decision on whether her cost of performance will exceed the value that the buyer places on the performance. Indeed, a seller will normally not even be interested in whether her cost of performance exceeds the buyer’s value. A seller’s only interest is whether her cost of performance exceeds the contract price; if the seller’s cost of performance is less than the contract price normally she will not breach the contract even if her cost of performance exceeds the buyer’s value. Accordingly, in the Loss Paradigm, as in the Overbidder Paradigm, breach by the seller normally will not be more efficient than performance, and if a seller concludes that her cost of performance will exceed the value of the performance to the buyer, normally her appropriate course of action is not to breach but to negotiate a termination of the contract.28 There is, however, a class of cases that fall within the Loss Paradigm in which specific performance should not be awarded. These are cases in which the seller’s cost of performance is so far in excess of the likely value of the performance to the buyer that it is clear that the buyer does not really want performance. Instead, the buyer only wants a decree of specific performance that 28.  In a somewhat analogous case, a study of the contract practices of nineteen English engineering manufacturers found that when buyers wished to cancel, typically the sellers would release the buyers in exchange for reimbursement of their costs plus a modest profit component. H. Beale & T. Dugdale, Contracts between Businessmen: Planning and the Use of Contractual Remedies, 2 Brit J.L. & Soc’y 45, 53 (1975). It seems likely that buyers would take a comparable approach to sellers who wished to cancel. See Stewart Macaulay, Non-​contractual Relations in Business: A Preliminary Study, 28 Am. Soc. Rev. 55, 61 (1963).

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he can opportunistically use as a lever to capture a portion of that excess. This class of cases is discussed in Chapter 24.

I V.   C O N C LUS I ON The theory of efficient breach cannot be sustained because it completely fails in one of its two most significant applications, the Overbidder Paradigm, and normally fails in its other significant application, the Loss Paradigm. Courts have correctly given the theory little attention, and should continue to do so.

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The Unconscionability Principle I .   I N T R O DUCT I ON One of the most important developments in modern contract law is the emergence of the principle that an unconscionable contract is unenforceable.1 Traces of that principle can be found in some older cases,2 and equity courts have long reviewed contracts for fairness when equitable relief was sought,3 but unconscionability was not a recognized principle under classical contract law. On the contrary, that school of thought embraced the bargain principle, under which bargains are enforceable according to their terms without regard to fairness. Exceptions were made for bargains involving fraud, duress, incapacity, and certain kinds of mistakes. However, those exceptions were narrowly bounded and rested in part on the ground that a contract requires consent and a contract that involves one of these exceptions lacks true consent. Beginning in the 1960s the position of contract law changed radically following the promulgation of Uniform Commercial Code Section 2-​302, which provides that “If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.” Section 2-​302 is limited to contracts for the sale of goods, but the principle it embodies has been embraced in other uniform acts,4 in the Restatement Second of Contracts,5 in the Restatement Second of Property,6 and in the case 1.  For ease of exposition the term contract will be used to include contract terms. 2.  See, e.g., Campbell Soup Co. v. Wentz, 172 F.2d 80 (3d Cir. 1948); McClure v. Raben, 33 N.E. 275 (Ind. 1893); Richey v. Richey, 179 N.W. 830 (Iowa 1920); Baltimore Humane Impartial Soc’y v. Pierce, 60 A. 277 (Md. 1905); Mersereau v. Simon, 8 N.Y.S.2d 534 (App. Div. 1938). 3.  See, e.g., Loeb v. Wilson, 61 Cal. Rptr. 377, 388–​89 (Ct. App. 1967); Schlegel v. Moorhead, 553 P.2d 1009, 1013 (Mont. 1976); McKinnon v. Benedict, 157 N.W.2d 665, 670–​71 (Wis. 1968). 4.  See Unif. Consumer Credit Code § 5.108 (1974); Unif. Consumer Sales Practices Act § 4 (1971); Unif. Residential Landlord and Tenant Act § 1.303(a)(1) (1972). 5.  Restatement (Second) of Contracts § 208 (Am. Law Inst. 1981) [hereinafter Restatement Second]. 6.  Restatement (Second) of Property § 5.6 (Am. Law Inst. 1977).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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law.7 The precise meaning and reach of the unconscionability principle, however, have still not been fully established. Early on, an effort was made to reconcile the unconscionability principle with the bargain principle.8 A  step in this direction was a distinction, initially drawn by Arthur Leff between procedural and substantive unconscionability.9 Essentially, Leff defined procedural unconscionability as unfairness in the bargaining process and substantive unconscionability as unfairness in the bargaining outcome even if unaccompanied by unfairness in the bargaining process.10 Procedural unconscionability is easy to reconcile with the bargain principle. That principle rests in significant part on the predicate that private actors are the best judges of their own utility. This predicate, however, only justifies the application of the bargain principle where both parties act voluntarily and are fully informed and the bargaining process is fair. Therefore, where the bargaining process is unconscionable—​unfair—​a major predicate of the bargain principle is not satisfied and the principle cannot properly be applied to enforce the resulting contract. It may seem difficult, however, to reconcile the bargain principle with a regime that allows judicial review of contracts just for substantive unconscionability, because under such a regime a contract could be found unconscionable even if the bargaining process was fair. Accordingly, the effect, if not the purpose, of the distinction between procedural and substantive unconscionability is to suggest that substantive unconscionability alone should be insufficient to render a contract unconscionable. The distinction between procedural and substantive unconscionability is often useful, because it can help drive to the surface what if anything is unconscionable about a promisee’s behav­ior. However, the distinction is also misleading, because often the bargaining process is unfair only if the resulting bargain is unfair. For example, there is nothing wrong about contracting with a person who is in distress. What is wrong is to contract with such a person in a way that exploits his situation by extracting an unfair price. Finally, the procedural/​substantive distinction does not address the crucial question:  How should it be determined whether a contract is procedurally or substantively unconscionable? The answer to that question is that two elements should figure in the determination of unconscionability. The first element is the nature of the market on which the contract was made. Contracts made on competitive markets will seldom be unconscionable, but when contracts are made off-​ market, or on markets that are not competitive, the stage is set for unconscionability. The second element is whether the contract involved moral fault. Regardless of the nature of the market on which a contract is made a contract will not be unconscionable without that element. 7.  Beginning with Williams v.  Walker-​Thomas Furniture Co., 350 F.2d 445, 448-​449 (D.C. Cir. 1965), which concerned the sale of a stereo for $714 to a buyer who was on welfare and had seven children, under a contract which provided that all payments by the buyer to the seller would be credited pro rata on all items she had purchased from the seller and not yet paid off, rather than credited in the order of purchase. 8.  See Melvin Aron Eisenberg, The Bargain Principle and Its Limits, 95 Harv. L. Rev. 741 (1982). 9.  Arthur Allen Leff, Unconscionability and the Code—​Emperor’s New Clause, 115 U. Pa. L. Rev. 485, 487 (1967). 10.  Id.

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I I .   T H E R O L E OF   M A R KET S In this chapter, the term competitive market will be used to mean a market that is either perfectly or reasonably competitive. A  perfectly competitive market has four characteristics:  a homogeneous commodity; perfect, cost-​free, and readily available information; productive resources that are sufficiently mobile that pricing decisions readily influence their allocation; and participants whose market share is so small that none can affect the terms on which the commodity is sold, so that each participant takes those terms as given.11 A reasonably competitive market is a market whose characteristics approximate those of a perfectly competitive market. There are relatively few perfectly competitive markets, but many reasonably competitive ones. Now assume a perfectly competitive market and let the parties to a bargain be S, a promisor-​ seller, and B, a promisee-​buyer. Given the conditions of a perfect market the contract price in such a market will be the market price. This price will rarely if ever be unconscionable, since in our society a perfectly competitive market is generally regarded as a fair mechanism to set prices: (1) By normal measures of value the market price will be equal to B’s benefit. (2) S would not voluntarily have agreed to transfer the contracted-​for commodity to B at any lower price, because if B had not agreed to pay the market price S could have sold the commodity to another buyer at that price. (3) Because cost-​free information is readily available the parties will almost always be fully informed. (4) The contract price will normally equal the seller’s marginal cost plus a normal profit. Furthermore, the price in a perfectly competitive market will normally be efficient. Given that pricing decisions on such a market readily influence the allocation of productive resources, a prospect of above-​normal profits will provide an incentive to increase supply, leading to an increase in capacity and a new and lower equilibrium price that yields only normal profits. In contrast, to the extent the price is kept from rising to the equilibrium or market price there is an incentive to decrease capacity by reallocating resources to other uses, and not replacing depleted resources. Moreover, if perfect competition prevails demand for the commodity would exceed supply at any price less than the market price. Some mechanism other than price would therefore be required for rationing supply among competing buyers, and supply would not be allocated to its highest-​valued use as measured by the amounts that competing buyers are willing to pay—​assuming, at least, that income is either distributed optimally or can best be redistributed by techniques other than price, such as taxation. These effects are scaled down where a market is only reasonably competitive. For example, exploitation is then a possibility, because commodities sold on a market that is only reasonably competitive usually are not homogenous and information is not cost-​free. In general, however, transactions on reasonably competitive markets are unlikely to be unconscionable for many of the same reasons that transactions on a perfectly competitive market will rarely if ever be unconscionable. It is important, however, to distinguish between commodities and the markets on which they trade. In the case of commodities that are sold on competitive markets, contracts are normally made on physical or virtual markets in which the public can readily participate. However, a commodity that is normally sold on a public market may occasionally be sold privately, that 11.  See, e.g., Edwin G. Dolan, Basic Microeconomics 160 (3d ed. 1983). For ease of exposition, the term price will be used to include all the terms offered by a seller.

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is, away from any public market that is readily accessible to both parties. Where that occurs the contract is made off-​market even though the commodity may also be traded on a competitive market. Unconscionability is most likely to be found where a transaction occurs either off-​ market or on a public market that for some reason is not even reasonably competitive.

III .   T H E R O L E O F  M OR A L   FA ULT In short, contracts made on perfectly competitive markets will rarely if ever be unconscionable, and contracts made on reasonably competitive markets will not often be unconscionable. However, the converse is not true: a contract that is made off-​market or on a noncompetitive market is not unconscionable for that reason alone. Instead, such a contract will be unconscionable only if it involves moral fault on the part of the promisee. Moral fault, for contract-​law purposes, should normally mean fault as a matter of social morality—​that is, as a matter of moral standards that are rooted in aspirations for the community as a whole and that, on the basis of an appropriate methodology, can fairly be said to have substantial support in the community, can be derived from norms that have such support, or appear as if they would have such support. The importance of moral fault in this connection is made explicit in many civil-​code and civil-​code ​based rules that parallel the principle of unconscionability. For example, the German Civil Code provides that: [A]‌legal transaction is void by which a person, by exploiting the predicament, inexperience, lack of sound judgment or considerable weakness of will of another, causes himself or a third party, in exchange for an act of performance, to be promised or granted pecuniary advantages which are clearly disproportionate to the performance.12

Similarly, the Principles of European Contract Law provide that: (1)  A party may avoid a contract if, at the time of the conclusion of the contract: (a) it was . . . in economic distress or had urgent needs, was improvident, ignorant, inexperienced or lacking in bargaining skill, and (b) the other party knew or ought to have known of this and, given the circumstances and purpose of the contract, took advantage of the first party’s situation in a way which was grossly unfair or took an excessive benefit.13

Although the essential role of moral fault is not as explicit under American law as it is under some civil-​code and civil-​code ​based rules, it is implicit in the concept of unconscionability: what 12.  Bürgerliches Gesetzbuch [BGB] [Civil Code] Aug. 18, 1896, as amended, §138(2) (emphasis added), translation at http://​www.gesetze-​im-​internet.de/​englisch_​bgb/​index.html; accord Obligationenrecht [OR] [Code of Obligations] Mar. 30, 1911, as amended, art. 21(1) (Switz.). 13. Principles of European Contract Law art. 4:109(1) (Comm’n on European Contract Law 1998) (emphasis added); accord UNIDROIT Principles of Int’l Commercial Contracts art. 3.10(1) (2004).

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kind of conduct is not conscionable must depend on what kind of conduct involves moral fault. This is not to say that a contract that involves any moral fault at all is necessarily unconscionable. So, for example, a seller’s use of mildly manipulative talk, while unfair, might not be unconscionable. Moral fault comes in different degrees, and the term unconscionable suggests a significant degree of moral fault. _​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​ It is unnecessary and ill-​advised to determine unconscionability on a case-​by-​case basis. Instead, the law should aim to develop unconscionability rules to govern classes of cases. The remaining sections of this chapter will be devoted to developing several such rules. The purpose of the enterprise is not to develop every specific unconscionability rule. On the contrary, unconscionability is a fundamental principle that continues to unfold as social norms evolve. However, a major purpose of this chapter is to explicate the methodology by which specific unconscionability rules should be developed. Three general propositions underlie this methodology. First, the development and application of specific unconscionability rules is closely related to whether the market on which a contract was made deviates from a competitive market. Second, because the bargain principle rests on arguments of fairness and efficiency, a specific unconscionability rule is especially appropriate when fairness does not support the application of the bargain principle to a class of transactions and efficiency will likely not be impaired—​or indeed may be enhanced—​by reviewing those transactions for fairness. Third, specific unconscionability rules can often be developed by using the general unconscionability principle as a charter that enables the court to either create new rules or enlarge the traditional boundaries of existing rules such as those dealing with duress, incapacity, and undue influence.

I V.   S P ECI F I C U N C O N S C I O N ABI L I T Y   NOR M S A. DISTRESS Suppose that A makes a bargain with B at a time when, through no fault of B, A is in a state of necessity that effectively compels him to enter into a bargain with B on any terms he can get—​a condition that will be referred to in this book as distress. This condition evokes various images—​for example, A is stranded in the desert and B adventitiously discovers him, or A needs a lifesaving operation that only B can perform. At first glance these images may seem similar. In fact, however, they present different problems, and together they illustrate most of the major issues raised by the problem of distress. Accordingly, those issues will be analyzed through an exploration of hypotheticals built upon these images. The Desperate Traveler. A, a symphony musician, has been driving through the desert on a recreational trip when she suddenly hits a rock jutting out from the sand. A’s vehicle is disabled and her ankle is fractured. She has no radio and little water, her cell phone isn’t working, and she will die if she is not soon rescued. The next day, B, a university geologist who is on his way from Tucson to inspect desert rock formations, adventitiously passes within sight of the accident and drives over to investigate. A explains the situation and asks B to take her back to Tucson, which is sixty miles away. B replies that he will help only if A promises to pay him two-​thirds of her wealth or $100,000,

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Moral Elements in Contract Law whichever is more. A agrees, but after they return to Tucson she refuses to keep her promise, and B sues to enforce it.

Under classical contract law A’s promise would be enforceable to its full extent: she has made a bargain, and none of the traditional contract defenses apply. The defense of duress might seem apposite, but traditionally that defense requires not only that the promisor was in distress but that she was put in distress by the promisee’s wrongful act or threat.14 B did not put A in distress, and B’s threat not to help A is not legally wrongful because tort law and criminal law impose no duty on strangers to rescue persons in distress even when life is at stake.15 This rule is morally indefensible, but this book concerns only contract law and takes other areas of law as given. Nevertheless, the contract in The Desperate Traveler is unconscionable, because a potential rescuer should have a duty to rescue if the cost and risk of rescue are relatively low and the rescue involved the unfair exploitation of distress: First, the transaction between A and B did not occur on a competitive market. Quite the contrary, the transaction occurred off-​market, and B was a monopolist since A did not have any readily available alternative source of rescue. Of course, B is only a bilateral monopolist, because if B is to derive an economic gain from A’s distress he needs A’s assent. However, that a monopoly is bilateral does not imply that the strengths of the two parties are equal. The parties’ relative strengths are largely determined by their relative costs if a bargain is not made. In The Desperate Traveler A’s cost for not making a bargain would be the loss of her life while B’s cost would only be a forgone financial windfall. Second, B’s conduct violated accepted moral standards. Our society posits, as part of its moral order, some degree of concern for others. In The Desperate Traveler B has acted wrongly in treating A’s life as solely an economic object. Efficiency considerations do not point in a different direction. Where rescue is adventitious no one else could provide rescue services at the time of the rescue, and prior to B’s accident there was no market on which B could have purchased a contingent contract to rescue. Accordingly, in the case of adventitious rescue, full enforcement of the victim’s promise is not required to move rescue services to their highest-​valued uses, and would have no measurable effect on the allocation of resources to rescue capacity. Instead, full enforcement of promises like that of A might well be inefficient. If it were known that victims in distress could be required to pay whatever price they agreed upon for an adventitious rescue, people might either be reluctant to engage in activity in which rescue is sometimes necessary or might spend an aggregate amount on precaution that exceeded the cost of adventitious rescue.16

14.  See, e.g. Cheshire Oil Co., Inc. v. Springfield Realty Corp., 385 A.2d 835, 839 (N.H. 1978) (“. . . [T]‌he coercive circumstances must have been the result of the acts of the opposite party. A contract signed because a party is bargaining under adverse conditions or in pressing want of pecuniary means is not unenforceable on account of duress if the other party is not responsible for those circumstances and did not create the necessities.”); Restatement Second § 175. 15.  See Chapter 9, infra. 16.  See R. Posner, Economic Analysis of Law 133–​34 (2d ed. 1977); Peter A. Diamond & James A. Mirrlees, On the Assignment of Liability:  The Uniform Case, 6 Bell J.  Econ. & Mgmt. Sci. 487 (1975); William M. Landes & Richard A. Posner, Salvors, Finders, Good Samaritans, and Other Rescuers:  An Economic Study of Law and Altruism, 7 J. Legal Stud. 83, 91–​93 (1978).

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Moreover, various mature legal systems have long allowed the courts to apply a fairness standard to the review of bargains made under distress. For example, German Civil Code Section 138(2) provides that a transaction is void “when a person [exploits] the distressed situation . . . of another to obtain the grant or promise of pecuniary advantages . . . which are obviously disproportionate to the performance given in return.”17 French law is in accord. At home it is well established in admiralty law that a contract for salvage—​that is, a contract to rescue a ship in distress or its cargo—​is reviewable for fairness. For example, in Post v. Jones18 the whaling ship Richmond had run inextricably aground on a barren coast off the Arctic Ocean. Several days later three other whaling ships came on the scene. These ships did not have full cargoes but the Richmond had more whale oil than the ships could take. At the instance of the captain of one of the ships, the Richmond’s captain held an auction of his ship’s oil. One of the three newly arrived captains bid $1/​barrel for as much as he needed; the two others bid $.75/​barrel; and each captain took enough oil at his bid price to complete his cargo. The three ships then returned to port with the Richmond’s oil and crew. In an action by the owners of the Richmond, the sale of the oil at the bid prices was set aside as unfair: The contrivance of an auction sale, under such circumstances, where the master of the Richmond was hopeless, helpless, and passive—​where there was no market, no money, no competition—​ . . . is a transaction which has no characteristic of a valid contract. . . . Courts of admiralty will enforce contracts made for salvage service and salvage compensation, where the salvor has not taken advantage of his power to make an unreasonable bargain; but they will not tolerate the doctrine that a salvor can take advantage of his situation, and avail himself of the calamities of others to drive a bargain. . . .19

This leaves open how to measure the promisee’s recovery in such cases. One possibility is to compensate the promisee for his financial costs. That remedy, however, would often fail to adequately recognize the benefit conferred upon the promisor. Furthermore, a financial-​cost rule might not provide a sufficient incentive to act. In The Desperate Traveler, for example, B’s financial cost is close to zero. Assuming that B is under no legal duty to rescue A, he therefore would have no economic incentive to perform the rescue if his recovery was limited to his financial cost. The need for an economic incentive in such cases should not be overemphasized; most individuals in B’s position would be likely to rescue A whether they had an economic incentive to do so or not. Not all will, however, and an economic incentive would be helpful at the margin. 17.  BGB § 138(2). 18.  60 U.S. (19 How.) 150 (1857). 19.  Id. at 159–​60. See also, e.g., Magnolia Petroleum Co. v. Nat’l Oil Trans. Co., 281 F. 336, 340 (S.D. Tex. 1922) (“I think it clear that this case is ruled by the general principle . . . that there is a clear right in the courts to set aside a salvage agreement, when made on the high seas under compulsion or hardship, morally or otherwise, when such agreement is unconscionable and inequitable, as this agreement plainly is.”). See also The Sirius, 57 F. 851 (9th Cir. 1893); Higgins, Inc. v. The Tri-​State, 99 F. Supp. 694 (S.D. Fla. 1951); The Don Carlos, 47 F. 746 (N.D. Cal. 1891); The Jessomene, 47 F. 903 (N.D. Cal. 1891); The Young America, 20 F. 926 (D.N.J. 1884); The Port Caledonia & The Anna, [1903] P. 184 (Eng.); Thomas J. Schoenbaum, Admiralty and Maritime Law §13-​6 (5th ed. 2012); Grant Gilmore & Charles L. Black, Jr., The Law of Admiralty 578–​79 (2d ed. 1975); W.R. Kennedy, Civil Salvage 309–​13 (Kenneth C. McGuffie ed., 4th ed. 1958).

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Admiralty law again suggests a solution. Although admiralty will not enforce unfair salvage-​ rescue contracts, it does provide ample compensation for rescuers. Recovery in salvage cases is viewed as both a reward and an inducement.20 Accordingly, in measuring recovery admiralty courts take into account the degree of danger to the rescued property; the value of the rescued property; the risk incurred by the salvor in effecting the rescue; the salvor’s promptness, skill, and energy; the value of the property the salvor employed; the degree of danger to that prop­ erty; and the salvor’s time and labor.21 In more general terms, the recovery in distress cases that involve an adventitious rescue, even though not in admiralty, should compensate the assisting party (the promisee) for all costs, tangible and intangible, and should also include a generous bonus to provide a clear incentive for action. Recovery measured in this way admits of no great precision, but that is not fatal in situations in which by hypothesis planning is not central. The viability of this approach is evidenced by the fact that it has stood the test of time in an area, admiralty, where distress and adventitious rescue are common occurrences.22 The moral obligation to assist a victim in peril, like A in The Desperate Traveler normally should attach only when the cost and risk of rendering assistance are relatively low. However, the victim can make costs low by agreeing to pay them, which she normally should do. Correspondingly, a potential assisting party who asks a victim to cover his costs, including his opportunity costs, together with a reasonable premium as an added incentive, has not acted in a way that is morally improper. Accordingly, a contract under which a victim in peril agrees to pay the costs of rescue together with a reasonable premium is not unconscionable. This illustrates the limitations of the distinction between procedural and substantive unconscionability. In a case like The Desperate Traveler the mere fact of making a contract to rescue is not unconscionable, because B would not be acting unconscionably if he demands only fair compensation. Accordingly, such a contract is unconscionable only if the promisee extracts an unfair price, because only in that case does the promisee engage in immoral exploitation of the promisor’s distress.23 The Desperate Patient. P, a business executive, is dying of a fatal disease and requires a surgery that until recently could not be accomplished. However, S, a surgeon, has just developed a new surgical

20.  See The Blackwall, 77 U.S. (10 Wall.) 1, 14 (1869). 21.  Id. at 13–​14; B.V. Bureau Wijsmuller v. United States, 487 F. Supp. 156 170, (S.D.N.Y. 1979); Gilmore & Black, supra note 19, 559–​62; Kennedy, supra note 19, at 161–​225; Schoenbaum, supra note 19, at §13-​6. Underlying these individual elements is the principle that the reward is to be computed generously in the light of “the fundamental public policy at the basis of awards of salvage—​the encouragement of seamen to render prompt service in future emergencies.” Kimes v. United States, 207 F.2d 60, 63 (2d Cir. 1953) (Clark, J.); see also The Telemachus [1957] 2 W.L.R. 200, 1 All E.R. 72 (Eng.) p. 47, 49 (“I have to arrive at such an award as will . . . in the interests of public policy, encourage other mariners in like circumstances to perform like services.”); The “Industry” (1835) 166 Eng. Rep. 381, 382; 3 Hag. Adm. 203, 204 (accord). 22.  Indeed, under modern shipping practice salvors typically leave the payment terms of their contracts open for determination after the event by negotiation or through arbitration. Kennedy, supra note 19, at 302; Schoenbaum, supra note 19, at §13-​6. Furthermore, under the Lloyd’s form salvage contract that is in almost universal use, if a fixed amount is agreed upon in advance it may be objected to thereafter, in which event compensation is fixed by arbitration. Id. 23. In Distress Exploitation Contracts in the Shadow of No Duty to Rescue, 86 N.C. L.  Rev. 315 (2008) Shahar Lifshitz argued that the cost of rescue includes the opportunity cost to extract a high price from the victim, so that in a case such as The Desperate Traveler the price is cost-​based. Id. at 349. However, because extracting such a price would be morally improper the law cannot properly consider that opportunity as a

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technique for doing it. Development of the new technique entailed $100,000 in out-​of-​pocket costs and forgone opportunities. At the moment no one but S can perform the surgery, and by the time others can learn the technique involved, P will have died. P asks S to operate on her. S, who has the capacity to perform many more of these operations than he is currently performing, replies that he will do so only if P promises to pay $1 million, his standard fee for the operation. P agrees. After S performs the operation, P refuses to keep her promise, and S sues.

As in The Desperate Traveler, P is in distress, the transaction is not conducted on a reasonably competitive market, and the promisee is a monopolist. However, there is a significant difference between the two cases. Unlike the geologist in the Desperate Traveler the surgeon has achieved his bargaining power not through adventitious circumstances but through his diligence, skill, and investment. Moreover, the prospect of deriving exorbitant gains may have been precisely the incentive that led the surgeon to work on developing the new surgical technique. It can therefore be argued that promises made in cases like The Desperate Patient should be enforced to their full extent so as to incentivize desirable investment. Accordingly, The Desperate Patient is much harder to resolve than The Desperate Traveler. Nevertheless, a medical provider who has a monopoly on a life-​and-​death procedure acts in a morally improper way if he demands an excessive price to perform the procedure. A price is excessive, in this context, if it exceeds an allocable share of the provider’s out-​of-​pocket costs for developing his rescue capacity, his opportunity costs of having forgone other profitable activities, and a generous premium to incentivize similar investments. Furthermore, less-​than-​full enforcement in such cases may be supported by efficiency considerations. In a perfectly competitive market the long-​run price of a commodity will equal its long-​run cost, including a reasonable profit. Accordingly, all consumers who are willing and able to pay the cost of production will be able to purchase the commodity. Monopolistic markets, however, involve a price in excess of cost, thereby choking off the demand of some consumers who would be willing to purchase the commodity for a price equal to the provider’s cost plus a reasonable profit. Therefore, a practice of judicial review for excessiveness of price in cases like The Desperate Patient, coupled with extremely liberal recovery, might be just as likely as a practice of full enforcement to result in the best allocation of resources. Once more this is precisely the line taken in Admiralty. Admiralty courts review salvage contracts for fairness not only when a rescuer adventitiously happens on the scene but also when the salvage is performed by a professional salvor whose rescue capacity results from a planned investment. However, adventitious and professional rescue are treated differently as regards the measure of recovery. To encourage investment in rescue resources, awards for rescue by professional salvors are deliberately higher than awards to adventitious salvors.24 The measure of cost for this purpose. To do so would be like saying that an extortionist who is paid $5,000 in exchange for his promise not to inflict a $10,000 damage to the payor is morally justified because he simply recovers his opportunity costs, and not even that. 24.  See, e.g., Salvage Chief—​S.T. Ellin, 1969 Am. Maritime Cas. 1739, 1740 (S.D. Cal 1966): [O]‌ne who maintains an expensive salvage vessel with expensive salvage equipment thereon . . . is entitled to a more liberal salvage award than the mere casual salvor. Were it not so, there would be no encouragement to the owner of such professional salvage vessel to provide such available salvage equipment and to maintain it always in available status. . . . [T]he Salvage Chief is called upon to perform salvage services only from time to time as the need arises; nevertheless the cost of maintenance of the Salvage Chief, with her crew, and in a state of readiness, goes on, day after day.

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recovery in cases like The Desperate Patient should parallel the measure of recovery in professional rescue-​at-​sea cases.

B.  PRICE-​GOUGING Price-​gouging is another specific form of unconscionability. Price-​gouging occurs when a seller significantly raises prices to take advantage of a temporary disruption of a market due to a disaster. For example, during the New York City blackout in July 1977 some sellers of candles, flashlights, transistor radios, and batteries charged many times normal price.25 Price-​gouging is similar to the exploitation of distress but differs in several respects. To begin with, the extent of the buyers’ need is usually much lower. Next, the need is by definition temporary: if there is a long-​term change in price levels—​due, for example, to wartime conditions—​charging prices at the new level should not be regarded as price-​gouging. Moreover, because usually less is at stake for the buyer than in distress cases, and the disruption is temporary, the amount involved in price-​gouging is usually small in absolute terms although high in percentage terms in relation to the pre-​catastrophe price. Finally, unlike distress cases, where the court normally must determine what a fair price would have been, in price-​gouging cases there is an easily administered measure of damages: the difference between the contract price and the pre-​disaster market price or the market price in adjoining non-​disaster areas. Price-​gouging satisfies the two elements of unconscionability. First, the normal market has ceased to function, and instead the disaster isolates a specific geographic area from national or even regional factors of supply. Second, absent a rise in costs it is morally improper for a seller to significantly raise its prices to exploit important needs resulting from a temporary disaster. The societal view that price-​gouging is immoral is evidenced by the fact that price-​gouging is prohibited by statute in about half the states.26 For example, New York General Business Law Section 396–​r provides that: (a) During any abnormal disruption of the market for consumer goods and services vital and necessary for the health, safety and welfare of consumers, no party within the chain of distribution of such consumer goods or services or both shall sell or offer to sell any such consumer goods or services or both for an amount which represents an unconscionably excessive price. For the purpose of this section, the phrase “abnormal disruption of the market” shall mean any change in the market, whether convulsion of nature, failure or shortage of electric power or other source of energy, strike, civil disorder, war, military action, national or local

See also W.E. Rippon & Son v. United States, 348 F.2d 627 (2d Cir. 1965); The Lamington, 86 F. 675, 683–​ 84 (2d Cir. 1898); B.V. Bureau Wijsmuller v.  United States, 487 F.  Supp.  156, 172–​73 (S.D.N.Y. 1979); The Glengyle [1898] A.C. 519 (H.L.) (Eng.); Kennedy, supra note 19, at 168–​73. In Nicholas E. Vernicos Shipping Co. v. United States, 349 F.2d 465, 472 (2d Cir. 1965), the services performed by the tugs of a professional salvor consumed only a day and did not appear to involve exceptional hazard, but Judge Friendly approved a generous award, calculated as twice the salvor’s monthly expenses for maintaining the tugs. 25.  New York’s Sequel to the’65 Blackout Is Bigger, Not Better, Wall St. J., July 15, 1977, at 1, col. 4. 26.  Geoffrey C. Rapp, Terrorist Attacks, Hurricanes, and the Legal and Economic Aspects of Post-​disaster Price Regulation, 94 Ky. L. Rev. 535, 541–​46 (2005).

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emergency, or other cause of an abnormal disruption of the market which results in the declaration of a state of emergency by the governor. . . . (b) . . . [P]‌rima facie proof that a violation of this section has occurred shall include evidence that (i) the amount charged represents a gross disparity between the price of the goods or services that were the subject of the transaction and their value measured by the price at which such consumer goods or services were sold or offered for sale by the defendant in the usual course of business immediately prior to the onset of the abnormal disruption of the market or (ii) the amount charged grossly exceeded the price at which the same or similar goods or services were readily obtainable by other consumers in the trade area.27

It might be argued that price-​gouging should not be treated as unconscionable because productive resources are efficiently allocated only if prices are set by the market. In price-​gouging cases, however, the market is dysfunctional, and in any event pricing levels in an isolated market during a transitory period are unlikely to affect the general allocation of productive resources. It might also be argued that if sellers are not permitted to charge what the market will bear, commodities will not be allocated to those persons who value them most highly. This argument, however, holds only if wealth is more or less evenly distributed. If it isn’t—​and it isn’t—​in disaster scenarios commodities will be allocated not to those who need them most and value them most highly but to those who have the most wealth.

C.  TRANSACTIONAL INCAPACITY Suppose the subject-​matter of a proposed bargain is highly complex. In such cases even an individual with average intelligence may lack the aptitude, experience, or judgmental ability to make a well-​informed decision concerning the desirability of entering into the bargain. Such an inability will be referred to in this book as transactional incapacity. Take, for example, the following hypothetical: Artless Heir. Niece is a twenty-​two-​year-​old high-​school graduate, employed in a stockroom. Niece’s aunt, who owned a commercial building, died on June 1. In her will she bequeathed a life interest in the building to her fifty-​year-​old sister. The remainder was bequeathed to Niece. Tenant is a major tenant in the building, and also holds a third mortgage on the building for $370,000 and a second mortgage on an unrelated movie theater for $330,000. The third mortgage pays 11 percent interest and the second mortgage pays 9 percent. Both mortgages have fifteen years to run. On July 1 Tenant, who has learned of the bequest to Niece, offers to make a deal under which Tenant will assign the two mortgages to her in exchange for her interest. Tenant points out that under this agreement Niece will derive an immediate annual income of more than $70,000, that this income will continue for fifteen years, and that when the mortgages mature in

27. N.Y. Gen. Bus. Law § 396-​r (2)–​(3) (2006). See People v. Two Wheel Corp., 512 N.Y.S.2d 439, 440 (N.Y. App. Div. 1987), aff ’d, People v.  Two Wheel Corp., 525 N.E.2d 692 (N.Y. 1988); People v.  Chazy Hardware, Inc., 675 N.Y.S. 2d 770, 771 (N.Y. Sup. Ct. 1998).

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Moral Elements in Contract Law fifteen years, she will receive $700,000 in cash. Niece enters into a contract with Tenant to make the exchange. Most real estate appraisers would agree that based on life expectancy tables, applicable discount rates, and the building’s value, Niece’s contingent remainder has a present fair value of $870,000–​ $950,000, and that Tenant’s two mortgages have a total present value of not more than $350,000. Tenant knows that a person with Niece’s background does not have the ability to value either her interest or the mortgages and that no one who had that ability would make the deal. After the contract is made, but before the exchange takes place, the estate’s lawyer learns of the deal and advises Niece not to go through with it. Niece follows the lawyer’s advice and refuses to convey her interest in the property. Tenant brings suit.

If the rules of classical contract law were applied, Niece’s promise would be enforceable to its full extent. She has made a bargain, and none of the traditional contract defenses seem to apply. The defense of incapacity might seem apposite, but traditionally that defense requires what might be called general incapacity, consisting of an inability to understand the nature and consequences of a transaction by reason of a mental illness or defect. For example, Restatement Second Section 15(1) provides: (1) A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect (a) The is unable to understand in a reasonable manner the nature and consequences of the transaction. . . .

But although a promisor’s lack of general capacity may forestall a traditional incapacity defense, contracts in which a promisee exploits the promisor’s transactional incapacity should be unconscionable. First, transactions involving a complex subject-​matter are usually not made on competitive markets, because the subject-​matter is not homogenous and there is only one seller. Furthermore, efficiency considerations fail to support the application of the bargain principle to the exploitation of transactional incapacity. The concept that a promisor is the best judge of her own utility can have little application because by hypothesis the promisor is not able to make a well-​informed judgment concerning the transaction. The promisee, on his part, has engaged in activity that the economic system has no reason to encourage. Second, if, as in Artless Heir, a promisee knows or has reason to know that a promisor lacks capacity to fully understand a complex transaction and its implications, and the promisee exploits that incapacity by inducing B to enter into the transaction on terms that a party who had full transactional capacity probably would not have agreed to, then the promisee has acted in a manner that violates social morality. This is true even though the promisor has the capacity to understand ordinary transactions, and even if her lack of capacity to understand the transaction at hand stems from limitations on her experience or training rather than from illness or defect. The high barrier set by the traditional test for incapacity may have stemmed in part from the drastic consequences of the application of that test. General incapacity usually renders a contract voidable by the promisor. The consequences of transactional incapacity should often be less severe, requiring only an adjustment in price. Similarly, under one line of authority, general incapacity constitutes a defense even if the promisee neither knew nor had reason to know of

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the promisor’s lack of capacity.28 However, transactional incapacity should not be deemed unconscionable unless the promisee knew or had reason to know of the incapacity and exploited it. Some support for a doctrine of transactional incapacity can be found in existing legal materials. Abroad, this concept is embodied in Section 138(2) of the German Civil Code: “[A]‌ legal transaction is void by which a person by exploiting the . . . lack of sound judgment . . . of another, causes himself . . . in exchange for an act of performance, to be promised or granted pecuniary advantages which are clearly disproportionate to the performance.” Some American cases have also adopted a rule very close to a doctrine of transactional incapacity. For example, in Morgan v. Reaser29 the Reasers, who owned a ranch, entered into a complex transaction with Morgan involving a conveyance of the ranch in exchange primarily for an apartment complex owned by Morgan. It quickly became apparent that the apartment complex was a losing proposition, and the Reasers sued for rescission. The court held for the Reasers because while “Reaser was not without some experience in the purchase and sale of real estate nor . . . completely lacking in understanding,” he “was without understanding of a transaction of this nature and magnitude.”30 Indeed, even Restatement Second Section 15, whose text seems to require general incapacity, includes a comment that looks toward transactional incapacity: “[A] person may be able to understand almost nothing, or only simple or routine transactions, or he may be incompetent only with respect to a particular type of transaction.”31 It might be argued against a doctrine of transactional incapacity that it would lead to undue uncertainty in contracting. However, sophisticated actors who engage in complex transactions normally deal with other sophisticated actors. If they deal with unsophisticated actors, they know it. A sophisticated actor, A, who engages in a complex transaction with an unsophisticated actor, B, and wants to make sure that the transaction is not deemed unconscionable on the ground of B’s transactional incapacity, has two simple ways to achieve that result. First, A can explain the transaction and its implications in terms that B can understand. So, for example, in Weaver v. American Oil Co.,32 which involved a complex and legalistically phrased form-​contract term that required the untutored operator of an Amoco gas station to indemnify Amoco against 28.  See, e.g., Verstandig v. Schlaffer, 70 N.E.2d 15, 16 (N.Y. 1946) (per curiam); cf. Restatement Second § 15(2)). 29.  204 N.W.2d 98 (S.D. 1973) (per curiam). 30.  Id. at 104. For comparable cases, see Vincent v.  Superior Oil Co., 178 F.  Supp.  276, 283 (W.D. La. 1959) (applying Louisiana law); Thatcher v. Kramer, 180 N.E. 434, 436–​37 (Ill. 1932); Hinkley v. Wynkoop, 137 N.E. 154, 158 (Ill. 1922); Succession of Molaison, 34 So. 2d 897, 903 (La. 1948). Two classic cases of the early common law, James v.  Morgan (1793) 83 Eng. Rep.  323; 1 Lev. 111; and Thornborow v. Whitacre (1790) 92 Eng. Rep.  270, 271; 2 Ld. Raym. 1164, turn on exploitation of the promisor’s lack of sophistication. James v. Morgan was an action to enforce a promise “to pay for a horse a barley-​corn a nail, doubling it every nail.” The buyer did not pay the promised amount and the seller brought suit. The buyer defended on the ground that “there were thirty-​two nails in the shoes of the horse, which being doubled every nail, came to five hundred quarters of barley.” Chief Justice Hyde directed the jury to award the plaintiff only the value of the horse. Thornborow was comparable to James. These cases were discussed in Hume v. United States, 132 U.S. 406, 413 (1889), in which the Court said that they “were plainly cases in which one party took advantage of the other’s ignorance of arithmetic to impose upon him.” Hume, supra. 31.  Restatement Second § 15, Comment b. 32.  276 N.E.2d 144 (Ind. 1971).

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Amoco’s own negligence, the court said: “The party seeking to enforce such a contract has the burden of showing that the provisions were explained to the other party and came to his knowl­ edge and there was in fact a real and voluntary meeting of the minds. . . .”33 Alternatively, A can and should advise B to get competent advice.34 This was the position taken in Morgan v. Reaser, where the court said, “There is such a lack of competency on the part of the defendants as to have made it necessary that they should have had protection and advice. . . .”35

D.  UNFAIR PERSUASION In a perfectly competitive market persuasion ordinarily plays little or no role: buyers and sellers either take or refuse the market price. As the characteristics of a market recede from perfect competition, however, persuasion may play an increasingly important role. This opens the possibility that a promisor who is normally capable of acting in a deliberative manner may be rendered temporarily unable to do so by the promisee’s use of unfair persuasion, that is, bargaining methods that deliberately impair the free and competent exercise of the promisor’s judgment and produce a state of acquiescence that the promisee knows or should know is likely to be highly transitory. Suppose, in such a case, the promisor changes her mind when the persuasion is removed, as in the following hypothetical: Troubled Widow. Wanda owns a small clothing boutique. On January 5, Wanda’s husband, Xaviar, dies in an automobile accident. At the time of his death Xaviar owed $60,000 to Robert. The debt was represented by a promissory note and secured by all of the stock in Xerxes Co., a corporation that Xaviar wholly owned. Wanda did not sign the note and was not liable on it. Although originally prosperous, Xerxes had run into major difficulties, and as of January 5 the stock was worth only $10,000–​$15,000. On January 9, Robert goes to Wanda’s house, bringing with him the note and the Xerxes stock, and tells Wanda that Xaviar’s memory will be permanently dishonored unless his debts are paid. Wanda says she does not want to talk about such things now, and asks Robert to come back at another time. Robert goes on talking about Wanda’s moral obligations and pounding away at the repugnance of dying with a dishonored reputation. Wanda pleads with him to stop, but Robert relentlessly continues. After two hours, Wanda agrees that in exchange for the note and stock she will pay Robert $60,000. The next day Wanda has second thoughts, and tells Robert she will not go through with the transaction.36

If classical c​ ontract-​law rules were applied Wanda’s promise would be fully enforceable. She has made a bargain, and none of the traditional contract-​law defenses appear to apply. The 33.  Id. at 148); cf. N.Y. Gen. Oblig. Law § 5-​702 (1981) (“plain English” statute). 34.  Cf. Lloyds Bank Ltd. v. Bundy, [1975] Q.B. 326, 345 (Eng.) (opinion of Sir Eric Sachs) (“Over and above the need any man has for counsel when asked to risk his last penny on even an apparently reasonable proj­ ect, was the need here for informed advice as to whether there was any real chance of the company’s affairs becoming viable if the documents were signed.”). 35.  204 N.W.2d 98, 104 (S.D. 1973). 36.  Troubled Widow is loosely based on Newman & Snell’s State Bank v.  Hunter, 220 N.W. 665 (Mich. 1928). The court there refused to enforce the contract on the ground that there was no consideration. Id. at 667.

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doctrine of undue influence, which might otherwise seem on point, traditionally requires either a relationship of dominance and subservience or a special relationship of trust that preexisted the contract. For example, Restatement Second Section 177(1) provides that “Undue influence is unfair persuasion of a party who is under the domination of the person exercising the persuasion or who by virtue of the relation between them is justified in assuming that that person will not act in a manner inconsistent with his welfare.” As stated by one commentator, “Fraud may be . . . practiced upon a perfect stranger. Undue influence can exist only where one party occupies a position of dominance over the other.”37 But why should it matter whether dominance existed before the transaction or only in connection with the transaction? The Comment to Restatement Second Section 177 states that “The ultimate question in determining whether the promisee engaged in unfair persuasion is whether the result was produced by means that seriously impaired the free and competent exercise of judgement.” That is exactly right. Unfair persuasion invariably occurs off-​market, and a promisee who extracted a promise by the use of a bargaining method that he knew or should have known seriously impaired the free and competent exercise of the promisor’s judgment, and thereby created a state of acquiescence that was only transitory, is as much at fault as a promisee who exploits a promisor’s transactional incapacity. Indeed, he is more at fault, because he not only exploits but deliberately creates a special type of incapacity. Treating unfair persuasion as unconscionable is also supported by considerations of efficiency. The bargain principle rests in substantial part on the premise that a bargain context induces a deliberative state of mind in a promisor, who is the best judge of her own utility. This premise is inapplicable where the promisee has used techniques of persuasion that are calculated to move the promisor out of a deliberative frame of mind and to change the promisor’s utility function in a way the promisee knows or has reason to know is only transitory. There is no efficiency reason for encouraging the production of such manipulative persuasion. A concern with unfair persuasion underlies and explains cooling-​off rules that have been adopted by a number of state legislatures,38 in the Uniform Consumer Credit Code,39 by the Federal Trade Commission,40 and by Congress.41 These rules permit a buyer who has made certain types of contracts in their own home to rescind the contract during a specified period. The rules recognize the problem of inducing a transitory state of acquiescence by unfair means, which is not uncommon in the door-​to-​door off-​market context, and fix the time periods within which a transitory state of acquiescence induced by unfair persuasion may be expected to recede. Some modern case law also supports treating unfair persuasion as wrongful. A well-​known example is Odorizzi v.  Bloomfield School District.42 Odorizzi, an elementary-​school teacher, had been arrested on criminal charges of homosexual activity. After he had been questioned by the police, booked, released on bail, and gone forty hours without sleep, two school district

37.  Milton Green, Fraud, Undue Influence and Mental Incompetence, 43 Colum. L. Rev. 176, 180 (1943). 38.  See William E. Hogan, Cooling-​Off Legislation, 26 Bus. Law. 875, 878 (1971); Byron D. Sher, The “Cooling-​Off ” Period in Door-​to-​Door Sales, 15 UCLA L. Rev. 717 (1968). 39.  Unif. Consumer Credit Code § 3.502 (1974). 40.  16 C.F.R. § 429.1 (2016). 41.  Consumer Credit Protection Act § 125, 15 U.S.C. § 1635 (2015); Depository Institutions Deregulation and Monetary Control Act of 1980 § 616, 15 U.S.C. § 1635(a)–​(g) (2015). 42.  54 Cal. Rptr. 533 (1966).

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officials came to his apartment and told Odorizzi that if he did not resign immediately he would be dismissed and his arrest would be publicized, thereby jeopardizing his chances of securing employment elsewhere, but that if he resigned at once the incident would not be publicized. Odorizzi resigned, and the criminal charges were dismissed. The court held that on these facts Odorizzi was entitled to reinstatement. Undue influence, the court said, involves two aspects—​ undue susceptibility and undue pressure: Undue influence in its second aspect involves an application of excessive strength by a dominant subject against a servient object. Judicial consideration of this second element in undue influence has been relatively rare, for there are few cases denying persons who persuade but do not misrepresent the benefit of their bargain. Yet logically, the same legal consequences should apply to the results of excessive strength as to the results of undue weakness. Whether from weakness on one side, or strength on the other, or a combination of the two, undue influence occurs whenever there results “that kind of influence or supremacy of one mind over another by which that other is prevented from acting according to his own wish or judgment, and whereby the will of the person is overborne and he is induced to do or forbear to do an act which he would not do, or would do, if left to act freely.”43

It might be objected that treating unfair persuasion as unconscionable would allow the courts to review any consumer transaction that is entered into as a result of sales talk or advertising. However, ordinary sales talk normally occurs in reasonably competitive markets and does not involve bargaining methods that seriously impair the free and competent exercise of judgment. Similarly, although advertising often relies on an appeal to non-​deliberative elements, persuasion is only unfair where the promisee creates and exploits a state of acquiescence that he knows or should know is only transitory. In the case of advertising, time must normally elapse between persuasion and purchase. Accordingly, advertisers normally have reason to believe that their advertising would be effective only if it produced a more-​than-​transitory effect. Moreover, reputable merchants commonly permit consumers to return unused merchandise for refund or credit, subject, sometimes, to a restocking fee. Accordingly, occasional erroneous application of the doctrine of unfair persuasion in a consumer context would do no more than produce a result that is often or usually obtainable from reputable merchants even without judicial intervention. Finally, by analogy to the cooling-​off rules the scope of the doctrine of unfair persuasion could and should be limited by requiring the promisor to make known her change of mind soon after the bargain, because a late objection implies that the seller’s persuasion had more than a transitory effect.

E.  UNFAIR SURPRISE Unfair surprise occurs where a party, A, inserts into a contractual writing a provision that will disadvantage A’s counterparty, B, and A knows or should know that B probably will not notice 43.  Id. at 540–​41 (quoting Webb v. Saunders, 181 P.2d 43, 47 (Cal. 1947)); accord, Keithley v. Civil Serv. Bd., 89 Cal. Rptr. 809 (1970); see also Methodist Mission Home v. N.A.B., 451 S.W.2d 539 (Tex. Civ. App. 1970) (unwed mother surrendered child for adoption under pressure from officials of home for unwed mothers in which she was residing).

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the provision, that B is unlikely to understand the provision if he does notice it, and that the provision lies outside B’s reasonable expectations. In theory, unfair surprise can arise in the context of fully negotiated contracts. For example, suppose A and B are exchanging drafts and narrowing down their differences with each round of exchange. In the next exchange A inserts a new provision that has nothing to do with the provisions the parties have been negotiating, and does not call B’s attention to the provision. Assuming the new provision is one that A knows or should know B would not have agreed to if he was aware of it, A’s act should be regarded as unfair and the provision should be deemed unconscionable.44 In practice, unfair surprise typically occurs in the case of form contracts. Form contracts will be discussed in Chapter 37.

F.  SALES AT ABOVE-​MARKET PRICES AND THE EXPLOITATION OF PRICE-​IGNORANCE Not infrequently a consumer purchases a relatively homogeneous commodity for more than the market price charged by conventional retailers in the same general area for identical or comparable commodities. Above-​market prices can be explained in several ways. Some explanations are benign. For example, a given seller’s prices may reflect extra value that the seller brings to the consumer, such as high-​level service or cachet. Indeed, when added value is taken into account the price may not be above market. Other explanations of above-​market prices, however, involve unconscionable conduct by the seller.

1.  One-​O ff Sellers One explanation for above-​market prices depends on a confluence of the concepts of consumer surplus and price-​ignorance. Consumer surplus arises because consumers normally value commodities at more than they agree to pay. For example, suppose Consumer C is shopping for a forty-​inch high-​definition TV and finds one that she likes at Best Buy for $500. Suppose C values the TV at more than $500. The difference between $500 and the value that C places on the TV—​roughly speaking, her willingness to pay—​constitutes consumer surplus. Sellers could capture all potential consumer surplus if they could perfectly price-​discriminate by selling every item at the price each buyer would be willing to pay. Usually, however, sellers do not and cannot know what each of their buyers would be willing to pay. Moreover, in a competitive market competition drives a seller’s price down to the marginal cost, and as a practical matter sellers in such a market must sell commodities to all contemporaneous buyers at the same price. Indeed, sellers in a competitive market have an incentive to not even try to capture consumer surplus. Suppose Consumer C purchases a Stouffer’s Frozen Turkey TV Dinner at

44.  Cf. Lawyer’s Duties:Duties to Other Counsel § 7, ABA Section of Litigation, http://​www.americanbar. org/​groups/​litigation/​policy/​conduct_​guidelines/​lawyers_​duties.html (last visited May 24, 2017): . . . As drafts are exchanged between or among counsel, changes from prior drafts will be identified in the draft or otherwise explicitly brought to other counsel’s attention. We will not include in a draft matters to which there has been no agreement without explicitly advising other counsel in writing of the addition.

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Supermarket S for $5.95. If C subsequently learns that other supermarkets sell the same TV dinner for $3.95 she is unlikely to shop again at S for anything—​unless she made her purchase in the knowledge that S is an upscale high-​priced supermarket—​because she will probably believe that if S overprices one product it also overprices others. Since S knows that this is how consumers behave, S will check the prices at comparable supermarkets on a continuing basis to keep its prices in line with the competition. Accordingly, if a market is reasonably competitive a consumer is unlikely to pay an above-​market price for a given item even if she is ignorant about prices and values the item at more than the market price. However, a commodity that is usually sold on a reasonably competitive market may also be sold off-​market. If a buyer purchases the commodity off-​market and is ignorant of the price charged on the market she may pay a price equal to her value for the commodity although, unbeknown to her, that price is higher, perhaps substantially, than the market price. For example, in 1980 the New York Times reported that a group of stores on Fifth Avenue in New York, which apparently dealt primarily with passersby, especially tourists, sold brand-​name radios, calculators, and other items for double or triple the list price—​that is, the price recommended by the manufacturers, which was not marked on the items.45 The stores offered no special advantage, and in the absence of such an advantage no consumer would knowingly pay twice or more the list price of brand-​name items. The explanation why some consumers did so is almost certainly that (1) the consumers were ignorant of the list and market prices for the relevant commodities, (2) they valued the commodities at the prices they paid, and (3) they assumed, based on experience, that all stores that offer no special advantage charge approximately the same price for a given commodity, so that further search would be unlikely to produce a materially better price and therefore would be inefficient. The stores, on their part, could get away with charging twice or more list prices because they were primarily engaged in one-​off transactions with passersby and therefore were not concerned that they would lose patronage when their customers learned the facts. Accordingly, the lack-​of-​a-​competitive-​market element of unconscionability is satisfied in this kind of case. The element of morally improper conduct is also satisfied. Selling relatively homogeneous commodities to consumers for two or three times the list or market price violates social morality because it constitutes a knowing and improper exploitation of consumers’ price-​ignorance. This price-​ignorance is rational because it is based on consumers’ observation, well grounded in experience although occasionally incorrect, that retail prices for comparable commodities will be comparable among stores that offer no special services or cachet. Treating such transactions as unconscionable will also probably promote efficiency. By hypothesis, the relevant commodities sell at a much lower price in most marketplaces. It therefore seems unlikely that above-​market prices charged by one-​off sellers are required to move the commodities to their highest-​valued uses or to properly allocate the factors necessary for production of the commodities. On the contrary, a prohibition of this type of pricing could reduce wasteful price searches, since consumers would then be confident that prices of homogeneous commodities would normally be comparable among similar stores. 45.  Ralph Blumenthal, On Fifth Avenue, Shoppers’ Jungle, N.Y. Times, July 9, 1980, at C1. For further data, see the companion article, “Good Price” Proves to Be No Bargain, N.Y. Times, July 9, 1980, at C9. These articles report that to fight this problem, New York City adopted consumer regulations that require merchants to mark all goods with the current selling price and also to disclose the manufacturer’s list price if it is lower than the marked selling price.

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2.  Door-​t o-​D oor Sellers A common case of above-​market prices involves door-​to-​door sellers. Some door-​to-​door sellers, such as Avon Cosmetics, depend to a significant extent on repeat business and reputation, and therefore are unlikely to charge prices materially above the market prices for comparable commodities. Often, however, that is not the case. Here is an example from The Wall Street Journal: In the world of home appliances, Kirby Co. likes to consider its product the Porsche of vacuum cleaners. In March of last year, 68-​year-​old Henrietta Taylor and her husband, Dennis, 79, answered a knock on the door of their mobile home in Fort Meade, Fla., to find two Kirby salesmen standing on the stoop. The Taylors didn’t need a vacuum cleaner; their old Electrolux was working fine. But the salesmen persisted with an hour-​and-​a-​half demonstration that included dumping dirt on the carpet to show off the Kirby’s cleaning power. “They were the pushiest people I ever saw,” Mrs. Taylor says. The Taylors agreed to buy the machine for $1,749. That far exceeded the value of their only carpet, a 12-​foot by 18-​foot living-​room rug. It also exceeded their monthly income of $1,100 in Social Security. To finance the purchase, the salesmen arranged for a loan—​with a 21.19% annual interest rate that brought the total in payments to $2,553.06. . . . The Kirby complaints often involve older customers who lack the will to stand up to grueling sales pitches. One evening in May 1996, Stephen and Wilma Tucker were sitting down to dinner when three Kirby salesmen showed up at their Springfield, Vt., home and spent five hours, despite protests from the 60-​year-​old Mr. Tucker that he was disabled, unemployed and incapable of buying so expensive a vacuum cleaner. One salesman even helped himself to some fried chicken, the Tuckers say. Finally, “more or less just to get them out of there, we agreed to it,” Mr. Tucker says. . . . Ms. [Thorhild] Christopher, who died in December 1996 at age 76, lived alone in a mobile home in Hernando, Fla., scraping by on about $1,500 a month in Social Security payments and money from her late husband’s U.S. Coast Guard pension. When she died, she owned two Kirby vacuum cleaners, the last one sold to her in September 1995 by a Kirby distributor in Spring Hill, Fla. Ms. Christopher’s niece, Gail Bosworth, says her aunt was suffering from Alzheimer’s disease by the time she paid $1,747.94 for the second Kirby . . . About 70% of Kirbys are financed through distributors, with 20%-​plus interest rates driving the total cost well above $2,000  . . .  To Kirby’s advantage, in-​home sales pitches don’t allow the consumer much room for comparison shopping. In appliance stores, customers can weigh the price of Eurekas against Bissells, or try out the $350 Hoover that Consumer Reports last year ranked first in quality, ahead of No. 2-​ ranked Kirby. But in their own living rooms, people submitting to Kirby sales pitches face pressure to make a decision on the spot. . . .46

46.  Joseph B. Cahill, Here’s the Pitch: How Kirby Persuades Uncertain Consumers to Buy $1,500 Vacuum, Wall St. J., Oct. 4, 1999, at A1.

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Transactions like those involving Kirby can be explained in several ways. One possible explanation is unfair persuasion. Consumers can leave stores but not their homes. Accordingly, door-​to-​door sellers may engage in high-​pressure tactics such as wearing out buyers by talking forever and refusing to leave. Another possible explanation is that door-​to-​door sellers such as Kirby are one-​off sellers, who capture all the buyer’s consumer surplus by exploiting price-​ ignorance to sell at the price the buyer is willing to pay, rather than the market price charged for comparable products in conventional marketplaces. A more benign explanation is that unlike one-​off stores, door-​to-​door sellers increase welfare by bringing product information to the attention of buyers who value the information and might not otherwise obtain it. Indeed, it might be argued that requiring door-​to-​door sellers to sell at market prices would be inefficient. If the above-​market prices charged by sellers such as Kirby covered only their costs plus a reasonable profit, they could not remain in business if they were required to charge the lower market price. To the extent that such sellers are engaged in the provision of information to consumers, their withdrawal from the market would result in the provision of less information. Potential buyers who would have valued the information therefor would forgo a benefit. It seems much more likely, however, that high-​price door-​to-​door sellers are not in the business of providing information. On the contrary, they are in the business of searching for and exploiting ignorance or, to put it differently, intercepting price-​ignorant buyers before the buyers have arrived at a conventional marketplace. These sellers’ costs are high because each salesperson must spend considerable time and effort searching for price-​ignorant buyers. The cost of that time and effort is paid for by high-​priced sales to those buyers. One way to determine how buyers value the information that door-​to-​door sellers provide is to ask the following question:  Suppose that actors behind the veil who know they may be consumers were given a choice between (1) a rule that required high-​price door-​to-​door sellers to disclose the market price of the commodity they are selling, at the cost of consumers occasionally missing out on information about the availability of a product because most above-​ market price door-​to-​door sellers would probably go out of business; or (2) a rule that did not require such disclosure, at the cost that some consumers will unknowingly pay twice or more the market price of a commodity. The phenomenon of loss aversion, and the likelihood that in time those consumers would come across market-​price information on their own, suggest that most actors would choose the former rule. If that is true, then refusing to enforce contracts with high-​price door-​to-​door sellers to their full extent would not reduce welfare even if some sellers were forced out of business. Similarly, in State v. ITM, Inc., 275 N.Y.S.2d 303 (Sup. Ct. 1966), ITM was engaged in an extensive door-​to-​ door business in which it sold appliances at prices two to three times the normal retail price—​for example, a Model 200 broiler at a cash price of $499 while its normal retail price was $199; a Model 300 broiler at a cash price of $699 while its normal retail price was $299; a central vacuum cleaner for $749 while its normal retail price was $350–​400; and color television sets at an average price of $999 while their average normal retail price was $600–​650. Id. at 320. A  study of door-​to-​door sales of cooking utensils, which compared three lines sold at retail with three lines sold door-​to-​door found that the door-​to-​door prices were two to three times as high as the retail prices. Although the door-​to-​door lines were of higher quality than the retail lines, it is unlikely that much of the price differential was accounted for by differences in manufacturing costs. Thomas E. Fish, The Direct Sale of Cooking Utensils 46–​47 (May 24, 1957) (unpublished M.B.A. thesis, University of California, Berkeley) (on file with the University of California, Berkeley, Graduate School of Business Library).

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3.  Extension of Credit There is still another possible explanation for above-​market prices for consumer goods in particular marketplaces. A 1966 Federal Trade Commission survey found that retail stores that sell goods in low-​income neighborhoods often charge double the price charged by general retailers.47 These stores do not necessarily trade on buyers’ ignorance concerning market prices. Instead, what likely explains their above-​market prices is that the prices impound a credit term. Consumers often buy goods on credit. Most of these consumers use credit cards or charge accounts on which they pay significant but not terribly high interest rates. However, low-​income consumers frequently do not qualify for either credit cards or conventional charge accounts because they lack creditworthiness. If a buyer at a low-​income-​ neighborhood store needed credit, and the store extended a loan to her at an interest rate that accurately reflected her creditworthiness, the interest rate probably would violate the usury laws. Those laws, however, can often be easily evaded. One way to evade those laws is to impound the loan into the price of the goods by raising the price to include the cost of the loan. Accordingly, the prices charged by low-​income-​neighborhood stores, may be much higher than the prices charged by general retailers because the prices charged by the low-​income-​ neighborhood sellers consists of both the price of the good and the price of credit. This technique often passes muster under the usury laws as a result of the time-​price doctrine. Under this doctrine the usury laws are not deemed applicable if in form there is no loan but only a stated price to be paid in stated installments. It is not an easy question whether a time price should be deemed unconscionable on the ground that if the impounded loan was separately stated it would be usurious. On the one hand, the usury laws may be viewed as resting on the proposition that a party who must pay an interest rate above that set in those laws is acting improvidently, so that a loan at that rate, explicit or implicit, would be unconscionable on the ground that the seller/​lender has knowingly exploited the buyer’s improvidence. On the other hand, if time-​price sales were deemed usurious many consumers who did not have enough creditworthiness to open charge accounts or obtain credit cards would be unable to buy durable goods such as washing machines, driers, sewing machines, television sets—​and stereo sets.

G.  SUBSTANTIVE UNCONSCIONABILITY We come now to the issue of whether pure substantive unfairness—​unfairness in the terms of a contract without regard to fairness of the bargaining process—​can render a contract unconscionable. If a promisor is the best judge of her own welfare, and there is no unfairness in the bargaining process, it might seem that the promisor should be required to keep her promise without judicial review of the fairness of the price. And indeed, many cases take the view that a contract is not unconscionable unless procedural unconscionability is shown.48 However,

47.  Fed. Trade Comm’n, Economic Report on Installment Credit and Retail Sales Practices of District of Columbia Retailers (1968). 48.  See, e.g., Gillman v. Chase Manhattan Bank, 534 N.E.2d 824 (N.Y. 1988).

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other cases have implicitly or explicitly held that substantive unfairness suffices to establish unconscionability. For example, in Toker v. Westerman49 the buyer paid $899.98 for a stripped-​ down refrigerator-​freezer, and sales tax, life insurance, and credit charges brought the total price to $1,229.76. By comparison, the normal retail price of a model was $350–​$400, and the most expensive comparably sized model, equipped with extra features, retailed for only $500. The court held that “the sale of goods for approximately 2 1/​2 times their reasonable retail value” was “shocking, and therefore unconscionable.”50 In Kugler v. Romain,51 the price for a set of books was $249.50 while the usual retail price for a comparable set was approximately $108–​$110; further, the books were shown to have less value to the buyers than advertised. The court concluded that the price was “unconscionable in relation to defendant’s cost and the value to the consumers.”52 In Jones v. Star Credit Corp.53 the buyer had purchased a food freezer for $900 plus a credit charge of over $400, while the retail price of a comparable unit was $300. The court concluded that “the value disparity itself leads inevitably to the felt conclusion that knowing advantage was taken of the plaintiffs.”54 Although the contracts in these cases were the product of door-​to-​door selling the courts’ conclusions in these and like cases cannot be explained on that ground: a contract is not unconscionable merely because it is made door to door, and the decisions in these cases did not explicitly rest upon or even invoke the concept of procedural unconscionability. Maxwell v. Fidelity Financial Services Inc.55 is a particularly striking case. Elizabeth Maxwell and her then-​husband Charles were approached in 1984 by Steve Lasica, a door-​to-​door salesman representing National Solar Corporation. The Maxwells lived in a modest neighborhood, their home was 1,539 square feet, the home was in need of significant repair and maintenance, and the market value of the home was approximately $40,000. Lasica sold the Maxwells a solar home water heater for $6,512, financed by a ten-​year 19.5 percent loan to the Maxwells from Fidelity Financial Services, a lender associated with National Solar, making the total cost of the heater nearly $15,000. The loan was secured by a lien on the Maxwells’ house. At the time of the transaction Elizabeth Maxwell earned approximately $400 per month working part-​time as a hotel maid and her husband earned approximately $1,800 per month working for the local newspaper. Elizabeth Maxwell made payments on the heater for about three-​and-​a-​half years, which reduced her principal balance to $5,733. Then in 1988 she borrowed an additional $800 from Fidelity.56 The new contract included the unpaid balance of $5,733 on the 1984 loan, a term-​life-​ insurance charge, and the new loan. The combined amount Maxwell was obliged to pay under the two loans totaled approximately $17,000, or nearly half the value of Maxwell’s home. The

49.  274 A.2d 78 (N.J. Union Cty. D. Ct. 1970). 50.  Id. at 454. 51.  279 A.2d 640 (N.J. 1971). 52.  Id. at 654. 53.  298 N.Y.S.2d 264, 266–​67 (Sup. Ct. 1969). 54.  Id. at 267. See also State v. ITM, Inc., 275 N.Y.S.2d 303, 321 (Sup. Ct. 1966) (“[T]‌hese excessively high prices constituted unconscionable contractual provisions.”). 55.  907 P.2d 51 (Ariz. 1995). 56.  The heater was never installed properly, never functioned properly, and was eventually declared a hazard, condemned, and ordered disconnected by the City of Phoenix. Id. at 53. However, the opinion in the case did not rest on these facts. Id. at 56.

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court held that a contract can be unenforceable solely because of substantive unconscionability, although it concluded that more evidence regarding the “commercial setting, purpose, and effect” in the transaction was necessary for determining the applicability of the unconscionability principle to the case: Substantive unconscionability concerns the actual terms of the contract and examines the relative fairness of the obligations assumed . . . Indicative of substantive unconscionability are contract terms so one-​sided as to oppress or unfairly surprise an innocent party, an overall imbalance in the obligations and rights imposed by the bargain, and significant cost-​price disparity. . . . . . . . Many courts, perhaps a majority, have held that there must be some quantum of both procedural and substantive unconscionability to establish a claim, and take a balancing approach in applying them . . . Other courts have held that it is sufficient if either is shown . . . [T]‌he leading commentators in this field have . . . endorsed [that] position. . . . Additional evidence that the dual requirement position is more coincidental than doctrinal is found within the very text of the statute on unconscionability, which explicitly refers to “the contract or any clause of the contract.” [UCC §2-​302] (emphasis added). Conspicuously absent from the statutory language is any reference to procedural aspects. That the UCC contemplated substantive unconscionability alone to be sufficient is the most plausible reading of the language in [§2-​302], given that the Code itself provides for per se unconscionability if there exists, without more, a substantive term in the contract limiting consequential damages for injury to the person in cases involving consumer goods. . . . It is wholly inconsistent to assert that unconscionability under [§2-​302] requires some procedural irregularity when unconscionability under [§2-​719] clearly does not. Therefore, we conclude that a claim of unconscionability can be established with a showing of substantive unconscionability alone, especially in cases involving either price-​cost disparity or limitation of remedies. . . . 57

The price that Maxwell paid for the solar water heater was reasonable at the time.58 Presumably, the interest rate on the loan was also reasonable. Accordingly, Maxwell cannot be explained away as a sale at an above-​market price through the exploitation of price-​ignorance. Instead, Maxwell seems to be a case involving the unfairness of entering into a transaction in which the price was grotesquely lopsided in proportion to the value of the heater to the consumer (and remember, this was only a water heater, not a house heater) based on the consumer’s income and value of the house. McKee v. AT&T Corp.59 is an example of a case involving substantive unfairness of nonprice terms. Michael McKee lived near Wenatchee, Washington. In November 2002, he signed up for AT&T long-​distance phone service. McKee’s monthly AT&T bills included Wenatchee’s utility-​ tax surcharges even though McKee lived outside Wenatchee. The surcharges amounted to no more than $2 in any given month. When McKee called AT&T to resolve this issue he was told that taxes were assessed by a zip code that included customers who lived both inside and outside

57.  Id. at 58–​59. Throughout this quote from Maxwell, citations to the U.C.C. replace the court’s citations to the Arizona version of the U.C.C. 58.  Memorandum from Jennifer Beerline to Melvin A. Eisenberg (June 15, 2008). 59.  191 P.3d 845 (Wash. 2008).

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Wenatchee. After his attempts to resolve his billing issues with AT&T failed McKee filed a class action lawsuit alleging violations of Washington’s Consumer Protection Act and usury statute. AT&T then moved to compel arbitration under its Consumer Services Agreement, a form contract that McKee had signed. Section 7 of the Agreement required binding arbitration of all disputes related to the Agreement, prohibited class actions, and required arbitrations to be kept confidential. The Agreement also provided that consumers had to reimburse AT&T for all costs and expenses in collecting charges and defending claims, while arbitrators were expressly forbidden to award attorneys’ fees to the consumer except where expressly authorized by a statute. McKee opposed the motion to compel arbitration on the ground that the Agreement was substantively and procedurally unconscionable. The court held that “substantive unconscionability alone is sufficient to support a finding of unconscionability” and concluded that AT&T’s arbitration provision was substantively unconscionable on several grounds. The waiver of the right to bring a class action was substantively unconscionable because the consumers’ individual claims were so small that without access to class-​wide relief competent counsel would be unavailable. The confidentiality clause was substantively unconscionable because it unreasonably favored a repeat player such as AT&T and disfavored a consumer such as McKee: confidentiality concealed any patterns of illegal or abusive practices and ensured that AT&T would accumulate a wealth of knowledge about arbitrators, legal issues, and tactics while consumers would have to reinvent the wheel in every claim. The attorney’s fee provision was substantively unconscionable because it was so lopsided. The court added, “[H]‌aving held below that the entire dispute resolution provision is substantively unconscionable, we find it unnecessary to reach the issue of procedural unconscionability.”60 And several courts have found class-​action waivers are substantively unconscionable in consumer contracts when the costs of pursuing the claim far outweigh the amount in controversy.61 Whether a contract is unconscionable normally turns in significant part on whether the promisor engaged in morally improper conduct. If the promisor has engaged in the exploitation of duress, transactional incapacity, or price-ignorance, or in price-gouging, unfair surprise, or the like, why should she be able to enforce the contract? Both friends and foes of unconscionability have tended to view the entire doctrine as paternalistic.62 This view is incorrect. To the extent that unconscionability rules are based on prohibitions against profiting from morally improper conduct the doctrine of unconscionability is no more paternalistic than the doctrines of fraud or duress: it is not paternalistic to refuse to enforce a contract obtained through morally improper conduct. However, a rule that allowed courts to refuse to enforce a contract purely on the ground that the promisor should not have entered into a contract because the cost to the promisor far outweighed any conceivable benefits could reasonably be regarded as paternalistic.

60.  Id. at 860. See also Lowden v. T-​Mobile USA, Inc., 512 F.3d 1213 (9th Cir. 2008). 61.  See, e.g., Ting v. AT&T, 319 F.3d 1126, 1150 (9th Cir. 2003); Luna v. Household Fin. Corp. III, 236 F. Supp. 2d 1166, 1178–​179 (W.D. Wash 2002); Wigginton v. Dell, Inc., 890 N.E.2d 541, 547 (Ill. App. 3d 2008); Whitney v. Alltel Commc’ns, Inc., 173 S.W.3d 300, 313–​14 (Mo. App. 2005); Fiser v. Dell Computer Corp., 188 P.3d 1215, 1221 (N.M. 2008); Vasquez-​Lopez, v. Beneficial Or., Inc., 152 P.3d 940, 949–​51 (Or. App. 2007); Coady v. Cross Country Bank, Inc., 729 N.W.2d 732, 745–​48 (Wis. App. 2007). 62.  See Seana Valentine Shiffrin, Paternalism, Unconscionability Doctrine, and Accommodation, 29 Phil. & Pub. Aff. 205, 221 (2000).

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That in itself would not be a fatal blow to such a doctrine. Paternalism is everywhere and is often highly desirable. Tenants may be paternalistically prohibited from entering apartment houses that could collapse in the aftermath of an earthquake, even if the tenants are informed about and willing to take the risk. Automobile drivers are paternalistically required to wear seat belts. Automobile manufacturers are paternalistically prohibited from making cars, and therefore consumers are unable to buy cars, that do not have specified safety features. Pharmaceutical companies are paternalistically prohibited from marketing drugs if the FDA determines that the drugs’ risks outweigh its benefits even if patients want the drugs and have no better alternative. Teenagers cannot bind themselves to contracts. Adults cannot bind themselves to indentured servitude. As these examples illustrate, whether a legal doctrine is paternalistic is a nonissue. The real issue is whether a doctrine is improperly paternalistic. Furthermore, if the doctrine of substantive unconscionability is paternalistic at all it is a very diluted form of paternalism. Under that doctrine the government forbids nothing and commands nothing. It simply says to the promisee, “If you can accomplish your ends without our assistance, fine. But don’t ask us to help you recover a pound of flesh.” As Seana Shiffrin has pointed out: [T]‌he institution of contract is an institution in which the community assists people who make agreements by providing a measure of security in those agreements. We may provide this assistance to one another for many reasons. Primary among them is that the institution facilitates agreements and transactions between strangers as well as people who lack a sufficient basis for an independently generated mutual trust . . .  Given this conception, the questions relevant for our inquiry are: whether it is reasonable to construct the institution such that its terms of assistance are qualified and provide security for only some of the voluntary agreements people may wish to make. . . . [The answer is that we] are not compelled to further (or to make possible) the projects of promisors, just because those agents act freely. . . . [U]‌nless we assume that one must ensure that others’ obligations are met, the promisor’s genuine responsibility does not entail that. . . . [the community] must undertake such enforcement through the forceful means and resources of a legal system. . . . The state may often, and perhaps should often, assist parties who make agreements. Its motivation for providing such assistance may be, in part, to create a supportive environment for such agreements and for the development and expression of autonomously formed aims. But viewing autonomous agreements as worthy of respect does not entail relinquishing one’s own capacities to exercise independent moral judgment or to set distinct priorities for action. . . . In deciding whether to join the endeavor of others, it is often permissible to consider its content. Even were respect for autonomy to require noninterference with voluntary, but unconscionable, agreements, it would not necessitate assistance in making and implementing them . . .63

In any event, the doctrine of substantive unconscionability may be justified on fairness grounds where a promisee knew or should have known that the promisor was improvident in

63.  Id. at 221–​24.

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entering into the contract and exploited that improvidence. Recall that the German Civil Code provides that: [A]‌legal transaction is void by which a person, by exploiting the predicament, inexperience, lack of sound judgment . . . of another, causes himself . . . to be promised or granted pecuniary advantages which are clearly disproportionate to [the value of his] performance.64

Similarly, the Principles of European Contract Law provide that: (1)  A party may avoid a contract if, at the time of the conclusion of the contract: (a) it was . . . improvident, . . . and (b) the other party knew or ought to have known of this and, given the circumstances and purpose of the contract, took advantage of the first party’s situation in a way which was grossly unfair . . . 65

The sale of a Kirby vacuum cleaner that costs twice as much as the value of the buyer’s only rug is an example of improperly taking advantage of a promisor’s improvidence. Maxwell too seems to fall within this category: Maxwell agreed to pay almost half the value of her house for a solar water-​ heating system when a non-​solar water-​heating system probably would have cost a fraction of that amount.66 As was said in another unconscionability case,67 AT&T carried a good joke too far. The principle that courts may properly refuse to enforce a contract on the ground that it was so improvident that inducing the promisor to make the contract was unconscionable is not free from doubt. The difficulty is illustrated by Williams v. Walker-​Thomas, discussed above. The court there focused on whether the provision that gave Walker-​Thomas the right to repossess items other than the stereo was unconscionable on the ground of unfair surprise. (The court didn’t use that term, but its approach amounted to pretty much the same thing.) However, another problem in the case was not addressed. Williams was living on $218 per month in government support, presumably welfare. From this amount she had to feed, clothe, and support herself and her seven children. Suppose the issue had been framed in terms of whether it was unconscionable for Walker-​Thomas to have sold Williams the stereo considering the price of the stereo, on the one hand, and Williams’s income and the needs of herself and her seven children, on the other. Although Williams’s purchase of the stereo may seem to have been improvident

64. Bürgerliches Gesetzbuch [BGB] [Civil Code] Aug. 18, 1896, as amended, §138(2) (F.R.G.) (emphasis added), translation available at http://​www.gesetze-​im-​internet.de/​englisch_​bgb/​index.html; accord Schweizerisches Obligationenrecht [OR] [Code of Obligations] Mar. 30, 1911, as amended, art. 21(1) (Switz.). 65.  Principles of European Contract Law art. 4:  109(1) (1998) (emphasis added); accord UNIDROIT Principles of Int’l Commercial Contracts art. 3.10(1) (2004). 66.  The disparity continues. According to an article about a resurgence in the solar water-​heater market, prices for solar water heaters range from $2,000 to $10,000, including installation costs. Gwendolyn Bounds, Cheap Hot Water? Just Add Sunshine, Wall St. J., Jan. 28, 2010, at D1. By contrast, a 2008 study of water heaters generally reported typical prices of $300 to $480 for conventional storage-​tank heaters, before installation, or a total price of $600 to $780, installed. Tankless Water Heaters: They’re Efficient but Not Necessarily Economical, Consumer Rep., Oct. 2008, at 28–​29. 67.  Campbell Soup Co. v. Wentz, 172 F.2d 80, 83 (3d Cir. 1948).

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it would have been undesirable to refuse to enforce the contract solely on the ground that it was unconscionable because of Williams’s possible improvidence, since that would unduly interfere with the freedom of choice for persons in her situation. After all, Williams might have wanted to bring music, or better music, into the lives of herself and her children, and although the total price was large in relation to her income, presumably the actual monthly payments were manageable within her budget. But is Maxwell different? One possibility is that Maxwell’s contract should not be unenforceable solely on the basis of the exploitation of improvidence because there is no distinction between Maxwell and Williams for this purpose. Such a conclusion might be generalized into a rule that the exploitation of improvidence should not be an unconscionability rule. But although that conclusion is plausible, on balance it is not preferable. As Shiffren argues, there should be room for the state, through the judiciary, to conclude that a transaction is so unfair that the state will not lend its monopoly of force to the promisee for the purpose of enforcing the contract. Furthermore, it may be that Maxwell can be distinguished from Williams on the ground of scale. To paraphrase an aphorism of Paul Mishkin, at some point a difference in degree may become a difference in kind. For unconscionability purposes, the sale of a home water heater that costs half the value of the home may be not only different in degree but different in kind from the sale of a stereo to a poor family for several hundred dollars.

H.  TWO STATUTES In addition to the UCC, two types of statutes bear on the issue of substantive unconscionability. One type of statute is known as an Unfair and Deceptive Acts and Practices, or UDAP, statute. UDAP statutes have been adopted in most if not all states. The statutes vary in detail, but most if not all prohibit unfair and unconscionable conduct, and many or most vest a state agency with rule-​making power. A state-​by-​state description of UDAP statutes is published by the Consumer Law Center on the internet. The other statute is the Uniform Consumer Credit Code (UCCC), which has been adopted by about a dozen states. Section 5.108 of the UCCC is particularly relevant to substantive unconscionability, and more particularly to the interaction between procedural and substantive unconscionability: [Unconscionability; Inducement by Unconscionable Conduct . . . ] (1)  With respect to . . . a consumer credit transaction, if the court as a matter of law finds: (a) the agreement or transaction to have been unconscionable at the time it was made, or to have been induced by unconscionable conduct, the court may refuse to enforce the agreement; or (b) any term or part of the agreement or transaction to have been unconscionable at the time it was made, the court may refuse to enforce the agreement, enforce the remainder of the agreement without the unconscionable term or part, or so limit the application of any unconscionable term or part as to avoid any unconscionable result. . . . (4) In applying subsection (1), consideration shall be given to each of the following factors, among others, as applicable. . . . (b) . . . . knowledge by the seller. . . . at the time of the sale. . . . of the inability of the consumer to receive substantial benefits from the property or services sold or leased;

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(c) . . . . gross disparity between the price of the property or services sold. . . . and the value of the property or services measured by the price at which similar property or services are readily obtainable in credit transactions by like consumers. . . . (e) the fact that the seller, lessor, or lender has knowingly taken advantage of the inability of the consumer or debtor reasonably to protect his interests by reason of physical or mental infirmities, ignorance, illiteracy, inability to understand the language of the agreement, or similar factors. . . . Comment . . . 4. [Subsection (4) lists] a number of specific factors to be considered on the issue of unconscion­ ability. It is impossible to anticipate all of the factors and considerations which may support a conclusion of unconscionability in a given instance so the listing is not exclusive. The following are illustrative of individual transactions which would entitle a consumer to relief under this section . . .  Under subsection (4)(b), a sale to a Spanish speaking laborer-​bachelor of an English language encyclopedia set, or the sale of two expensive vacuum cleaners to two poor families sharing the same apartment and one rug; Under subsection (4)(c), a home solicitation sale of a set of cookware or flatware to a housewife for $375 in an area where a set of comparable quality is readily available on credit in stores for $125 or less; Under subsection (4)(e), a sale of goods on terms known by the seller to be disadvantageous to the consumer where the written agreement is in English, the consumer is literate only in Spanish, the transaction was negotiated orally in Spanish by the seller’s salesman, and the written agreement was neither translated nor explained to the consumer, but the mere fact a consumer has little education and cannot read or write and must sign with an “X” is not itself determinative of unconscionability. . . .68

68.  Unif. Consumer Credit Code (1974).

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Donative Promises I .   S I M P L E D O N AT I VE PR OM I S ES This chapter concerns donative promises, that is, promises to make a gift. The term gift, in turn, is used in this book to mean a voluntary transfer that is made, or at least purports to be made, for affective reasons such as love, affection, friendship, comradeship, or gratitude; or to satisfy moral duties or aspirations such as benevolence or generosity; and that is not expressly conditioned on a reciprocal exchange. Donative promises fall into several categories. For example, a donative promise may be made to an individual or a social-​service institution, may or may not have been relied upon, may or may not be founded on a preexisting moral obligation, and may or may not be cast in a form to which the legal system gives special recognition. In this book donative promises that are not cast in such a form, have not been relied upon, are not based on a preexisting moral obligation, and are made between individuals who are in an affective relationship, such as family or friendship, will be referred to as simple donative promises. It is and should be a basic principle of contract law that simple donative promises are unenforceable. This principle will be referred to in this book as the Donative Promise Principle. This principle is well established in both common ​law and most civil-​law countries.1 Dougherty v. Salt2 is a leading example of the law governing simple donative promises. There, Tillie had an eight-​year-​ old nephew named Charley. One day while Tillie was visiting Charley and his guardian, she made out and handed to Charley a promissory note to pay Charley $3,000 at her death or before. The note recited that it was for value received, but it was clear that the promise embodied in the note was donative—​that is, it was a promise to make a gift to Charley. When Tillie died the note was still unpaid, and Charley brought suit against her estate. The New York Court, in an opinion written by Judge Cardozo, held that although Tillie’s promise was in writing and recited that 1.  In contrast, completed gifts, including gifts made by delivery of a written conveyance, are normally not reversible. See Ray Andrews Brown, The Law of Personal Property §§ 7.2, 7.10 (Walter B. Raushenbush ed., 3d ed. 1975). Under cover of this rule the courts may occasionally enforce a written donative promise by treating it as a conveyance. See Faith Lutheran Retirement Home v. Veis, 473 P.2d 503, 507 (1970); Judson L. Temple, Note, Gifts Effected by Written Instrument: Faith Lutheran Retirement Home v. Veis, 35 Mont. Law Rev. 132, 140 (1974). Similarly, under the law of trusts a person can effectively declare himself trustee of a thing on another’s behalf, and under cover of this rule the courts may occasionally enforce a donative promise by treating it as a declaration of trust. See Brown supra, § 7.21. 2.  125 N.E. 94 (N.Y. 1919).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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value had been received, the promise was simply “the voluntary and unenforceable promise of [a]‌gift” and therefore unenforceable.3 It is widely accepted that there is a moral obligation to keep a promise. Certainly that is so as a matter of social morality, and contributions by various philosophers make a showing that it is also so as a matter of critical morality.4 Why then should not all promises, including simple donative promises, be enforceable? The answer is that the question, what kinds of promises should the law enforce, should not be confused with its cousin, what kinds of promises are actors morally obliged to keep? The law should be based not only on morality but also on policy and experience, and for reasons of policy and experience the law should refuse to enforce certain types of promises that for reasons of morality should be kept. The phenomenon of conduct that is morally but not legally required or prohibited is not restricted to promises. In some cases, such as cutting in line, the injury caused by the violation of a moral norm is not significant enough to justify the cost of creating and enforcing a legal sanction. In other cases, such as the failure to support aged parents, making a moral norm legally enforceable would intrude too far, without sufficient justification, into intimate areas. In still other cases, policy and experience may look in a different direction than morality does. Accordingly, as Thomas Scanlon has said, “The fact that some action is morally required is not, in general, a sufficient justification for legal intervention to force people to do it; and the rationale for the law of contracts does not seem to be . . . an instance of the legal enforcement of morality.”5 In short, the moral obligation to keep a promise is a strong starting point for concluding that there should be a legal obligation to keep a promise, but it is not the end of the inquiry. To get to the end of the inquiry it is necessary to also consider issues of policy and experience raised by any given class of promises. Simple donative promises are the major class of promises that are not legally enforceable—​ that lack consideration. Accordingly, such promises provide a critical entry point into the question why some types of promises are unenforceable. The legal treatment of simple donative promises also carries heavy social freight. The concept that bargain promises are legally enforceable, while donative promises are not, implicates fundamental questions of social value. The unenforceability of simple donative promises also bears directly on one of the deepest questions of contract law: whether contract law should be based on the deontological objective of ensuring that promisors keep their promises because it is morally right that promises be kept, or on utilitarian objectives such as compensating injured promisees and increasing social wealth. In the context of donative promises the issues of policy and experience have been the subject of continuing controversy. The stage-​setting work is Lon Fuller’s classic article, “Consideration and Form.”6 Fuller posited that both substantive and formal issues—​we might now say substantive and process issues—​were relevant in determining whether a given class of promises should be enforceable. Process issues in this context include evidentiary concerns, concerns about the deliberativeness with which a given type of promise is characteristically made, and concerns of administrability. Substantive issues involve the social reasons, other than process concerns, why a given class of promises should or should not be enforced. The two kinds of issues are related. In

3.  Id. at 95. 4.  See Thomas M. Scanlon, Promises and Practices, 19 Phil. & Pub. Aff. 199 (1990). 5.  Thomas M. Scanlon, Promises and Contracts, in The Theory of Contract Law:  New Essays 86, 99–​100 (Peter Benson ed., 2001). 6. 41 Colum. L. Rev. 799 (1941).

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particular, the stronger the substantive interest in enforcing a given class of promises the readier the law should be to tolerate process concerns. Unlike bargain promises, simple donative promises raise several process concerns. To begin with, simple donative promises raise serious evidentiary concerns. Such promises are often made out of the blue with no evidentiary context, no witnesses, and no writing. Accordingly, it would be too easy, or so it may be thought, for a plaintiff to counterfeit such a promise and falsely convince a jury that the promise was made, particularly where the promisor died before suit was brought and therefore could not testify. Next, if a person is to come under a legal obligation simply by virtue of having made a promise, it might at least be required that the promise be of a type that is usually made in a deliberative manner. In the case of simple donative promises, however, the promisor is often emotionally involved with the promisee and tends to look mainly to the promisee’s interests rather than her own. Accordingly, such a promise is more likely to be uncalculated than deliberative. Indeed, such promises are frequently made in an emotional state brought on by a surge of gratitude, an impulse of display, or some other intense but only transient emotion. For example, in Dougherty v. Salt Tillie made her promise only after she had told Charley’s guardian that she wanted to take care of Charley and the guardian taunted her by responding, “I know you do, Tillie, but your taking care of the child will probably be done like your brother and sister done, taking it out in talk.”7 It is sometimes argued in favor of enforcing donative promises that a bargain promise, which is legally enforceable, may be rash (for example, a bid in a heated auction) while a donative promise may be deliberately made. In a world with perfect and costless information the law might individually examine every promise of whatever kind to determine whether the promise was deliberately made. In the real world, however, such an inquiry would be chancy and the prospect of such an inquiry would reduce the value of bargain promises. Accordingly, in determining whether a given type of promise should be enforceable the type should be examined at wholesale, as a class, not at retail, one by one. Although it is true that some bargain promises are rashly made, observation suggests that this is not a common phenomenon, particularly in bargains between commercial actors. In any event, this point does not address other reasons why bargain promises should be enforceable but simple donative promises should not. Another concern lies on the border between process and substance. If simple donative promises were made legally enforceable solely on the ground that there is a moral obligation to keep promises, they should be no more enforceable than the underlying moral obligation they create. All promises are subject to certain relatively well-​specified moral (and legal) excuses, such as incapacity, but simple donative promises are likely to be subject to many additional and extremely fluid moral excuses, such as “I find that I unexpectedly need a lot of money for my new business,” or “for a retirement home,” or “for my sick nephew,” and on and on. In particular, the obligation created by a donative promise may be excused by acts of the promisee amounting to ingratitude, or by a change in the personal circumstances of the promisor that would make it improvident to keep the promise. If Uncle promises to give Nephew $50,000 in two years, and Nephew later wrecks Uncle’s living room in a drunken rage, no one, not even Nephew, is likely to expect that Uncle remains morally obliged to keep his promise. The same result should follow if Uncle suffers a serious financial setback and is barely able to take care of the needs of his immediate family,

7.  125 N.E. 94 (N.Y. 1919).

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or if Uncle’s wealth remains constant but his personal obligations significantly increase in an unexpected manner, as through marriage, the birth of children, or illness, or perhaps even if Uncle’s wealth and personal obligations both remain constant, but due to his miscalculation the gift would jeopardize his ability to maintain himself in the manner to which he is accustomed. The need to recognize these kinds of excuses as defenses if simple donative promises were enforceable is evidenced by the civil law. Under the German Civil Code, for example, a donative promise is normally enforceable if the promise is in writing and authenticated by a notary—​a special type of lawyer in civil law countries who combines the roles of family counselor and specialist in the drafting of personal instruments, such as conveyances and wills. The notarial formality ensures due deliberation and brings home to the promisor that she is entering into a transaction with legal implications. However, the German Civil Code does not stop its treatment of donative promises there, but instead goes on to provide extensive treatment of circumstances arising after an otherwise enforceable donative promise has been made. Under article 530(1) a donative promise may be revoked “if the donee, by any serious misconduct towards the donor or a close relative of the donor shows himself guilty of gross ingratitude.”8 Under article 519 “[a]‌ donor is entitled to refuse fulfillment of a promise made gratuitously insofar as, having regard to his other obligations, he is not in a position to fulfill the promise without endangering his own reasonable maintenance or the fulfillment of obligations imposed upon him by law to furnish maintenance to others.”9 The Code also places substantial limits on the power of an individual to disenfranchise his immediate family by either gift or will.10 Comparable limits are found in the French Civil Code. As these civil code rules suggest, our own legal system could not appropriately make donative promises enforceable unless we were also prepared to follow the civil law by developing and administering a body of rules dealing with fluid moral excuses such as ingratitude and improvidence. Certainly such an enterprise is possible, but the administrative problems the enterprise would entail must be given weight, because the equilibria of affective relationships are often too subtle to be easily regulated by legal rules. An inquiry into improvidence involves the measurement of wealth, lifestyle, dependents’ needs, and even personal utilities. An inquiry into ingratitude involves the measurement of a maelstrom, because many or most donative promises arise in an intimate context in which emotions, motives, and cues are invariably complex and highly interrelated.11

8.  See Bürgerliches Gesetzbuch [BGB] [Civil Code] § 530(1), translation at https://​www.gesetze-​im-​ internet.de/​englisch_​bgb/​englisch_​bgb.html (Ger.). For example, in Bundesgerichtshof [BGH] [Federal Court of Justice] Jan. 30, Juristische Rundschau 263, 1970 the court held that a donee-​daughter was ungrateful on the ground that she had voluntarily confirmed to the police her husband’s denunciation of her parents for pandering (by tolerating the adultery of the donee’s daughter, who lived with the donee’s parents) and the pandering charges were dropped by the prosecutor for lack of evidence. 9.  Id. § 519. 10.  See id. §§ 528, 530. See also Code Civil [c. civ] [Civil Code] French Civil Code arts. 953, 955, 960 (Fr.). 11.  Cf. Reichsgericht [RG] [Empire Court of Justice] Mar. 27, 1916, Juristische Wochenschrift [JW] 833, 1916. (son’s harsh words about father had to be seen in the context of father’s provocation); RG, Oct. 30, 1907, JW 744, 1907. (in determining whether donee’s actions constitute gross ingratitude, it is relevant whether he acts under the subjective impression that the donor has committed serious provocation).

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Given the various process concerns that enforcement of simple donative promises would entail the question then becomes whether the substantive reasons for enforceability of such promises are strong enough to outweigh the process problems. Fuller thought not. He concluded that while “an exchange of goods . . . conduces to the production of wealth and the division of labor, a gift is, in Bufnoir’s words, ‘a sterile transmission.’ ”12 This is probably an oversimplification. Taken as a class, gifts tend to redistribute wealth to donees who have more utility for material possessions than their donors.13 However, it is questionable whether redistribution of wealth is an appropriate goal of contract law, and even if it is, the enforcement of donative promises would be a relatively trivial instrument for achieving that end. Similarly, although a donative promisee suffers an injury if the promise is broken, unless he has relied upon the promise the injury is likely to be relatively slight, consisting primarily of disappointment and hurt feelings. Furthermore, the effect on the actual amount of gifting if simple donative promises were enforceable is indeterminate. It is possible that more gifting would occur because unwilling donative promisors would then be forced to keep their promises. However, it is also possible that less gifting would occur: probably many donative promisors make gifts only because they have earlier promised to do so, and some prospective donative promisors might refrain from promising in the first place if they knew the promise was legally enforceable. Richard Posner adduces further reasons for and against enforcing simple donative promises.14 He argues that the present value of a donative promise to the promisee must take account of the probability that the promise will not be performed. Accordingly, an enforceable donative promise will have greater present value to the promisee than an unenforceable promise. Moreover, since the utilities of a donative promisor and a donative promisee are usually interdependent, if the promise has greater value to the promisee the promisor herself will derive greater value from the promise. Therefore, Posner argues, under an unenforceability regime a donative promisor who wants to confer upon a promisee a present value of $100 must promise to give more than $100, while under an enforceability regime the promisor need only promise to give $100.15 In the end, however, Posner concludes that donative promises should not be enforceable because of the process costs that would be involved, including the cost of litigation and the cost of legal error, that is, the cost of determinations that a donative promise had been made when in fact it had not.16 Moreover, Posner argues, because donative promises typically arise in a familial context, a donative promisee will often have social sanctions at his disposal that may be as or more effective than legal sanctions.

12.  See Fuller, supra note 6, at 815; Claude Bufnoir, Propriété et Contrat 487 (2d ed. 1924). 13.  A redistribution is also not sterile in that it may enhance the utilities of both donor and donee. See Harold M. Hochman & James D. Rodgers, Pareto Optimal Redistribution, 59 Am. Econ. Rev. 542, 542–​43 (1969). 14.  Richard A. Posner, Gratuitous Promises in Economics and Law, 6 J. Legal Stud. 411 (1977). 15.  As a practical matter this argument is probably inapplicable in many or most cases because it depends on the promisor’s forming a belief that the promisee thinks there is a significant likelihood that the promise will not be kept. A donative promisee may well so think, but a donative promisor is unlikely to believe that the promisee so thinks, and often or usually the promisor would consider the promisee ungrateful for even entertaining such a thought. 16. Posner, supra note 14, at 411–​15.

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Goetz and Scott come to a similar conclusion following a different route.17 They point out that a promise of any kind allows the promisee to engage in beneficial reliance—​actions that would make the promise more valuable if it is kept. For example, suppose Aunt promises to put her teenage Niece through college. Niece can increase the value of Aunt’s promise by taking high-​school courses that will prepare her for college, rather than vocational courses that would prepare her for the job market as soon as she graduates high school, which is what she would do if the promise had not been made. The more certain it is that a promise will be kept, the more the promisee can prudently engage in beneficial reliance and the more valuable the promise will be.18 In the end, however, Goetz and Scott also support an unenforceability regime. By making a promise, they point out, a promisor is obliged to forgo opportunities that she would have had if she had not made the promise. Often these lost opportunities will cause the promisor to regret having made the promise. To avoid such regrets, a promisor can make her promise subject to a variety of explicit conditions. For example, instead of saying, “I will give you this rug in two years,” a promisor might say, “I will give you this rug in two years if I don’t decide before then to move to a larger house” or “if my son doesn’t decide that he wants the rug,” and so forth. Under an unenforceability regime, a full specification of regret conditions is unnecessary. If, on the other hand, simple donative promises were enforceable, then unless donative promisors explicitly and heavily conditioned their promises they might often be required to perform under circumstances that would lead them to regret having made the promise. Since the social context in which simple donative promises are made might inhibit the making of heavily conditioned promises, if simple donative promises were enforceable many potential donative promisors would probably prefer making no promise at all to making a heavily conditioned promise. Therefore, an enforceability regime might lead to less gifting rather than more. Goetz and Scott’s point may be slightly recast as follows. In commercial contexts parties contract on the basis of the commercial preferences they have and expect to still have at the time of performance. Usually, a commercial promisor can make a good forecast of its future preferences, because commercial preferences normally remain relatively stable. (Of course, the market may move against a promisor, but that doesn’t mean her commercial preferences change, only that those preferences have been frustrated.) In contrast, the nature of intimate relationships, and therefore personal preferences, in affective contexts frequently change during the period between the time a contract is made and the time performance is due. Unfortunately, a person who makes a simple donative promise may not realize that her personal preferences and her relationship with the promisee may very well change, and even if she does realize that, she will find it very difficult to forecast her future personal preferences and the future state of the relationship. As a result, when a donative promise is made, the conditions under which the promisor will want to make the promised gift when the time comes for performance are likely to be radically underspecified. That doesn’t make too much difference if simple donative promises are unenforceable, because under an unenforceability regime the promisor need not specify those 17.  Charles J. Goetz & Robert E. Scott, Enforcing Promises: An Examination of the Basis of Contract, 89 Yale L.J. 1261 (1980). 18.  On the other hand, in a seminar on the theory of contracts Gordon Fauth pointed out that a donative promisor might prefer promisee uncertainty. By promising a $5,000 gift in the future, the promisor may secure the attention of the promisee to her wishes over the life of the promise, something that an outright gift or an enforceable donative promise might not accomplish.

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conditions. Under an enforceability regime, however, those conditions would need to be fully specified, and it would be extremely difficult to make all the necessary forecasts and extremely cumbersome to make all the conditions explicit. Recently, a number of commentators have criticized the Donative-​Promise Principle. Jane Baron’s criticism is representative.19 Baron argues that gifts as well as bargains involve exchanges and reciprocity, because a gift must not only be given but accepted, and the acceptance of a gift by a donee often entails the assumption of certain social obligations to the donor. Since gifts, like bargains, involve exchange and reciprocity, Baron concludes that the markedly different treatment of donative and bargain promises shows that the law reflects a social devaluation of gifts. In short, in Baron’s view the real reason for the Donative-​Promise Principle is that bargain promises are deemed socially important whereas donative promises are not. To consider Baron’s argument it is useful to compare the world of contract and the world of gift. Although contract is sometimes defined to mean any legally enforceable promise,20 the social meaning of contract carries the narrower connotation of bargained-​out deals. In this book, the term contract is used in that narrower sense, and the term world of contract is used to mean the hard-​edged, primarily commercial world in which deals are made. As mentioned, the term gift is used to mean a voluntary transfer made for affective reasons or to satisfy moral objectives, and is not explicitly or implicitly conditioned on an exchange that is seen as the price of the voluntary transfer. The term world of gift is used in this book to include both gifts and promises to make gifts. This departs somewhat from conventional legal usage, because the common law draws exceptionally sharp distinctions between gifts and promises to make gifts. Gifts are irrevocable; promises to make gifts are unenforceable. Gifts are part of property law; promises to make gifts are part of contract law. The term world of gift is used here in a more inclusive way, to include both gifts and promises to make gifts—​not because there are no meaningful distinctions between the two but because the manner in which the law should treat promises to make gifts is intimately related to the nature of gifts. Although it is true, as Baron states, that gifts may involve exchange and reciprocity, unlike commercial contracts they need not involve either. Consider, for example, anonymous gifts, gifts to strangers, and services to the dying. More important, in our culture when a gift is followed by reciprocity or exchange the reciprocity or exchange is qualitatively different than in a bargain. In a bargain what each party transfers is seen as the price of what the other party transfers. In a gift that is not the case. Indeed, if it is the case there is no gift. Reciprocity or a kind of exchange may very well occur, but if it does occur it is not viewed, or at least is not purportedly viewed, by the parties as the price of the original transfer; and that is true even if the donor hoped for or expected reciprocity by the donee. There are vital economic, social, and psychological differences between hoping for or expecting an unspecified reciprocal exchange that is not viewed as the price of the original transfer, on the one hand, and requiring a specified exchange that is viewed as the price of the original transfer, on the other. Accordingly, even if a donor hopes for or 19.  Jane B. Baron, Gifts, Bargains, and Form, 64 Ind. L.J. 155 (1989). See also, e.g., Robert A. Prentice, “Law &” Gratuitous Promises, 2007 U. Ill. L. Rev. 881, 928–​30; E. Allen Farnsworth, Promises to Make Gifts, 43 Am. J. Comp. L. 359, 367–​68 (1995); Carol M. Rose, Giving, Trading, Thieving and Trusting: How and Why Gifts Become Exchanges and (More Importantly) Vice Versa, 44 Fla. L. Rev. 295 (1992); Carol M. Rose, Giving Some Back—​A Reprise, 44 U. Fla. L. Rev. 365, 370 (1992); Steven Shavell, An Economic Analysis of Altruism and Deferred Gifts, 20 J. Legal Stud. 401, 419–​20 (1991). 20.  See, e.g., Restatement Second § 1 (Am. Law Inst. 1981) [hereinafter Restatement Second].

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expects reciprocity, she cannot require or demand reciprocity without transforming her transfer from a gift into a bargain. For example, suppose that A gives a beautiful silver ring to B, and shortly thereafter B gives a beautiful watch to A or makes love to A. If, when A gave B the ring, A said, “I will give you this ring if you agree to give me back a watch in return,” or “I will give you this ring if you agree to make love to me tonight,” A has made a bargain, not a gift. If, on the other hand, A states no condition when giving the ring to B, and B later gives A the watch or makes love with A, and A and B do not view the watch or the lovemaking as the price of A’s ring, but rather as an act of affection or love, there is a gift notwithstanding that there is a strong element of reciprocity in B’s action. Just as a transfer is not a gift if it is conditioned on a reciprocal transfer that is purportedly a price, so a reciprocal transfer is not a gift if it is purportedly a payment. For example, suppose that A gives B a wedding present worth $500, and subsequently B gives A $500 for A’s own wedding and says, “I am giving you $500 as a gift to pay you for your wedding present to me.” Or suppose that A gives B a friendship ring, and B gives A a ring in return, stating, “I am giving you this ring as a gift to pay you for your ring.” In both cases, despite B’s use of the word gift the reciprocal transfer would not be a gift. Indeed, in both cases the reciprocal transfer would be more likely to poison the relationship between A and B than to promote it. The difference between gifts and bargains is reflected in a cluster of other attributes. For example, a bargain is about commodities—​using that term in its broadest sense to include anything that can be purchased and sold—​and focuses on the amount of money and the monetary value of the commodity that the parties agree to exchange. In contrast, gifts are about affective relationships or the achievement of moral duties or aspirations. In bargains, commodities are ends in themselves; in gifts, commodities are means to an end. In bargains, the nexus between the parties is the commodity; in gifts, the nexus between the parties is their affective relationship or their common moral or aspirational objective. Of course, a gift often consists of an object, but a gift is not simply the transfer of an object. In an affective relationship the significance of a gifted object lies not just in the material value the transferee places on the object but also or more in the totemic manner in which the gifted object reflects or manifests the relationship between the donor and the donee. The totemic aspect of gifted objects is reflected in various ways. For example, a party who has bargained for a commodity is free to immediately resell the commodity in the market. In contrast, a donee who immediately sold a gifted object would normally insult the donor by treating the object purely as a commodity rather than as a totem of the relationship. Indeed, the totemic aspect of gifted objects may lead a prospective donee to decline a gift, even though the gift has monetary value and the donee is not required to provide anything tangible in exchange, because the gift would be an inappropriate totem. For example, if A and B are dating, A may refuse an expensive gift from B because the gift would imply an intensity to the relationship that A does not feel. Similarly, if A is a young adult she may reject a large gift of money from her parents because accepting the gift would compromise her efforts to become psychologically independent. In both cases the affective cost of the gift to the donee would outweigh its monetary value. In contrast, a person who is offered a commodity in a bargain transaction will normally accept or reject the offer based on the difference between his monetary value for the commodity and the price. The totemic aspect of a gifted object is one reason donors usually make gifts of objects rather than equivalent amounts of cash. Cash is a cold, market commodity, whereas objects are often invested with warmth. Furthermore, the gift of an object, rather than cash, shows that the donor not only cares about the donee but has thought about the donee’s special characteristics and has expended on the donee not simply money, which is a market element, but time, thought, and

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trouble, which are personal elements. Perhaps most important, an object, unlike cash, constitutes and persists as a totemic embodiment of the affective relationship between the donor and the donee. (These factors also help explain why donors often give gift certificates rather than an equal amount of cash. Although a gift certificate may be an imperfect substitute for an object, it is sufficiently specific to require and reflect some thought about the donee, its acquisition entails some time and effort by the donor, and it can be converted into a totemic object.) The special value of gifted objects, as opposed to cash, in most situations, is unwittingly illustrated in an article by an economist, Joel Waldfogel, “The Deadweight Loss of Christmas.”21 Waldfogel concluded that a gift of an object rather than cash is inefficient, because although a donor might choose a gift that the recipient values above its price, “it is more likely that the gift will leave the recipient worse off than if she had made her own consumption choice with an amount of cash equal to the amount the gift-​giver paid for the gift.”22 Waldfogel based his conclusions on two surveys of undergraduate economics students. In both surveys each student was asked to estimate the total amount paid by gift-​givers for all the holiday gifts the student received in Christmas 1992. In one survey the students were then asked, “[a]‌part from any sentimental value of the [gifted] items, if you did not have them, how much would you be willing to pay to obtain them?”23 (Emphasis added.) The respondents collectively estimated that donors paid an average of $438 for the donees’ total gifts but expressed a willingness to pay only an average of $313 for the same gifts. Waldfogel concluded that “the average ratio of value to estimated price—​or average ‘yield’—​was 66.1 percent24 and the deadweight loss for noncash gifts actually exceeds one-​third.”25 In the second survey the respondents were asked to estimate their value for the gifts as the “amount of cash such that you are indifferent between the gift and the cash, not counting the sentimental value of the gift.”26 (Emphasis added.) The respondents in this survey estimated that $509 was paid for their gifts but, Waldfogel reported, they valued these gifts at only $462.27 Averaged across gifts, the yield on noncash gifts was 83.9 percent, “suggesting,” Waldfogel concluded, “a deadweight-​loss fraction of 16.1 percent.”28 In fact, however, Waldfogel naively misunderstood his own data. Waldfogel never asked the students how they valued the gifts. Instead, he asked only how they valued the gifts apart from sentimental value. Having instructed the students to eliminate sentimental value from their responses, Waldfogel then took it upon himself to eliminate sentimental value from the value to the students, thereby substituting his own utility calculus for those of the student respondents. In a seminar on the theory of contracts, Ed Anderson, then a student at Berkeley, made another criticism of Waldfogel’s methodology: Waldfogel’s article presents itself as being quite a bit more scientific than it actually is. In particular, he has not eliminated other potential ways to read his data. Waldfogel is measuring utility 21.  Joel Waldfogel, The Deadweight Loss of Christmas, 83 Am. Econ. Rev. 1328 (1993). 22.  Id. 23.  Id. at 1331. 24.  Id. 25.  Id. at 1332. 26.  Id. at 1331. 27.  Id. at 1332. 28.  Id.

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Moral Elements in Contract Law by comparing what students estimate the gift-​giver paid (price) against what the students say they themselves would pay for the identical gift (value, survey 1) and against the amount for which the students would sell the gift (value, survey 2). [In Waldfogel’s view,] the average ratio of value/​price in both surveys of less than one represents persistent inability of the gift-​ giver to efficiently fulfill the desires of the recipient (resulting in the overall deadweight loss of utility). . . . Notice, however, that the data [are] also consistent with a model of perfectly efficient utility matching, but persistently biased estimates of relative bargain-​hunting abilities. On average, the students estimate that their givers paid higher prices than they themselves would have paid. Couldn’t one conclude that the students consistently, but erroneously, see themselves as better shoppers than their benefactors? . . . I suspect Waldfogel’s data is at least partially skewed by this phenomenon, which he does not account for. If so, he is overestimating the deadweight loss by some unknown amount. He needs to use an objective measure of price in his denominator (he needs to get the gift-​givers to bring in their receipts). As it is, Waldfogel has really measured perceived deadweight loss of Christmas, rather than the actual deadweight loss of Christmas.

Of course, if a gift of $X in cash provided the same sentimental value—​a better term might be satisfaction—​as a gifted object that cost $X, Waldfogel would be right. But that’s not the way people value gifts. The value that a donee derives from the gift of an object consists of the economic value he places on the object and the satisfaction he derives from the gift of the object, including such factors as his pleasure that the donor values him, has expended time and effort in selecting the gift, has considered his preferences, and so forth. The total utility that a donee derives from a gift of an object therefore may very well exceed the utility that the donee derives from a gift of the amount of cash that the object would cost. In contrast, there are many situations—​such as a gift by a houseguest, a gift to a loved one on Valentine’s Day, or a gift to a spouse or parent on a birthday—​where a gift of cash would be regarded as bizarre, deeply insulting, or both. In one limited survey, British students were asked a short series of questions about giving checks, noncash presents, or gift certificates to their mothers for their birthdays. The final question was, “You said that you would find it more acceptable to send your mother a present you had chosen, which had cost ₤X, than to send a cheque of the same value.” (All subjects had said this). “How much would you have to make the cheque for, to make it as good as a present costing ₤X?” Seven out of twelve subjects refused to name any sum in answer to this question. These subjects indicated either that a check would be absolutely unacceptable or that no amount they could contemplate would make it acceptable. Of the five subjects who gave numerical answers, four stated amounts that were greater than the cost of a selected present and the fifth stated the same amount.29 Judith Martin (Miss Manners) makes the point nicely: Dear Miss Manners: I have had many visitors in my home, some of them my children’s friends. I have great judgment problems defining who pays what. . . . Should we accept any money donated at the end of their stay?

29.  P. Webley, S.E.G. Lea & R. Portalska, The Unacceptability of Money as a Gift, 4 J. Econ. Psychol. 223, 225–​27 (1983).

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Gentle Reader: When you or your children issue invitations to visit, do you mention that you are running a bed and breakfast? . . . Offering cash at the end of the stay is an insult—​suggesting that a visit to you is for sale—​however much you might appreciate such an insult.30

Where a cash gift is inappropriate the distress, anger, or other negative emotions that the gift provokes will reduce the value of the gift to the donee. In such cases, the value that the donee puts on the cash is likely to be less than the value the donee would have put on an object that the donor could have purchased with the cash. Therefore, except where cash is an appropriate gift it is a cash gift that often or perhaps even normally creates a deadweight loss, not the gift of an object. Presumably for this reason, Waldfogel reported that he primarily gives gift certificates rather than cash.31 In short, Waldfogel got matters upside down. A gift of an object will provide the donee with (1) utility in the form of financial value equal to the financial value the donee assigns to the gift, and (2) utility in the form of the satisfaction that the donee derives from being gifted with the object. A gift of cash will provide the donee with utility in the form of the financial value amount of the cash, and can provide utility in the form of satisfaction, although probably not as much satisfaction as a comparably priced object of roughly the same value. But a cash gift can also provide the donee with dissatisfaction, in the form of unhappiness, where such a gift is inappropriate. Not surprisingly, more recent studies show that Waldfogel’s data in “The Deadweight Loss of Christmas” was either highly unreliable or just plain wrong. A second study by Waldfogel concluded that the “average yield” on noncash gifts—​that is, the ratio between the students’ estimate of the cost of the gifts and the financial value they put on the gifts—​was 93 percent, much higher than the 66–​84 percent yield that Waldfogel reported in his original study.32 (And bear in mind that this “yield” still excluded the psychological utility created by noncash gifts.) Surveys by John List and Jason Shogren showed that the average yield on noncash gifts as compared to cash gifts was either 98–​99 percent or 121–​135 percent, depending on the methodology used in the survey.33 A survey by Sara Solnick and David Hemenway showed that donees value gifts at 214  percent more than the estimated purchase price, even excluding sentimental value.34 A study by Shane Frederick showed that people significantly overestimate what others will pay for consumer goods (recall that estimates of this type constituted the baseline for Waldfogel’s 30.  Judith Martin, Miss Manners, If They Visit You, You Pay for Them, S.F. Chron., Oct. 7, 1996, at D8. 31.  See Hubert B. Herring, Dislike Those Suspenders? Don’t Complain, Quantify!, N.Y. Times, Dec. 25, 1994, at C3. 32.  Joel Waldfogel, The Deadweight Loss of Christmas: Reply, 86 Am. Econ. Rev. 1306, 1307 (1996). 33.  John A. List & Jason Shogren, The Deadweight Loss of Christmas: Comment, 88 Am. Econ. Rev. 1350, 1352 (1998). 34.  Sara J. Solnick & David Hemenway, The Deadweight Loss of Christmas: Comment, 86 Am. Econ. Rev. 1299, 1300. (1996). For related analyses, see Joel Waldfogel, Gifts, Cash, and Stigma, 40 J. Econ. Inquiry 415 (2002); Canice Prendergrast & Lars Stole, The Non-​monetary Nature of Gifts, 45 Eur. Econ. Rev. 1793 (2001); Bradley J. Ruffle & Orit Tykocinski, The Deadweight Loss of Christmas: Comment, 90 Am. Econ. Rev. 319, 323 (2000); Sara J. Solnick & David Hemenway, The Deadweight Loss of Christmas: Reply, 90 Am. Econ. Rev. 325 (2000); Bradley J. Ruffle, Gift Giving with Emotions, 39 J. Econ. Behav. & Org. 399 (1999); Sara J. Solnick & David Hemenway, The Deadweight Loss of Christmas: Reply, 88 Am. Econ. Rev. 1356 (1998); Joel Waldfogel, The Deadweight Loss of Christmas: Reply, 88 Am. Econ. Rev. 1358 (1998); Webley, Lea & Portalska, supra note 29.

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measurements and conclusions). In one study, thirty-​five subjects bid on ten products and estimated what the median bid of the others would be. On average, they overestimated the median by 43 percent. In another study, 308 subjects stated what they would pay for eight imaginary goods and added their best guess as to what the previous or next respondent had said. The typical student would pay $690 to have perfect teeth but imagined that the previous or next subject would pay $1,350.35 It can now be seen that Baron, like Waldfogel, got matters upside down. Just as cash is likely to confer less utility on a donee than an object, so too legally enforceable donative promises normally would have less affective value than unenforceable donative promises that are nested in the world of gift. Making simple donative promises legally enforceable—​moving such promises from the world of gift into the world of contract—​would decrease, not increase, the social value of such promises. An enforceability regime would commodify, and thereby impoverish, simple donative promises. It could never be clear to the promisee, or even to the promisor, whether a donative promise that was made in a spirit of love, friendship, affection, or like reasons, was also performed for those reasons, or instead was performed to discharge a legal obligation or avoid a lawsuit. There is still another substantive reason for not enforcing simple donative promises. Just as donative promisors have moral obligations, so too do donative promisees. Suppose that a person who made a simple donative promise lacks an objectively satisfactory excuse for not keeping the promise, but nevertheless does not want to perform. Perhaps the promisor has an excuse that she believes is satisfactory although reasonable persons would not agree. Perhaps the promisor has simply changed her mind. Under the morality of duty the promisor is obliged to keep her promise: in the world of contract if the promisor has a duty to keep her promise, it is morally proper for the promisee to enforce the promise. In the world of gift, however, matters are not so straightforward. It may be wrong to break a simple donative promise, but also wrong to insist on its performance. Under the morality of aspiration if a donative promise is made for affective reasons, such as love or friendship, and the promisee has not relied, he normally should release a repenting promisor. An article by Andrew Kull36 is instructive in this regard. Kull argues that simple donative promises should be enforceable.37 However, he also concludes that if Uncle has made a donative promise to Nephew, and later changes his mind, it might well be “unthinkable” for Nephew to sue Uncle.38 But if suit is unthinkable, how can enforceability be desirable? The Donative-​Promise Principle prevents the unthinkable from occurring by capturing, as an enforceability regime would not, the promisee’s obligation to release a repenting promisor from a simple donative promise.39 35.  Shane Frederick, Overestimating Others’ Willingness to Pay, 39 J. Consumer Res. 1, 1–​3. (2012). 36.  Andrew Kull, Reconsidering Donative Promises, 21 J. Legal Stud. 39 (1992). 37.  Id. at 59–​64. 38.  Id. at 63. 39.  In conversation, Steve Sugarman has pointed out that the moral obligation of a donative promisee may also be conceptualized in terms of generosity. Under the Donative Promise Principle a donative promisor may repent without an objectively satisfactory excuse even though the generous thing would be to keep the promise to avoid disappointment to the promisee. In contrast, under an enforceability regime a donative promisee could insist on performance even though the generous thing would be to release the repenting promisor. As between donative promisor and donative promise, the better alternative is to allow a donor to be ungenerous rather than to give legal muscle to an ungenerous promisee.

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To summarize, enforcing simple donative promises would effectively convert these promises into their cash equivalents, would submerge into an economic relationship the affective relationship that a promised gift is intended to totemize, would ignore the obligations of a donative promisee, and would induce many potential donative promisors to either heavily condition their donative promises or refrain from making such promises at all. Simple donative promises would be degraded into bills of exchange and the gifts made to keep such promises would be degraded into redemptions of the bills. To protect a few promisees, an enforceability regime would cut off something very important in social life and harm donative promisors and even donative promisees as a class. The Donative ​Promise Principle does not show that the law fails to value donative promises. Just the opposite is true: the Donative-​Promise Principle is justified not because simple donative promises are less important than bargain promises but because they are more important. The world of affective gift is a world of our better selves, in which values such as love, friendship, affection, gratitude, and comradeship are the prime motivating forces. These values are too important to be squeezed into the hardheaded profit-​maximizing world of contract. It is precisely because those values are usually missing from the world of contract that the law must play a central role in that world.

II.   F O R M A L D O N AT I VE PR OM I S ES —​ P R O MI S E S UNDER   S EA L The process concerns raised by simple donative promises might be overcome by the form in which a donative promise is cast. If the concern is that donative promises are easy to counterfeit and often lightly made, separate treatment might well be afforded to promises whose form provides evidentiary security and demonstrates deliberation. Moreover, there are reasons of social policy that favor enforcing donative promises that are cast in a form that not only provides evidentiary security and implies deliberation, but also shows that the promisor had a specific intent to be legally as well as morally bound. For example, a promisor may want to ensure performance by her estate if she dies without having completed performance, or may want to derive the satisfaction of having made a fully effective promise, to protect her present aspirations against defeat by a less worthy future self, to increase the value of her promise, or to permit the promisee to make reliable plans on the basis of the promise. Accordingly, a legal system could plausibly choose to enlarge a donative promisor’s choice-​set by making donative promises enforceable if they are cast in a promissory form that is a natural formality, that is, a promissory form that is popularly understood to carry legal enforceability in its train. The trick is to identify such a formality, because if a form is not a natural formality actors may inadvertently use the form without a specific intention to be legally bound. Under early common law a donative promisor could legally bind herself by using the form of a seal.40 Originally, a seal for these purposes consisted of a bit of wax at the end of an instrument   The moral obligation of an affective promisee to release a repenting promisor might also be explained on the basis of implication. 40.  The governing rule was sometimes expressed by the statement that a seal “raises a presumption of ” or “imports” consideration. Under developed English law the presumption was not rebuttable. Theodore

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that bore the impression of a promisor’s personal seal incised into a signet ring. Normally the wax would be heated, dripped onto the document, and then impressed with the signet. In its origin, therefore, the seal was a natural formality that ensured both deliberation and proof, involving, as it did, a writing, a ritual of hot wax, a physical object that personified its owner, and a popular association with legal enforceability. Later, however, the definition of a seal became highly attenuated and the elements of ritual and personification dropped away, because as the law concerning seals developed the courts ceased to require either a wax impression or a personal seal. Instead, an impression made with a metal stamp, a gummed paper wafer, the printed word seal, the printed initials L.S. (locus sigilli, the place of the seal), a stylized scrawl made with a pen (often called a “scroll”), or a recital of sealing, each came to constitute a seal.41 With this development the seal ceased to be a natural formality and became instead an empty device whose legal consequences were not widely understood. In tandem with the social attenuation of the seal came a widespread although not universal elimination of the legal effect of a seal. There is a close relationship between these two developments. A sealed promise deserved special treatment only to the extent that the seal was a natural formality. When the seal was attenuated to the point of social emptiness there was no longer any justification for giving the seal a special effect, and most states adopted statutes that stripped the seal of its legal effect. In consequence, today in most states there is no legal device that can be employed with the certainty that it will bind a donative promisor.42 Accordingly, the question arises whether the legislature should adopt, or the courts should recognize, some other natural formality that would have this effect. A good candidate for this purpose is nominal consideration. Essentially, the term nominal consideration plays off the bargain theory of consideration. A bargain is a substantive transaction consisting of an exchange in which each party views what she gives as the price of what she gets. In contrast, a transaction is said to involve nominal consideration when it has the form but not the substance of a bargain, because it is clear that the promisor did not view what she purports to get under the transaction as the price of what she is to give. In short, nominal consideration is a bargain in name only—​hence the name. Characteristically, nominal consideration involves a deliberately false recital, in a written instrument, that a bargain has been made. Nominal consideration is usually easy to identify, because either the nominal performance is, by agreement, either not rendered or rendered but has virtually no value. A typical example is a recital, in a contract between A and B, that A has

F.T. Plucknett, A Concise History of the Common Law 634 (5th ed. 1956); 3 W.S. Holdsworth, A History of English Law 419–​20 (3d ed. 1923). Probably the same held true in most states prior to modern statutory developments. See, e.g., Cochran v. Taylor, 7 N.E.2d 89, 91 (N.Y. 1937).   The common law has no equivalent to the notarial form employed in many civil-​law countries, because there is no subset of the legal profession that corresponds to the functions played by notaries in those countries. There are notaries in the United States but they are not connected to the legal profession, and their only function is to authenticate signatures. 41.  Restatement Second § 96 cmt. a. 42.  A person with donative intent, A, can partially circumvent the Donative Promise Principle by declaring himself trustee of property that he presently owns, and naming the person to be benefited as the beneficiary of the trust. However, this device will only work if the benefit is to consist of property that A presently owns. Furthermore, the creation of a trust imposes various duties on the trustee that A might not want to assume.

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paid $1 to B where the $1 is either not paid, by agreement, or is insignificant compared to the value of B’s promised performance. Nominal consideration is a natural formality because there is no reason for a promisor to make a false recital of a bargain unless she has a specific intent to make her promise legally enforceable and believes a false recital of a bargain will have that effect. Under classical contract law, only bargain promises were legally enforceable—​ had consideration—​with some limited exceptions, such as sealed promises, which were enforceable under classical contract law on historical rather than principled grounds. As a result, nominal consideration presented a problem for classical contract law. On the one hand, the bargain theory of consideration is premised on the existence of a bargain, and a nominal bargain is not a bargain. On the other hand, classical contract law put a heavy premium on objectivity, and whether a purported bargain is real or nominal turns on a subjective element—​was the promisor bargaining for the stated consideration or not? Classical contract law chose the value of objectivity over the value of reality. Both Holmes and Restatement First took the view that the form of a bargain would suffice to make a promise enforceable. Holmes expressed his view in two well-​known aphorisms: Consideration is as much a form as a seal, and [I]‌t is the essence of a consideration, that, by the terms of the agreement, it is given and accepted as the motive or inducement of the promise. Conversely, the promise must be made and accepted as the conventional motive or inducement for furnishing the consideration. The root of the whole matter is the relation of reciprocal conventional inducement, each for the other, between consideration and promise.

By the term reciprocal inducement, Holmes meant bargain. By the term conventional, Holmes apparently meant a formal expression whose meaning and significance is artificially determined, such as a bidding convention in the game of bridge. Thus in Holmes’s view if a promisor adopted the convention—​that is, the form—​of a bargain, the law would enforce her promise as though she had made an actual bargain. An important illustration in Restatement First provided: . . . A wishes to make a binding promise to his son B to convey to B Blackacre, which is worth $5000. Being advised that a gratuitous promise is not binding, A  writes to B an offer to sell Blackacre for $1. B accepts. B’s promise to pay $1 is sufficient consideration.43

Restatement Second reverses the position of Restatement First on nominal consideration and instead adopts a test that requires a bargain in fact rather than in form. This reversal is embodied in two new Illustrations: 4. A desires to make a binding promise to give $1000 to his son B. Being advised that a gratuitous promise is not binding, A writes out and signs a false recital that B has sold him a car for $1000 and a promise to pay that amount. There is no consideration for A’s promise.

43.  Restatement (First) of Contracts §84, illus. 1 (Am. Law Inst. 1932) [hereafter, Restatement First].

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Moral Elements in Contract Law 5. A desires to make a binding promise to give $1000 to his son B. Being advised that a gratuitous promise is not binding, A offers to buy from B for $1000 a book worth less than $1. B accepts the offer knowing that the purchase of the book is a mere pretense. There is no consideration for A’s promise to pay $1000.44

This is one of the few instances in which the rule adopted in Restatement First was better than the rule adopted in Restatement Second. A  rule that nominal consideration makes a promise enforceable would enable donative promisors to make their promises legally enforceable if they have a specific intention to do so. If a donative promisor casts her promise in a form that is specifically and popularly associated with legal enforceability she declares by her use of the form that she is deliberately moving out of the affective world and into the legal world. This declaration justifies the law in putting aside concerns about the effect that enforceability would have on the world of gift. The form of nominal consideration also significantly reduces process concerns based on evidentiary security and deliberativeness. The administrability concern remains, because fluid moral excuses such as ingratitude and improvidence should be recognized under nominal-​ consideration regimes just as they are recognized under Civil Code regimes. However, that concern is outweighed by the substantive advantage of providing a facility to donative promisors who have a specific intent to make their promises legally enforceable. On balance, therefore, the better rule is that nominal consideration makes a donative promise enforceable.

I II.   P R O MI S E S B A S ED ON  A M OR A L O B L I G AT I O N T O   C OM PENS AT E F O R   A P R I O R BENEF I T All promises create moral obligations. A special type of donative promise, however, is based on a preexisting moral obligation—​specifically, a moral obligation to compensate the promisee for a benefit the promisee conferred upon the promisor in the past. This type of donative promise (often said to involve “past consideration”) should also be enforceable. To understand why that is so, it is necessary first to examine why a promise is relevant in such cases. After all, if A has conferred a benefit on B, and B has a moral obligation to compensate

44.  Although Restatement Second rejects the concept of nominal consideration as a general principle it does provide that nominal consideration makes a promise enforceable in two specific areas—​options and guaranties. (An option is an offer accompanied by an enforceable promise to hold the offer open.) The cases in this area are not entirely consistent. The majority rule is that a recital of nominal consideration does not make an option binding. On the other hand, many of the cases hold that even the most negligible consideration will make an option enforceable if it is paid. See, e.g., Bd. of Control v. Burgess, 206 N.W.2d 256, 258 (Mich. 1973) ($1 nominal consideration not paid; option unenforceable; it would have been enforceable if the $1 had been paid). The reason for this distinction is not clear, because if the consideration is really nominal it is no less a form just because it is paid. Perhaps actual payment of nominal consideration is viewed as a better form than the mere recital of a bargain, because a physical transfer may have more psychological impact than a written recital.

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A for the benefit, why can’t A sue B under the law of unjust enrichment even without a subsequent promise by B to pay for the benefit? One reason is that it will often be hard to determine whether B has a moral obligation to compensate A for a benefit conferred because not every conferral of a benefit gives rise to such an obligation. For example, if my neighbor pitches in to help me paint my fence I have no moral obligation to compensate him for his time. If I give my niece a wedding gift she has no moral obligation to compensate me for its value. Furthermore, a rule that allowed recovery in unjust enrichment for an unrequested benefit that was unaccompanied by a subsequent promise to compensate for the benefit could encourage officious intermeddlers to confer unwanted benefits, and could make actors such as B liable for the value of benefits they would have declined to accept and pay for if they had been given a choice.45 Moreover, because the benefit in such cases was not requested, establishing the value of the benefit to the benefited party would often be very difficult. These problems are overcome when the benefited party promises to make compensation for the benefit. First, as long as the benefit gave rise to a plausible moral obligation, a promise by which the benefited party recognizes such an obligation should normally be enough to resolve the issue of whether a moral obligation existed. Next, since liability will attach only if the benefited party makes a promise to pay we normally don’t need to be concerned about persons being made liable for benefits they might not want. Finally, as long as the amount stated in the promise provides plausible evidence of the value of the benefit to the promisee, we normally don’t need to be concerned about the difficulty of measuring that value. In short, a promise to compensate for an unrequested benefit conferred should be enforceable where the promisor has a moral obligation to make compensation for the benefit and the promise removes the barriers that would make a recovery in unjust enrichment undesirable. Of course, a promise based on a moral obligation is not motivated by financial self-​seeking. This is what makes it a donative promise. However, the substantive reasons for enforcing promises of this type outweigh any process concerns that enforcement would entail. Under classical contract law promises to compensate for a past benefit to the promisor were deemed to be unenforceable because they fell outside the bargain principle. Exceptions were made in the case of promises that fell into one of three categories: a promise to pay a debt that was barred by the statute of limitations, a promise to pay a debt that had been discharged in bankruptcy, and a promise by an adult to pay a debt contracted when the adult was a minor. However, these categorical exceptions were justified on the bizarre theory that the effect of the new promise was not to create a new legal obligation—​which under classical contract law would require consideration—​but only to remove a defense against an existing although unenforceable legal obligation. Why a promise to remove such a defense did not require consideration, and the meaning of an unenforceable legal obligation, were left unexplained. In addition to the three categorical exceptions, some cases held that a promise to compensate the promisee for a past material benefit was enforceable. For example, in Webb v. McGowin46 Webb had incurred serious bodily injury by rescuing McGowin, an officer and owner of Webb’s employer, from serious injury or death. As a result of his injuries Webb was unable to work. Later, McGowin promised to pay Webb a modest monthly amount for the rest of Webb’s life.

45.  See Restatement Second § 86 cmt. a. 46.  168 So. 196 (Ala. Ct. App. 1935), cert. denied, 169 So. 199 (Ala. 1936).

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After McGowin died his executor stopped payment, and Webb brought suit. The court held for Webb: Some authorities hold that, for a moral obligation to support a subsequent promise to pay, there must have existed a prior legal or equitable obligation, which for some reason had become unenforceable, but for which the promisor was still morally bound. This rule, however, is subject to qualification in those cases where the promisor, having received a material benefit from the promisee, is morally bound to compensate him for the services rendered and in consideration of this obligation promises to pay.47

The term material benefit is ambiguous; it can mean either a significant benefit or a benefit that significantly increases the promisor’s financial wealth. The former meaning is preferable, but generally speaking the cases seem to tacitly adopt the latter meaning. Webb v.  McGowin implicitly adopted the financial meaning of material, but stretched the meaning to its breaking point by concluding that saving a life conferred a financial benefit. The court said, “Life and preservation of the body have material, pecuniary values, measurable in dollars and cents. Because of this, physicians practice their profession charging for services rendered in saving life and curing the body of its ills, and surgeons perform operations. The same is true as to the law of negligence, authorizing the assessment of damages in personal injury cases based upon the extent of the injuries, earnings, and life expectancies of those injured.”48 Restatement Second includes a new provision, Section 86, which adopts the principle that a promise based on a benefit previously received is enforceable under certain conditions. This Section provides: (1) A  promise made in recognition of a benefit previously received by the promisor from the promisee is binding to the extent necessary to prevent injustice. (2)  A promise is not binding under Subsection (1) (a) if the promisee conferred the benefit as a gift or for other reasons the promisor has not been unjustly enriched; or (b) to the extent that its value is disproportionate to the benefit.

In accepting the principle that a past benefit that imposes a moral obligation to make compensation for the benefit supports a promise to make such compensation, Section 86 represents a significant advance over classical contract law. However, Section 86 took a wrong turn by excluding from its scope cases in which “the promisor has not been unjustly enriched,” and thereby purporting to base enforceability in these cases on unjust enrichment rather than on a promise based on a moral obligation. If a promisor has been unjustly enriched in a legal sense, the law of restitution normally permits recovery even without a subsequent promise, and whether the promisor is unjustly enriched in any other sense must turn on concepts of morality, not law. Indeed, even a requirement of unjust enrichment in a moral sense seems too narrow. For example, if B is rescued from drowning by A, and B later makes a promise of compensation, it cannot be said that B was unjustly enriched. What is unjust about needing and receiving rescue?

47.  Id. at 198. 48.  Id.

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The question should simply be whether the promisor made her promise in recognition of a moral obligation to make compensation to the promisee by reason of a past benefit conferred. The text of Section 86 does not include a requirement that the benefit be financial, or even material, but that requirement is implicit in Illustrations 1 and 6. Illustration 6 provides: . . . A finds B’s escaped bull and feeds and cares for it. B’s subsequent promise to pay reasonable compensation to A is binding.

In contrast, Illustration 1 provides: . . . A gives emergency care to B’s adult son while the son is sick and without funds far from home. B subsequently promises to reimburse A for his expenses. The promise is not binding under this Section.

In the view of those who framed Section 86, therefore, saving the life of B’s bull confers a benefit on B, but saving the life of B’s son does not. Is there a parent, or indeed a human being, who would agree with this conclusion? This conclusion is not justified by the text of Section 86 and is morally intolerable. There is no reason in either policy or morality why the requirement of a benefit conferred to support a promise should be limited to a financial benefit. On the contrary, the concept of benefit, for this purpose, should be construed expansively to include benefits that gave rise to at least a plausible moral obligation to make compensation49—​an obligation the promisor recognizes by her promise. The next issue is remedy. The remedy for breach of a given type of enforceable promise should depend on the reason that type of promise is enforceable. Where the enforceability of a promise is rooted in a past benefit to the promisor the remedy should be related to the value of the benefit to the promisor. In some cases enforcement to the full extent of the promise is appropriate—​not because expectation damages are appropriate, but because the value of the benefit is difficult to determine and the value assigned by the promisor is plausible. Accordingly, under Restatement Second Section 86(2) a promise based on a past benefit is unenforceable if it is disproportionate to the benefit. Ordinarily, the amount promised should be deemed the value of the benefit to the promisor, even if that amount exceeds the objective or market value of the benefit, provided the amount is plausibly related to that value. However, that presumption is rebutted when the amount promised is clearly disproportionate to that value. This position is exemplified in Illustrations 12 and 13 to Section 86: 12. A, a married woman of sixty, has rendered household services without compensation over a period of years for B, a man of eighty living alone and having no close relatives. B has a net worth of three million dollars and has often assured A that she will be well paid for her services, whose reasonable value is not in excess of $6,000. B executes and delivers to A a written promise to pay A $25,000 “to be taken from my estate.” The promise is binding. 13. The facts being otherwise as stated in Illustration 12, B’s promise is made orally and is to leave A his entire estate. A cannot recover more than the reasonable value of her services. 49.  Illustration 6 is based on Mills v. Wyman, 20 Mass. (3 Pick.) 207 (1825), a case that is almost 200 years old. See Kevin M. Teeven, Conventional Moral Obligation Principle Unduly Limits Qualified Beneficiary Contrary to Case Law, 86 Marq. L. Rev. 701, 708–​09 (2003).

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In short, a promise based on a moral obligation to compensate for a past benefit should be enforceable to the extent of the benefit; whether a moral obligation exists should depend on whether the promisor could plausibly have so believed; and the extent of the benefit should be determined by the promisor, as long as the amount of the promise is not clearly disproportionate to the value of the benefit.

IV.   P R O MI S E S T O   GI VE T O  S OCI A L -​ S E RV I C E I N S TI T UT I ONS Another class of donative promises consists of promises to make gifts to social-​service institutions, such as charities, universities, museums, or hospitals. (Such promises are conventionally referred to as charitable subscriptions. That convention will not be followed in this book, because most social-​ service institutions are not charities and a promise to give to such an institution usually does not take the form of a subscription.) Promises to give to social-​service institutions should be enforceable as a matter of policy: in a society such as ours, which stresses the promotion of general welfare through these decentralized institutions, there is an important social policy in favor of such giving.50 The strength of that policy outweighs any remaining process concerns. The law, however, has been ambivalent about the enforceability of promises to give to social-​ service institutions. On the one hand, at least until recently the courts have generally taken the position that such promises are unenforceable in the absence of consideration—​that is, in the absence of a bargain or reliance.51 On the other hand, the courts have sometimes twisted themselves into knots to find a bargain or reliance in these cases.52 The better rule is to straightforwardly treat donative promises to social-​service institutions as enforceable on social-​welfare grounds. That is exactly the position taken in Restatement Second Section 90(2), which provides that a “charitable subscription” is binding. Restatement Second Section 90(2) has been followed

50.  See, e.g., Salsbury v. Nw. Bell Tel. Co., 221 N.W.2d 609, 613 (Iowa 1974); Congregation B’Nai Sholom v. Martin, 173 N.W.2d 504, 510 (Mich. 1969); More Game Birds in Am., Inc. v. Boettger, 14 A.2d 778, 780 (N.J. 1940); Jewish Fed’n v. Barondess, 560 A.2d 1353, 1354 (N.J. Super. Ct. Law. Div. 1989). 51.  See, e.g., Friends of Lubavitch/​Landow Yeshiva v. N. Tr. Bank, 685 So. 2d 951, 952 (Fla. App. 1996); Lake Bluff Orphanage v. Magill’s Ex’rs, 204 S.W.2d 224, 226 (Ky. 1947); Floyd v. Christian Church Widows and Orphans Home, 176 S.W.2d 125, 129 (Ky. 1943); King v. Trs. of Bos. Univ., 647 N.E.2d 1196, 1203 (Mass. 1995); Congregation Kadimah Toras-​Moshe v. DeLeo, 540 N.E.2d 691, 693–​94 (Mass. 1989); Md. Nat’l Bank v. United Jewish Appeal Fed., 407 A.2d 1130, 1135–​37 (Md. 1979); Mount Sinai Hosp. v. Jordan, 290 So. 2d 484 (Fla. 1974); In re Estate of Timko v.  Oral Roberts Evangelistic Ass’n, 215 N.W.2d 750, 752 (Mich. Ct. App. 1974); Danby v. Osteopathic Hosp. Ass’n, 104 A.2d 903 (Del. 1954); De Pauw Univ. v. Ankeny, 166 P. 1148, 1149 (Wash. 1917). 52.  See, e.g., Danby v. Osteopathic Hosp. Ass’n. of Del., 104 A.2d 903, 907 (Del. 1954); Congregation B’nai Sholom v. Martin, 173 N.W.2d 504, 509–​10 (1969); In re Couch’s Estate, 103 N.W.2d 274, 276 (1960); I. & I. Holding Corp. v. Gainsburg, 12 N.E.2d 532, 534 (1938); Allegheny College v. Nat’l Chautauqua Cty. Bank, 246 N.Y. 369, 159 N.E. 173, 176 (1927); Central Me. Gen. Hosp. v. Carter, 132 A. 417, 419–​20 (Me. 1926); Thompson v. McAllen Federated Woman’s Bldg. Corp., 273 S.W.2d 105, 108–​09 (Tex. Civ. App. 1954).

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by some courts,53 and may eventually become the general rule, as did Restatement First Section 90, discussed below. What should be the appropriate remedy in these cases? Again, the remedy for breach should be based on the reason that the promise is enforceable. Since promises to give to social-​service institutions should be enforceable on the basis of a policy that favors such giving, such promises should be enforceable to their full extent.

V.   T H E R O L E OF   R EL I A NCE Simple donative promises should not be and are not enforceable. Suppose, however, that a donative promise has been relied upon. Some of the process concerns associated with simple donative promises remain. For example, reliance may provide some evidence that a promise was actually made, but it seldom provides full evidentiary security, because the kind of reliance often involved in a donative context—​such as making a purchase or taking a trip—​may often be consistent with either the existence or the nonexistence of a promise. However, where the promisee reasonably relies upon a donative promise there is a strong substantive interest in enforcing the promise. The principle here is liability for a significant injury caused by moral fault. The promisor is at fault for making a promise and then breaking it. The fault caused a loss to the promisee, because the promise induced the promisee to incur costs that he would not otherwise have incurred, on the reasonable assumption that the promise would be kept. Unlike the case of a simple donative promise, therefore, if a relied-​upon donative promise is broken the promisee is worse off than he was before the promise was made.54 In brief, reliance works a qualitative change in the nature of the promisee’s injury: a relying promisee has suffered not merely disappointment, but an actual diminution of his wealth. The strength of this substantive interest outweighs the process concerns about enforcing donative promises. The distinction between the world of contract and the world of gift also helps explain why relied-​upon donative promises should be enforceable: if a donative promisor refuses to compensate the promisee for harm caused by the promisor’s fault in making and then breaking a promise, she takes the reason for enforcement out of the affective realm. (In the case of a simple donative promise, if the promisor repents the morality of aspiration suggests that normally the promisee should release the promisor. Even under the morality of aspiration, however, a donative promisee is not morally obliged to excuse a promisor from a duty that is based on, and limited to, compensation for harm.) Nevertheless, based on the bargain theory of consideration classical contract law took the position that reliance did not make donative promise enforceable. For example, in Kirksey v.  Kirksey,55 Isaac Kirksey’s sister-​in-​law, Antillico Kirksey, was widowed and had several 53.  See P.H.C.C.C., Inc. v. Johnston, 340 N.W.2d 774, 776 (Iowa 1983); Woodmere Acad. v. Steinberg, 363 N.E.2d 1169, 1172 (N.Y. 1977). But see Arrowsmith v. Mercantile-​Safe Deposit and Tr. Co., 545 A.2d 674, 684–​85 (Md. 1988). 54.  See Scanlon, supra note 4, at 202–​03 (when one person, A, uses words or actions that he knows or should know would induce another, B, to reasonably believe that A is committed to take a certain course of action, and A knows or should know that B will incur costs if A does not take the action, A should take steps to ensure that if he does not take the action B will not suffer a loss). 55.  8 Ala. 131 (1845).

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children.56 Antillico lived on public land under a lease, was comfortably settled, and would have attempted to secure the land that she lived on. Isaac lived sixty or seventy miles away. On October 10, 1840, Isaac wrote Antillico the following letter: Dear Sister Antillico—​Much to my mortification, I heard, that brother Henry was dead, and one of his children. I know that your situation is one of grief, and difficulty. You had a bad chance before, but a great deal worse now. I should like to come and see you, but cannot with convenience at present. . . . I do not know whether you have a preference on the place you live on, or not. If you had, I would advise you to obtain your preference, and sell the land and quit the country, as I understand it is very unhealthy, and I know society is very bad. If you will come down and see me, I will let you have a place to raise your family, and I have more open land than I can tend; and on the account of your situation, and that of your family, I feel like I want you and the children to do well.57

Within a month or two after receipt of the letter, Antillico abandoned her possession without disposing of it, and moved to Isaac’s place. For two years, Isaac put her in comfortable houses and gave her land to cultivate. At the end of that period, however, Isaac told Antillico to leave the houses and the land, and put her in an uncomfortable house in the woods. Thereafter, Isaac made Antillico leave that house too, as well as his property. Antillico sued Isaac and the jury rendered a verdict in her favor for $200. On appeal, the court reversed the verdict. The brief opinion was written by a dissenting judge: Ormond, J.—​The inclination of my mind, is, that the loss and inconvenience, which the plaintiff sustained in breaking up, and moving to the defendant’s, a distance of sixty miles, is a sufficient consideration to support the promise, to furnish her with a house, and land to cultivate, until she could raise her family. My brothers, however think, that the promise on the part of the defendant, was a mere gratuity, and that an action will not lie for its breach.58 56.  William Casto & Val Ricks, “Dear Sister Antillico . . .”: The Story of Kirksey v. Kirksey, 94 Geo. L.J. 321, 328 (2006) reports that the name of the plaintiff was Angelico, not Antillico. Because the opinion in the case uses the latter name, to avoid confusion that name will be used here. 57.  8 Ala. at 131. 58.  Id. See also Brawn v. Lyford, 69 A. 544, 546 (Me. 1907); Thorne v. Deas, 4 Johns. 84, 102 (N.Y. Sup. Ct. 1809). But see Steele v. Steele, 23 A. 959, 960 (1892); Devecmon v. Shaw, 14 A. 464, 465 (1888).  In Dear Sister Antillico, supra note 56, Casto and Ricks conclude on the basis of extensive historical research and a few leaps of deduction that Isaac actually made a bargain with Antillico to live on his land, rather than a donative promise. “Isaac had an ulterior motive. He meant to place [Antillico] on public land to hold his place—​his preference [a right to buy public land at a discounted price, provided certain conditions were satisfied]—​so that he could buy the land later from the U.S. government at a lucrative discount. He was bargaining for her to act as a placeholder, and she knew it . . .” Dear Sister Antillico, supra, at 324–​25. Casto and Ricks claim that by “more open land than [he] could tend,” Isaac meant land open for public settlement. Dear Sister Antillico, supra, at 344–​46. What Isaac’s letter really meant, Casto and Ricks conclude, is “There you are on open land . . . but society is bad there. Come here instead. I will put you on open land as well, that I possess, and you will be no worse off economically and bettered health-​wise and socially. You settle for me on open land that I possess, wherever that is, until the government grants me a preference, and you will always have a place to live.” Dear Sister Antillico, supra, at 345. Dear Sister Antillico is a treasure trove of information, but the evidence that Casto and Ricks marshal in support of their conclusion that Isaac and Antillico made a bargain is not convincing. Although the

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As time went on, however, some courts managed to find a way around the rule that donative promises were unenforceable even if relied upon. These courts did so either by artificially construing a relied-​upon promise as a bargain;59 by directly holding, in a few cases, that reliance made a promise enforceable;60 or by holding that donative promises in certain categories—​most prominently, charitable subscriptions, promises in contemplation of marriage, and promises to give land—​were enforceable if relied upon (although in these cases enforcement was conceptually predicated on the category into which the relied-​upon promise fell rather than on the principle of reliance61). Then in 1932, Restatement First, authored principally by Williston, but with Corbin and other as advisors, simply shouldered aside the conceptual barrier to enforcing relied-​upon donative promises. Although Restatement First adhered in terms to the bargain theory of consideration62 it provided that certain nonbargain promises were enforceable “without consideration.” In particular, Restatement First Section 90 provided that a promise that the promisor should reasonably expect to induce action or forbearance by the promisee, and which does so, is binding if injustice could be avoided only by enforcement of the promise and certain other conditions were satisfied. Partly as a result of Section 90, the principle that reasonable reliance makes a donative promise enforceable—​ customarily referred to as the principle of promissory estoppel—​is now an accepted part of American contract law. To understand the significance of this principle, it is useful to invoke the concept of a paradigm in the sense developed by Thomas Kuhn in The Structure of Scientific Revolutions.63 As Kuhn uses the term, a paradigm is a model, principle, or theory that explains most or all phenomena within its scope, but is sufficiently open-​ended to leave room for the resolution of further problems and ambiguities through the paradigm’s application.64 When newly formulated, a paradigm looks both backward and forward. Looking backward, a new paradigm permits and indeed requires the reconstruction of prior explanations of phenomena within its scope. Looking forward, the new paradigm will be applied and extended, by further conclusion is stated in unqualified terms, the reasoning advanced to support the conclusion proceeds largely on the basis of statements introduced by terms such as “[n]‌ow suppose,” “or so he thought,” “[t]hat argument is more plausible if,” “more likely [Kirksey] knew,” the facts “strongly suggest,” Antillico and Kirksey “may have thought that,” “we propose that,” “[p]robably,” “[v]arious explanations are possible,” and—​at least twelve times—​“perhaps.” Furthermore, the authors’ reasoning depends in part on the assumption that Antillico understood public-​land law at the time of Kirksey’s promise but not at the time of her eviction.   Even if Casto and Ricks’s conclusion was correct, however, it would have very limited bearing on the meaning of Kirksey v. Kirksey. Whatever might have been the best interpretation of Isaac’s letter in light of the historical facts that Casto and Ricks uncovered, the court explicitly interpreted the letter as “a mere gratuity,” not as a bargain. Indeed, if the court thought Isaac and Antillico had made a bargain it should have and probably would have held for Antillico. So whatever are the historical facts the holding, on the basis of the facts as the court understood them, was that reliance on a donative promise does not suffice to make the promise enforceable. 59.  See, e.g., Siegel v. Spear & Co., 138 N.E. 414 (N.Y. 1923). 60.  See, e.g., Devecmon v. Shaw, 14 A. 464 (1888). 61.  See Benjamin F. Boyer, Promissory Estoppel: Principle from Precedents (pts. 1–​2), 50 Mich. L. Rev. 639, 873 (1952); Warren L. Shattuck, Gratuitous Promises—​A New Writ?, 35 Mich. L. Rev. 908 (1937). 62.  See Restatement First § 75. 63.  Thomas S. Kuhn, The Structure of Scientific Revolutions (2d ed. 1970). 64.  Id. at 10, 23, 181–​87.

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articulation and specification, to resolve additional problems and ambiguities and to uncover new or previously disregarded phenomena. But as a new paradigm is applied and extended in this manner it typically happens that anomalies—​phenomena the paradigm does not account for—​are uncovered. These anomalies may eventually lead to the formation of another new paradigm.65 With the rise of classical contract law, bargains emerged as the paradigmatic form of consideration.66 For some time thereafter, contract law was concerned to a great extent with the articulation and specification of that paradigm. For example, courts and scholars analyzed such problems as why executory (unperformed) bargains should be enforceable,67 and whether to enforce bargains involving a performance that was already legally required,68 bargains that were only nominal,69 and bargains in which one of the promises was illusory.70 While the bargain paradigm was being worked out, at least in principle no room was left for the role of reliance, because a donative promise, whether or not relied upon, fell outside the paradigm. The initial accomplishment of Section 90 was to adopt a second paradigm—​that promises are enforceable if reasonably relied upon. Section 90 provided a principled ground for results that had seemed anomalous under the bargain principle, such as the categorical exceptions that had been drawn in cases involving bailments, marriage, and land. However, that is not what drove the adoption of Section 90. If the reliance principle was not normatively justified, Williston undoubtedly would not have formulated Section 90. Instead, he would have concluded that the previously anomalous cases should be rejected or cabined off, not used as raw material for a transformation. What drove the adoption of Section 90 was that it provided a normatively desirable principle to govern relied-​upon nonbargain promises. When Section 90 was first adopted in 1932, many observers believed that its operation was restricted to the enforceability of relied-​upon donative promises. However, nothing in Section 90 so stated, and indeed the Comment and Illustrations to Restatement First Section 90 contemplated the application of the reliance principle in commercial contexts. Beginning in the middle of the twentieth century, the role of reliance evolved from a principle of consideration to a paradigm that was employed to generate reliance-​based rules in other areas, such as mistake, changed circumstances, offer and acceptance, and the Statute of Frauds. The role of reliance in these areas will be developed in subsequent chapters.

65.  Id. at 6–​7, 27, 29, 52–​65. 66.  Legal paradigms differ from scientific paradigms in various respects, but Kuhn himself drew on the model of legal reasoning in explaining his theory. See id.at 23. 67.  See, e.g., C. C. Langdell, Summary of Contracts §§ 81–​89 (2d ed. 1880); C.C. Langdell, Mutual Promises as a Consideration for Each Other, 14 Harv. L. Rev. 496 (1901); James Barr Ames, Two Theories of Consideration (pt. 2), 13 Harv. L.  Rev. 29 (1899); Samuel Williston, Successive Promises of the Same Performance, 8 Harv. L. Rev. 27 (1894). 68.  See, e.g., Restatement Second § 73. 69.  See Section C of this chapter, supra. 70.  See, e.g., 1 Samuel Williston & George J. Thompson, A Treatise on the Law of Contracts § 103B (rev. ed. 1936); Arthur L. Corbin, The Effect of Options on Consideration, 34 Yale L.J. 571–​74 (1925).

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V I .  M E A S U R I N G R E L I A NCE DA M A GES IN   A D O N AT I V E - P ​ R OM I S E CONT EXT Prior to the emergence of the reliance principle, the basic remedy in contract law was expectation damages, which is intended to put the promisee forward the position he would have been in if the promise had been kept. When the reliance principle emerged the issue arose whether breach of a promise that is enforceable only because it has been relied upon should be remedied by (1) expectation damages, which are intended to put the promisee forward to the position he would have been in if the promise had been kept; or (2) reliance damages, which are intended to put the promisee back to the position he was in before the promise was made, measured by the out-​of-​pocket and opportunity costs incurred by the promisee in reliance on the promise. Restatement First Section 90 did not speak to that issue, but in a famous colloquy on the floor of the American Law Institute, Williston took the position that the remedy under Section 90 was expectation damages. Mr. Williston: . . . Johnny says, “I want to buy a Buick car.” Uncle says, “Well, I will give you $1000.” . . . [Uncle] knows that that $1000 is going to be relied on by the nephew for the purchase of a car. . . . [Mr.] Tunstall: . . . Suppose the car had been a Ford instead of a Buick, costing $600. . . . . . . Johnny says, “I want to buy a Ford,” and . . . not being familiar with the market price of a Ford, the uncle says, “I will give you $1000.” Now, is the uncle obligated for the $1000 or for the price of the Ford? Mr. Williston: I think he might be bound for the $1000. . . . Mr. Coudert: . . . Please let me see if I understand it rightly. Would you say, Mr. Reporter, in your case of Johnny and the uncle; the uncle promising the $1000 and Johnny buying the car—​say, he goes out and buys the car for $500—​that uncle would be liable for $1000 or would he be liable for $500? Mr. Williston: If Johnny had done what he was expected to do, or is acting within the limits of his uncle’s expectation, I think the uncle would be liable for $1000; but not otherwise. . . .71 When pressed for justification of this extraordinary conclusions Williston fell back on the extreme conceptualism of which he was occasionally capable: Either the promise is binding or it is not. If this promise is binding it has to be enforced as it is made. . . . I  could leave this whole thing to the subject of quasi contracts so that the promisee under those circumstances shall never recover on the promise but he shall recover such an amount as will fairly compensate him for any injury incurred; but it seems to me you have to take one leg or the other. You have either to say the promise is binding or you have to go on the theory of restoring the status quo.72

71.  Proceedings April 29, 1926, 4 A.L.I. Proc. App., 88, 95–​96, 98–​99. 72.  Id. at 103–​04. See also id. at 94.

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Williston’s position is singularly unpersuasive: it produces counterintuitive results, as the car hypotheticals show, and it implicitly assumes that the extent of a promisor’s liability rests not on policy and fairness, but on the label attached to the cause of action. Just as a promise need not be legally enforceable simply because it is morally binding, neither need a promise be enforced to its full extent simply because it is legally enforceable. Instead, the basic principle should be that the remedy for breach of a given type of enforceable promise depends on the reason that the type of promise is enforceable. Under this principle if a promise is enforceable because and only because it has been relied upon the remedy normally should be reliance damages. Moreover, awarding expectation damages for breach of a promise that is enforceable only because it has been relied upon could induce a promisee to engage in strategic behavior by taking a low-​cost action solely for the purpose of making the promise immediately and fully enforceable. That problem is avoided by limiting recovery to the promisee’s costs, because under a reliance-​damages regime the promisee is made no better off by relying than by not relying. In recognition of these difficulties Restatement Second rejected Williston’s position by adding a new sentence to Section 90(1)—​the counterpart of Restatement First Section 90—​ which provides that the remedy granted for breach may be limited as justice requires.73 The express purpose of this sentence is to sanction the use of reliance damages where a promise is enforceable solely because it has been relied upon.74 This leads to the question: Just how should reliance damages be measured in the donative-​ promise context? The answer to this question is usually straightforward when strictly financial costs are involved. If Aunt promises to give Niece $1,000 for opera tickets during the 2016–​2017 season, and retracts her promise after Niece has purchased and used $500 worth of tickets, Aunt should be liable for $500, not for $1,000. However, cases involving personal costs are harder to resolve, because the dollar value of such costs is often very difficult to measure. In Kirksey v.  Kirksey, for example, Antillico’s financial costs probably were very small, but her personal costs probably were substantial, consisting of the emotional and physical travail of the journey to and from Isaac’s farm and the loss of an opportunity to remain in a settled existence rather than twice resettling. Antillico should have been able to recover those personal costs, but it would be very difficult to measure those costs directly. One solution would be to throw the issue to the factfinder for intuitive measurement, as in personal-​injury cases. In personal-​injury cases, however, the transaction typically is not consensual and, partly for that reason, typically no objective financial measure is at hand. In contrast, where a donative promise has been relied upon, in the right circumstances the promise could provide a rough measure of the promisee’s personal costs. For example, in Kirksey v. Kirksey we know that the promise was sufficient to induce Antillico to relocate, but we do not know if a lesser promise would have been sufficient. Rather than attempting to measure Antillico’s personal costs intuitively, the law should measure them objectively, although indirectly, by using her financial expectation (the rental value of a place on Isaac’s farm for the promised duration) as a surrogate measure of her financial and personal costs, provided those costs appear significant, difficult to quantify, and reasonably related to the promisee’s expectation. An important index for determining whether this three-​factor test has

73.  Restatement Second § 90(1). 74.  See id. § 90 Reporter’s Note. See also 42 A.L.I. Proc. 296–​97 (1965) (remarks of Professor Braucher).

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been satisfied is whether the promisee was induced to make a substantial change in her life that is not easily reversible. Under this index, expectation damages probably would have been appropriate in Kirksey v. Kirksey as a surrogate for reliance damages.75 A related issue concerns the treatment of benefits that the promisee received prior to the breach. If the benefits are financial, the amount of the benefits should normally be deducted from the promisee’s recovery. For example, suppose that A plans to purchase fire insurance for his goods. Knowing A’s plan, B makes a donative promise to purchase the insurance for him. A accordingly forbears from insuring the goods himself. B fails to buy the policy, and A’s goods are destroyed by fire. If the goods had been insured the premium would have been $150 and the insurance company would have paid $5,000 to make good A’s loss. A’s damages against B should be, not $5,000, but $4,850, the amount by which he is worse off as a result of B’s promise. Again the issue is more difficult when personal benefits are involved. For example, suppose Uncle promises to give Niece the amount of Niece’s expenses, up to $4,500, for a three-​week vacation in New York City. After Niece has been in New York for the full three weeks and has spent $4,500, Uncle repudiates his promise. In an action by Niece to recover $4,500, should Uncle be entitled to offset the personal benefits that Niece derived from the trip? For these purposes the value of personal benefits to the relying promisee would ordinarily be the amount that the promisee would have been willing to pay for the benefits. The difficulty of determining that amount suggests that unless it is clear that the promisee’s personal benefits are significant and measureable they should ordinarily be disregarded in determining her recovery. This position may seem to be in tension with the position that in some cases the promisee should be able to recover the value of his personal costs. However, the tension is minor and the difference is not without reason. A promisor who breaks a foreseeably relied-​upon promise is at fault and therefore should bear the brunt of the promisee’s resulting loss. In contrast, a promisee is not at fault for enjoying personal benefits prior to the breach.

75.  Cf. Newmeyer v. Newmeyer, 140 A.2d 892 (Md. 1958) (donor’s promise to pay balance due on car purchased as a gift enforced in full); Young v. Overbaugh, 39 N.E. 712 (N.Y. 1895) (promise to give real estate enforced in full where defendant had entered into possession and made significant improvements); Wells v. Davis, 14 S.W. 237 (Tex. 1890) (same); Boyer, supra note 61, at 663–​65 (noting that enforcing a promise often avoids the problem of valuation of improvements). An example, in an arguably nondonative context, is reported in connection with a lawsuit against the Professional Golf Association’s tour. Until 1977 any golfer who had won the U.S. Open or the PGA Championship was entitled to a lifetime exemption under which he could enter any tournament on the PGA tour without having to qualify by either performance or competition. In November 1977 the PGA decided that beginning in 1979 the past champions would have to meet certain performance guidelines as a condition to entering a tournament. The past champions then filed for an injunction against enforcement of the new rule. Dave Marr, their unofficial spokesman, stated, “We don’t want to do anything to hurt the game or the tour, but we feel they are taking away something that belongs to us. Many of us have built our lives around having that exemption. If we’d known it was going to be taken away, we might have arranged our lives differently.” John S. Radosta, Golfer’s Exemption Suit Looms as Blockbuster, N.Y. Times, Jan. 31, 1978, at 19.

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V I I .   T H E L I F E O F   R EL I A NCE Against the background of the emergence of the reliance paradigm, in 1974 Grant Gilmore argued in The Death of Contract76 that “promissory estoppel . . . has, in effect, swallowed up the bargain principle.”77 More broadly, he argued, because reliance-​based liability and damages are tort-​like, contract had merged into tort. “We are told that Contract . . . is dead. And so it is.” 78 Gilmore did not make much of a normative argument that the reliance principle should swallow up the bargain principle and that contract should merge into tort. Instead, Gilmore essentially took the stance of a historian, gathering up precedents as evidence without evaluating them. The evidence, however, consisted mostly of old cases, and not too many of those. Gilmore gathered some adherents. On the whole, however, the reaction to The Death of Contract was that the book was elegant, provocative, and occasionally brilliant, but often questionable or worse as history and wrongheaded in asserting that the reliance principle had swallowed up the bargain principle and that contract was dead.79 The book had many readers but little if any influence on the law. Around fifteen years later, in the 1980s and early 1990s, several commentators turned Gilmore’s thesis on its head. What was dead or dying, they said, was not contract but reliance as a reason for the enforceability of nonbargain promises, that is, promises that were not part of, in aid of, or ancillary to a bargain. Instead, the test of enforceability for nonbargain promises depended on the seriousness, or perhaps the purpose, of the promise. The approaches of these commentators differed in important ways, but a leading article by Edward Yorio and Steve Thel, “The Promissory Basis of Section 90,”80 is emblematic.81 Yorio and Thel’s principal thesis was that under existing contract law whether a donative promise is enforceable depends not on whether the promisee relied but solely on whether the promise was seriously made (the seriousness thesis). As a matter of existing doctrine, they said, “A promise will be fully enforced under [Section 90] if the promise is proven convincingly and is likely to have been serious and well considered when it was made. . . . [T]‌he basis of Section 90 in the courts is promise, not reliance. . . . If a promise is identified as serious . . . the court will enforce it.” Yorio and Thel maintained that their enterprise was positive, not normative—​that their concern was only what the law is, not what the law should be: “Our thesis is not that the basis of Section 90 76.  Grant Gilmore, The Death of Contract (1974). 77.  Id. at 72. 78.  Id. at 3. 79.  See, e.g., Richard A. Epstein, Book Review, 20 Am. J. Legal Hist. 68 (1976); Ralph James Mooney, The Rise and Fall of Classical Contract Law: A Response to Professor Gilmore, 55 Or. L. Rev. 155 (1976) (book review); James R. Gordley, Book Review, 89 Harv. L. Rev. 452 (1975). 80. 101 Yale L.J. 111, 113 (1991). 81.  See also Randy E. Barnett, The Death of Reliance, 46 J. Legal Educ. 518, 522 (1996); James Gordley, Enforcing Promises, 83 Cal. L. Rev. 547, 569 (1995); Jay M. Feinman, The Last Promissory Estoppel Article, 61 Fordham L. Rev. 303, 306 (1992); Michael B. Kelly, The Phantom Reliance Interest in Contract Damages, 1992 Wisc. L. Rev. 1755, 1781 n.78; Jay M. Feinman, Promissory Estoppel and Judicial Method, 97 Harv. L. Rev. 678, 687–​88 (1984). In another important article, Dan Farber and John Matheson argued that under an emerging rule, whether a promise was enforceable depended on whether it was made “in furtherance of an economic activity.” Daniel A. Farber & John H. Matheson, Beyond Promissory Estopppel: Contract Law and the “Invisible Handshake,” 52 U. Chi. L. Rev. 903, 904–​05 (1985).

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ought to be promise. Rather, we describe and analyze the reported cases and show that the basis of the Section is promise.”82 The obvious way to establish the seriousness thesis would have been to take a large sample of nonbargain cases and then determine how many cases in the sample enforced promises on the basis of seriousness alone. However, Yorio and Thel did not take that tack. Instead, they attempted to establish their thesis indirectly, by making two other claims about existing contract law. The first claim (the no-​reliance-​damages claim) was that expectation damages, not reliance damages, are awarded in “Section 90 cases.” 83 The second claim (the possibility-​of-​reliance-​ sufficies claim) was that in cases that Yorio and Thel characterized as “Section 90 cases” courts do not require actual reliance, but only the possibility of definite and serious reliance.84 If definite and serious reliance by the promisee was within the promisor’s reasonable expectation, they argue, “the promise was likely well considered and [therefore] deserving of legal enforcement.”85 Most of Yorio and Thel’s article was devoted to attempting to establish their no-​reliance-​damages claim by discussing cases they believed supports that claim. Their argumentation, however, had very serious flaws. To begin with, Yorio and Thel’s enterprise was intended to concern “Section 90 cases,” as evidenced by the title of their article—​“The Promissory Basis of Section 90.” As adopted in Restatement First, Section 90 did not explicitly speak to the issue of damages. On the floor of the ALI, Williston took a position on damages analogous to Yorio and Thel’s no-​reliance-​damages claim.86 When Restatement Second was published, however, Section 90(1) amended Section 90 to make clear that reliance damages could indeed be awarded in Section 90 cases. That doesn’t seem to leave much room for an argument that Section 90 does not support reliance damages. Given the endorsement of reliance damages in Restatement Second Section 90, Yorio and Thel attempted to establish the reliance claim by turning to the case law. But an enterprise that purports to describe case law must begin with a clear definition of the population of cases to be described. Yorio and Thel never jumped that hurdle, because they never made clear what constitutes a “Section 90 case.” The term, as they use it, cannot mean cases decided under Section 90, because many of the cases they cite were decided before Section 90 was adopted in Restatement First. The term cannot mean donative-​promise cases, because most of the cases they cite involve commercial promises, and in any event many donative-​promise cases involve neither reliance in general nor Section 90 in particular. The term cannot mean cases based on the promisee’s actual reliance, because Yorio and Thel claimed that whether the promisee actually relied is irrelevant. In short, Yorio and Thel made an empirical claim about certain kinds of cases but failed to provide a specification of what kind of cases they had in mind. 82.  Yorio & Thel, supra note 80, at 114–​15 (emphasis in original). 83.  See id. at 112–​14, 166; Farber & Matheson, supra note 81, at 909; Mary E. Becker, Promissory Estoppel Damages, 16 Hofstra L.  Rev. 131, 136–​45 (1987); Paul T. Wangerin, Damages for Reliance across the Spectrum of Law: Of Blind Men and Legal Elephants, 72 Iowa L. Rev. 47, 49–​54, 89–​98 (1986); James O. Bass, Jr., Note, Promissory Estoppel—​Measure of Damages, 13 Vand. L. Rev. 705, 709–​11 (1960). 84.  Yorio & Thel, supra note 80, at 152–​60. 85.  Id. at 126–​27. The precise formulation of the test for seriousness that Yorio and Thel employ varies. At one point they put the test as follows: “The promisor’s commitment may be shown to be sufficiently serious by her contemplation of particular and substantial reliance, by the formality of the promise, by the situation of the promisee, or by a chance of benefit to the promisor.” Id. at 166. 86.  See Section G of this chapter, supra.

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Furthermore, Yorio and Thel’s no-​reliance-​damages claim is falsified by the many Section 90 cases in which reliance damages have been awarded. An example is First National Bank v. Logan Mfg. Co.87 In that case Garrett and Moore sought to borrow funds from First National Bank for the purpose of purchasing a plastics business and moving it to Indiana. Brandt, a representative of the Bank, orally assured Garrett and Moore that the necessary loan would be made, and prepared a written loan application for them to sign. The application was signed, and then approved by the Bank, subject to the condition that the loan would be guaranteed by the State of Indiana. In the end, however, the Bank did not grant the loan, and Garrett and Moore sued. The court concluded that the Bank had not breached an oral contract, because when Brandt gave his oral assurance, the Bank had not yet agreed on the terms of the loan. The Bank also had not breached the written contract, because a condition to that contract—​the guarantee by Indiana—​had not been fulfilled. However, the court held, Garrett and Moore were entitled to relief on the basis of promissory estoppel, because they had relied to their detriment upon Brandt’s assurances that the bank would lend the money. The court then turned to the issue of remedy, and self-​consciously adopted a reliance measure: Having concluded that the appropriate theory of recovery is promissory estoppel, we look again to the Restatement for guidance on the measure of damages. Section 90 provides that “[t]‌he remedy granted for breach may be limited as justice requires.” . . . We conclude that under the circumstances here, damages such as are required to prevent injustice are those referred to as “reliance damages.” . . . We conclude that justice does not require the award of lost profits, . . .”88

In the face of cases such as First National Bank, Yorio and Thel’s basic strategy was to marshal cases that support their no-​reliance-​damages claim and explain away cases that do not. The problem with this approach is that the case law can be used with equal force to make the opposite point by marshaling cases that support reliance damages and explaining away cases that do not. For example, almost every case that Yorio and Thel relied upon to support their no-​reliance-​ damages claim can be explained away on one or more of the following grounds:

(1) The case involved a bargain although the bargain was not commercial. For example, “If you take care of me, I will leave you $20,000 in my will.” (2) The case involved a commercial promise that was either part of, in aid of, or ancillary to a bargain.89 (3) The measure of damages was not at issue in the case.90 (4) Reliance damages were identical to expectation damages, so that the damage award can be characterized in either way.91

87.  577 N.E.2d 949 (Ind. 1991). First National Bank was decided around the time that “The Promissory Basis of Section 90” was published, and may have been unavailable to Yorio and Thel when that article was written. However, there are other, earlier cases just like First National Bank. See, e.g., Westside Galvanizing Serv. Inc. v. Georgia-​Pacific Corp., 921 F.2d 735, 739 (8th Cir. 1990). 88.  First National Bank, 577 N.E.2d at 956. 89.  See, e.g., Janke Const. Co. v. Vulcan Materials Co., 527 F.2d 772 (7th Cir. 1976); Grayddon v. Knight 292 P. 2d 632 (Cal. 1956). 90.  See, e.g., Ricketts v. Scothorn, 77 N.W. 365 (Neb. 1898). 91.  See, e.g., Devecmon v. Shaw, 14 A. 464 (Md. 1888).

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(5) The promisee’s reliance was not readily quantifiable,92 so that expectation damages either had to be or reasonably could be used as a surrogate for reliance damages. (6) The case arose before the late 1940s.93 All cases arising before that time are of limited persuasiveness on the issue of reliance damages because the explicit acceptance of reliance damages did not begin until around the 1950s. Before then, the courts may have assumed, as did Williston, that the only measure of damages open to them in a contracts case was the expectation measure. (7) The case involved a type of donative promise to give to a social-​service institution (a type of promise commonly known as a charitable pledge) that has traditionally been given special treatment, presumably on policy grounds.94

This brings up a deeper problem with Yorio and Thel’s methodology. Yorio and Thel disclaimed any interest in whether “the basis of Section 90 ought to be promise.”95 However, what the law is can seldom be determined without regard to what the law should be. In reasoning from precedent a deciding court can focus either on what a precedent court said or on what it did. Focusing on what a precedent court did will almost never yield a determinate rule, because a deciding court can make a precedent stand for a variety of rules by stressing some facts in the precedent and downplaying others. Normally, therefore, reasoning from precedent begins with what a precedent court said, rather than what it did. Nevertheless, a deciding court always has power to emphasize one or the other. This power allows the deciding court to modify or transform the prior stated rule because what a precedent court did often can be interpreted in multiple ways. The extent to which courts exercise this power, and more generally the way in which courts interpret a precedent, always depends in large part on the extent to which the rule announced in the precedent is substantially congruent or incongruent with the rule that is normatively best on the basis of policy, morality, and experience.96 That is why the cases can be marshaled either for or against the principle that reliance damages are awarded in serious nonbargain promises. If a court believes that reliance damages should be awarded it will marshal the cases that said that, and explain away the cases that didn’t by focusing on what the courts in those cases did rather than what they said. If a court believed that expectation damages should be awarded it will do just the reverse. The force that will drive the court down one road rather than the other is the normative weight of each alternative. And indeed, notwithstanding Yorio and Thel’s disclaimer of the role of ought in their thesis, deep down the thesis seems to rest at least in part on the concept that contract law should be centered on promoting promise-​keeping by promisors rather than protecting promisees or advancing general social interests. Yorio and Thel’s no-​reliance-​damages claim was forcefully, if unconvincingly, argued. In contrast, the possibility-​of-​reliance claim—​that in determining whether nonbargain promises are enforceable the courts do not require actual reliance, but only the prospect of it—​does not

92.  See, e.g., Feinberg v. Pfeiffer Co., 322 S.W. 2d 163 (Mo. App. 1959). 93.  See, e.g., Ricketts v. Scothorn, 77 N.W. 365 (Neb. 1898). 94.  See Section E, supra. 95.  Yorio & Thel, supra note 80, at 114. 96.  See Melvin A. Eisenberg, The Nature of Common Law 160–​61 (1988).

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even rise to the level of plausibility. To begin with, Restatement First Section 90 and Restatement Second Section 90 both explicitly require actual reliance. Restatement First Section 90 provided: A promise which the promisor should reasonably expect to induce action or forbearance of a definite and substantial character on the part of the promisee and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise.97

Similarly, Restatement Second Section 90(1) provides: A promise which the promisor should reasonably expect to induce action or forbearance on the part of the promisee or a third person and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise.98

The case law follows suit. First National Bank is an example; there are many others.99 Yorio and Thel argue otherwise.100 Pride of place in this part of their argument is given to an 1888 case, Devecmon v. Shaw.101 Uncle promised Nephew that if Nephew went to Europe, Uncle would reimburse Nephew for his expenses. Nephew did go to Europe, but Uncle died before reimbursing him. The court held that Nephew was entitled to recover from Uncle’s estate.102 Devecmon is a strange case for Yorio and Thel to rely upon in claiming that courts do not require reliance in “Section 90 cases.” First, the case was decided more than a hundred years ago and fifty years before Section 90 was published. Second, Nephew did rely on Uncle’s promise, and the court based its judgment on that reliance: [T]‌he testimony would have tended to show that the plaintiff incurred expense at the instance and request of the deceased, and upon an express promise by him that he would repay the money spent. . . . Great injury might be done by inducing persons to make expenditures beyond their means, on express promise of repayment, if the law were otherwise. . . . It is nothing to the purpose

97. Emphasis added. 98. Emphasis added. 99.  See, e.g., Pitts v. McGraw-​Edison Co., 329 F.2d 412, 416 (6th Cir. 1964) (“Although there may be other facts in the present case which prevent it from coming within the scope of [section 90], we believe that an important fact is that the plaintiff in no way altered his position for the worse by reason of defendant’s letters of July 1 and July 20, 1955”); Hayes v. Plantations Steel Co., 438 A.2d 1091, 1096 (R.I. 1982) (“[T]‌he important distinction between Feinberg and the case before us is that in Feinberg the employer’s decision definitely shaped the thinking of the plaintiff. In this case the promise did not.”); Alden v.  Presley, 637 S.W.2d 862, 864–​65 (Tenn. 1982); Bush v. Bush, 177 So. 2d 568, 570 (Ala. 1965) (“On the other hand, if Mama Bush . . . made the will but John and William did not act in reliance on the will . . . then the promise would not be binding.”); Dewien v. Estate of Dewien, 174 N.E.2d 875, 877 (Ill. App. Ct. 1961) (“The testimony in this case fails to support the claim that plaintiff ‘acted in reliance upon the doctor’s promise to her’ ”); Feinberg v. Pfeiffer Co., 322 S.W.2d 163, 168 (Mo. Ct. App. 1959) (“Was there . . . an act on the part of plaintiff, in reliance upon the promise contained in the resolution, as will . . . create an enforceable contract under the doctrine of promissory estoppel?”). 100.  Yorio & Thel, supra note 80. 101.  14 A. 2d 464 (Md.). 102.  Id. at 465.

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that the plaintiff was benefited [sic] by the expenditure of his own money. He was induced by this promise to spend it in this way, instead of some other mode.103

In the face of Restatement First Section 90, Restatement Second Section 90(1) and the case law, and in the absence of a normative argument, which Yorio and Thel eschew, their principal argument for the possibility-​of-​reliance claim was based on Restatement Second Section 90(2). This section provides that a marriage settlement or a charitable subscription is binding without proof that the promise induced action or forbearance. However, Section 90(2) gives Yorio and Thel no help at all. To begin with, a marriage settlement is unenforceable unless there has been a marriage. As to marriage settlements, therefore, Section 90(2) is easily explained on the ground that when two persons marry after a marriage settlement has been made they should conclusively be deemed to have relied upon the settlement. Once a person has been promised that he will be compensated if he takes a given act, it will be impossible for either the person or a court to sort out whether and to what extent the act was motivated by the promise of compensation. Cardozo gave the quintessential expression to this thought in DeCicco v.  Schweizer,104 itself a marriage-​settlement case: It will not do to divert the minds of others from a given line of conduct, and then to urge that because of the diversion the opportunity has gone by to say how their minds would otherwise have acted. If the tendency of the promise is to induce them to persevere, reliance and detriment may be inferred from the mere fact of performance. The springs of conduct are subtle and varied. One who meddles with them must not insist upon too nice a measure of proof that the spring which he released was effective to the exclusion of all others.

As to charitable subscriptions (which are better called promises to social-​service institutions), Yorio and Thel could properly have argued that as a normative matter such promises should be enforced even without reliance. However, Yorio and Thel declined to base their claims on normative grounds. And unfortunately for their argument, at least up to now most cases that have enforced charitable subscriptions have required either reliance or a bargain. It is true that the reliance or bargain element in the cases that enforce charitable subscriptions is sometimes attenuated, but this can be explained on the ground that the real reason for enforcement is public policy. In any event, as a matter of positive law many courts have refused to enforce charitable subscriptions in the absence of actual reliance or an actual bargain. Perhaps most important, Restatement Second Section 90(2) actually undermines rather than supports Yorio and Thel’s non-​reliance claim. If promises were enforceable under Section 90(1) even without reliance, there would have been no need for Section 90(2). By dropping a reliance requirement for two special classes of donative promises, Section 90(2) underscores that Section 90 requires reliance in all other cases. Yorio and Thel’s argument that the prospect of reliance screens out serious from nonserious promises is also inconsistent with the nature of promising. As Corbin stated, a promise is “an expression of intention that the [addressor] will conduct himself in a specified way or bring about a specified result in the future, communicated in such manner to [an addressee] that he

103.  Id. at 465. 104.  117 N.E. 807, 810 (N.Y. 1917). See also Klockner v. Green, 254 A.2d 782, 785 (N.J. 1969).

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may justly expect performance and may reasonably rely thereon.”105 Accordingly, all promises, not just some promises, ordinarily involve the prospect of reliance. The prospect of reliance may screen out those expressions that are promises from those expressions that are not, but it does not screen out seriously made promises from other promises. In short, Yorio and Thel did not offer persuasive evidence to establish their thesis that “If a promise is identified as serious . . . the court will enforce it.” Furthermore, their thesis is directly falsified by hundreds of cases that refuse to enforce seriously made commercial promises. That population includes, for example, cases that refuse to enforce a promise, no matter how seriously made, to accept part payment in full discharge of a debt,106 to make a one-​way modification of a contract,107 or to hold an offer open for a fixed period of time,108 as well as cases that refuse to enforce a promise, no matter how seriously made, that is exchanged for an illusory promise.109 These kinds of cases have been discussed in Chapter 5. As shown in that chapter, most of these cases were incorrectly decided as a normative matter. But Yorio and Thel’s seriousness thesis, which takes the form that “the law is . . . ,” cannot rest on an argument that the hundreds of cases that denied enforcement of seriously made promises were wrongly decided as a normative matter. In the late 1990s, several commentators conducted statistical studies to examine the issues raised by Yorio and Thel and others. Like Yorio and Thel, the statistical studies focused on what the law is rather than on what the law should be. Unlike Yorio and Thel, however, the statistical studies were based on the number of “wins” compared to the total number of relevant cases, rather than on an evaluation of the cases. In one of these studies, Questioning the “New Consensus” on Promissory Estoppel: An Empirical and Theoretical Study,110 Robert Hillman examined all reported decisions between July 1, 1994 and June 30, 1996, in which a promissory estoppel claim was made or discussed.111 Hillman’s data demonstrated that Yorio and Thel’s no-​reliance-​damages and possibility-​of-​reliance claims were incorrect: actual reliance was the reason for a ruling in favor of the promisee in 93 percent of promissory estoppel claims that succeeded on the merits and 56 percent of claims that survived a motion to dismiss.112 Similarly, the courts awarded reliance-​based relief in approximately half the cases in which either a claim 105.  1 Arthur L. Corbin, Corbin on Contracts § 13 (rev. vol. 1963). 106.  See, e.g., Foakes v. Beer, [1884] 9 App. Cas. 605 (H.L.) (Eng.). 107.  See, e.g., Gross v.  Diehl Specialties, Int’l, Inc., 776 S.W.2d 879, 883 (Mo. Ct. App.  1989); Vito v.  Pokoik, 150 A.D.2d 331 (1989); Okemah Constr., Inc., v.  Barkley-​Farmer, Inc., 583 S.W.2d 458, 460 (Tex. Civ. App. 1979); Mark B. Wessman, Retaining the Gatekeeper: Further Reflections on the Doctrine of Consideration, 29 Loy. L.A. L. Rev. 713, 759–​63 (1996) (discussing the modification rule and collecting recent cases). 108.  See infra Chapter 5. See also, e.g., Dickinson v. Dodds, [1876] 2 Ch D 463 (Ct. App.) (Eng.); Wessman, supra note 107, at 719–​23 (discussing the firm-​offer rule and collecting recent cases). 109.  See infra Chapter  5. See also, e.g., Propane Indus., Inc. v.  Gen. Motors Corp., 429 F.  Supp.  214, 219–​21 (W.D. Mo. 1977); Wickham & Burton Coal Co. v. Farmers’ Lumber Coal Co., 179 N.W. 417, 419 (Iowa 1920). 110. 98 Colum. L. Rev. 580 (1998). 111.  Id. at 582. See also Robert W. Hillman, The Unfulfilled Promise of Promissory Estoppel in the Employment Setting, 31 Rutgers L.J. 1 (1999); Sidney W. DeLong, The New Requirement of Enforcement Reliance in Commercial Promissory Estoppel: Section 90 as Catch 22, 1997 Wis. L. Rev. 943. 112.  Id. at 597.

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of promissory estoppel was successful on the merits, the form of relief was clear, and affirmative relief was granted. But Hillman also concluded that “the data demonstrate the remarkable lack of success of promissory estoppel claims.” This conclusion was strained. Hillman claimed that his data showed that in cases in which promissory estoppel claims were made or discussed the rate of “wins” on the merits was very low—​just over 5 percent.113 However, that is not what the data shows. First, Hillman’s sample included cases that are not relevant, or are only barely relevant, to his conclusion, because the sample included cases in which promissory estoppel was discussed but no promissory estoppel claim was made.114 Second, Hillman counted losses on motions to dismiss as losses but did not count wins on motions to dismiss as wins. Third, and most important, Hillman’s data showed that where promissory estoppel claims failed on the merits many or most did so for reasons other than the validity of the reliance principle, such as lack of a definite promise, lack of detrimental reliance, lack of reasonable reliance, a Statute-​of-​Frauds problem, or a parol-​evidence-​rule problem.115 In such cases the party who made the promissory estoppel claim lost but the loss was not based on the court’s rejection of the doctrine of promissory estoppel. To put this differently, Hillman’s data did not “demonstrate a remarkable lack of success of promissory estoppel claims” by claimants who actually and reasonably relied and whose claims were not defeated by a free-​standing defense. This point was forcefully brought home by Juliet Kostritsky in “The Rise and Fall of Promissory Estoppel or Is Promissory Estoppel as Unsuccessful as Scholars Say It Is:  A New Look at the Data.”116 Kostritsky examined 760 promissory-​estoppel cases in state courts during the five-​year period 1990–​1994. She first showed that determining the rate of success of promissory estoppel claims is no easy matter, because the determination depends on several critical variables, which include:  (1) How “wins” are defined—​which turns out to be a very slippery concept. (2) Whether a “loss” is based on the court’s view of promissory estoppel or on some other factor entirely, such as a failure to show that a promise was made and broken, a failure to demonstrate reliance, or a fatal procedural error. (3) Whether the promissory estoppel claim was rendered moot because the court made its decision without reaching the merits of that claim. (4) Whether a promissory estoppel claim was not advanced by either litigant although the court discussed promissory estoppel in passing. The bottom line is that if wins is defined to include both wins on the merits and wins on a motion, and total cases is defined to exclude cases in which either promissory estoppel was moot or irrelevant or the outcome turned on elements other than promissory estoppel, then the plaintiffs won in 55 percent of the promissory estoppel cases.117 As Kostritsky concluded, “The results . . . show that promissory claims succeed at significant rates when demonstrably weak claims are subtracted.”118 113.  Id. at 591 tbl.1.3. 114.  Id. at 582 (emphasis added). 115.  See id. at 599 tbl 5.1 (“Reasons for Failure of Promissory Estoppel Claims—​Cases Decided on the Merits”). 116. 37 Wake Forest L. Rev. 531 (2002). 117.  Id. at 555, 581–​82. 118.  Id. at 542 (emphasis in original).

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To summarize, donative promises should not be and are not enforced just because they are seriously made; if a donative promise is reasonably relied upon, it normally should be and will be enforced by virtue of the reliance; and the remedy in such cases normally should be and will be reliance damages except when such damages cannot readily be measured. Contract lives; so does reliance.

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The Duty to Rescue in Contract Law If t wo parties, A  and B, have either entered into a contract or

taken significant steps to form a contractual relationship, and in that context B is at risk of unintendedly incurring an unbargained-​for loss that A  could prevent by taking an action that would not require him to forgo an existing or potential bargaining advantage, undertake a significant risk, or incur some other cost that is either more than immaterial or unreasonable under the circumstances, then A is under a moral and legal duty to take the action. Call this the duty to rescue in contract law. The chapter begins with an examination of the no-​duty-​to-​rescue rule and its exceptions in tort and criminal law. Next, a duty to rescue—​to bestir oneself to prevent loss to another—​ in contract law is discussed. The following chapter details a central case of the duty to rescue: the duty to mitigate. Later chapters consider other instantiations of the duty to recue in contract law.

I .  T H E N O -​D UT Y   R UL E In tort and criminal law the general rule, subject to numerous exceptions, is as follows: one actor, A, is under no duty to take action to save another, B, from physical peril, even if the necessary action would carry no significant risk to A and failure to take the action would probably or even certainly result in death or substantial injury to B.1 This rule—​which will be referred to in this chapter as the no-​duty rule, is stated as follows in Restatement Second of Torts Section 314: “The fact that [an]

1.  See, e.g., Salmon v. Chute, (1994) 4 NTLR 149, 160 (Austl.) (“[T]‌he common law countries have not . . . introduced a . . . general offence of ‘failing to rescue.’ ”); Peter M. Agulnick & Heidi V. Rivkin, Criminal Liability for Failure to Rescue: A Brief Survey of French and American Law, 8 Touro Int’l L. Rev. 93 (1998); John T. Pardun, Good Samaritan Laws: A Global Perspective, 20 Loy. L.A. Int’l & Comp. L.J. 591, 594–​602 (1998); Jay Silver, The Duty to Rescue: A Reexamination and Proposal, 26 Wm. & Mary L. Rev. 423, 426–​28 (1985).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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actor realizes or should realize that action on his part is necessary for another’s aid or protection does not of itself impose upon him a duty to take such action.” Comment c to Section 314 adds: The rule stated in this Section is applicable irrespective of the gravity of the danger to which the other is subjected and the insignificance of the trouble, effort, or expense of giving him aid or protection. . . . The result of the rule has been a series of older decisions to the effect that one human being, seeing a fellow man in dire peril, is under no legal obligation to aid him, but may sit on the dock, smoke his cigar, and watch the other drown. . . .

The scope of the no-​duty rule in tort and criminal law is exemplified by the cigar-​smoking hypothetical and also by Illustrations 1 and 4: 1. A sees B, a blind man, about to step into the street in front of an approaching automobile. A could prevent B from so doing by a word or a touch without delaying his own progress. A does not do so, and B is run over and hurt. A is under no duty to prevent B from stepping into the street, and is not liable to B. 4. A, a strong swimmer, sees B, against whom he entertains an unreasonable hatred, floundering in deep water and obviously unable to swim. Knowing B’s identity, he turns away. A is not liable to B.

Some of the actual cases are as dramatic as these Illustrations. For example, in Yania v. Bigan2 A and B were engaged in a business discussion on A’s land when B jumped into a pit of water, apparently at A’s urging. A did nothing to save B and B drowned. The court held that A was not liable. People v. Beardsley is a criminal-​law counterpart.3 A’s paramour had been in A’s home, drinking heavily and taking morphine tablets, and had fallen into a coma. Knowing this, A left his home without giving any aid to his paramour, who died. The court held that A had no duty to do so. Despite the absence of tort or criminal liability in a rescue context, it is generally recognized that an actor is under a strong moral obligation to take action to save a victim from physical peril if there is no significant risk or other cost to the actor and failure to take the action would probably result in death or substantial injury to the victim. “[A]‌ll agree,” says Liam Murphy, “that the person who fails to effect an easy rescue is a moral monster.”4 Restatement Second of Torts, after stating in the Comment to Section 314 that an actor may lawfully “sit on the dock, smoke his cigar, and watch [a victim] drown,” adds that “decisions [that take this position] have been condemned . . . as revolting to any moral sense.”5 As the court observed in Soldano v. O’Daniels:6 The refusal of the law to recognize the moral obligation of one to aid another when he is in peril and when such aid may be given without danger and at little cost in effort has been roundly criticized. Prosser describes the case law sanctioning such inaction as a “refus[al] to recognize the

2.  155 A.2d 343 (Pa. 1959). 3.  113 N.W. 1128 (Mich. 1907). 4.  Liam Murphy, Beneficence, Law, and Liberty: The Case of Required Rescue, 89 Geo. L.J. 605, 625 (2001). 5.  Restatement (Second) of Torts § 314, cmt. c (Am. Law Inst. 1965). 6.  190 Cal. Rptr. 310 (Ct. App. 1983).

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moral obligation of common decency and common humanity” and characterizes some of these decisions as . . . “revolting to any moral sense.”7

Given the strong moral obligation, most people will perform easy rescues even if they are under no legal obligation to do so. Others, however, will not. This is shown by the scores of cases in which an actor did not perform an easy rescue, such as Soldano v. O’Daniels,8 where a bartender would not allow a would-​be rescuer to use his phone; Yania v. Bigan,9 where the defendant did nothing to save a person who was drowning in a pit of water on his land; Harper v. Herman,10 where the defendant did not warn the plaintiff that water was too shallow for diving; and People v. Beardsley,11 where the defendant did nothing to save a woman who was in a coma and dying in his home. Beside the courtroom cases are tragic unlitigated events, such as the Kitty Genovese incident, in which thirty-​seven people looked out the windows of their apartments, saw a young woman being murdered, and did not even lift a finger to call 911.12 Reporter Peter Abblebome writes of a hit-​and-​run accident: Mr. Torres, in critical condition and apparently paralyzed, would have been merely a local crime story if not for . . . the insatiable appetite for daily video of the Internet and the nightly news. This one came in the form of a police video from May 30 that shows two cars, what looked like a dark Honda chasing a tan Toyota. Traveling on the wrong side of the street, the first just misses Mr. Torres, who had just bought milk at the corner store. The second hits him, sending him flying over the windshield. Both cars speed off. As Mr. Torres lies on the pavement, nine cars go past without stopping, people walk by or stop and look, seemingly without doing anything to stop traffic or comfort him, until a police cruiser on its way to another call drives up.13

Accordingly, experience shows that the imposition of a legal duty to rescue is a necessary incentive to lead into action those many potential rescuers who have either failed to internalize the moral norm or have internalized it so weakly that it is overborne by slight considerations of personal inconvenience. The imposition of such a duty therefore would increase the amount of rescue and lead to lives being saved and personal injuries being averted or ameliorated at little cost. The no-​duty rule is not just misaligned with community views of morality: it may also have the effect of affirmatively distorting behavior. A major function of legal rules is to mark out those social norms that the community regards as especially important. The inclusion in the law of a duty to rescue a victim from physical peril would send a message to members of a society that they owe one another an obligation of due concern. The omission of a duty in the law to rescue

7.  Id. at 313 (quoting William L. Prosser, Handbook of the Law of Torts § 56, at 340–​41 (4th ed. 1971)). 8.  190 Cal. Rptr. 310. 9.  155 A.2d 343 (Pa. 1959). 10.  499 N.W.2d 472 (Minn. 1993). 11.  113 N.W. 1128 (Mich. 1907). 12.  See Martin Gansberg, 37 Who Saw Murder Didn’t Call the Police, N.Y. Times, Mar. 27, 1964, at 1. See also, e.g., Peter Applebome, The Day the Traffic Did Not Stop in Hartford, N.Y. Times, June 8, 2008, at 35. 13. Applebome, supra note 12.

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sends the message that due concern is not an obligation. The former message is highly desirable. The latter message is highly undesirable.14

I I .   O F F E R A N D ACCEPTA NCE A duty to rescue—​to bestir oneself to prevent loss to another—​is imposed in various settings in the area of offer and acceptance: in particular, in the settings of silence as acceptance, late acceptance, unilateral contracts, and performance.

A.  SILENCE AS ACCEPTANCE It is often said that there is a general rule of contract law that silence is not acceptance. The rule as so stated is much too broad in two respects. First, there are many exceptions to the rule, and the number of cases that have held that on the facts silence was acceptance is probably greater than the number of cases that have held that on the facts silence was not acceptance. Second, one of the exceptions to the nominal rule is that silence does constitute acceptance where the offeror has so stated and the offeree, in remaining silent, intended to accept. Accordingly, a better statement of the nominal rule would be that generally speaking an offeror cannot require an offeree to bestir himself to reject the offer at the risk of being bound to a contract if he does not. This formulation of the nominal rule can be explained in terms of the following paradigm case: A and B are strangers. B writes to A, “I offer to buy your car for $13,000. If I don’t hear from you otherwise, we have a contract.” A throws B’s letter away without intending to accept. A’s silence should not and does not constitute acceptance. In the paradigm case B’s only potential loss is a defeated unreasonable expectation to which A did not contribute, and A, on his part, gains no benefit from his silence. Given the lack of either prior interchange on the subject-​matter of the offer, of a significant loss to B, or of a benefit to A, it would be unreasonable to impose upon A the costs of communicating a rejection to B at the risk of becoming liable under a contract if he does not, however low those costs might be.15 When, however, A’s silence occurs in the context of a prior interchange, or when the stakes get higher—​either because B may suffer a significant loss or because A may be enriched at B’s expense—​then at least where the costs to A, the offeree, would be very low, fairness may require A to bestir himself to take action to inform B, the offeror, that the offer is not accepted. For example, in one recurring scenario B begins to render services that will benefit A. B expects to be paid for the services, as A knows or has reason to know. The rule in such cases is that if it is easy for A to notify B that he does not intend to pay, A must do so, and if he does not 14.  A number of policy and empirical arguments have been made for the no-​duty rule in tort and criminal law. The literature on both sides of these arguments is too voluminous to be considered in this book. Suffice to say that most although by no means all scholars have found the arguments unpersuasive. 15.  For a cost-​based analysis of the problem of silence as acceptance, see Avery Katz, The Strategic Structure of Offer and Acceptance: Game Theory and the Law of Contract Formation, 89 Mich. L. Rev. 215, 249–​72 (1990).

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he will be liable for the value of the services. Day v. Caton16 is a well-​known case of this kind. A and B owned adjoining lots. B built a brick party wall (presumably a load-​bearing wall, not just a fence) that straddled the boundary between the lots and benefited A. The court held that if A knew or should have known that B expected A to pay for half the wall, and said nothing while B continued to build, A would be liable for half the value of B’s services: If a party . . . voluntarily accepts and avails himself of valuable services rendered for his benefit, when he has the option whether to accept or reject them, even if there is no distinct proof that they were rendered by his authority or request, a promise to pay for them may be inferred. . . . [W]‌hen one stands by in silence, and sees valuable services rendered upon his real estate by the erection of a structure (of which he must necessarily avail himself afterwards in his proper use thereof), such silence, accompanied with the knowledge on his part that the party rendering the services expects payment therefore, may fairly be treated as evidence of an acceptance of it, and as tending to show an agreement to pay for it.17

In reaching its conclusion, the court employed a hypothetical that made clear that whether A has a duty to bestir himself to take action in such a case depends on the facts: If a person saw day after day a laborer at work in his field doing services, which must of necessity inure to his benefit, knowing that the laborer expected pay for his work, when it was perfectly easy to notify him if his services were not wanted, even if a request were not expressly proved, such a request, either previous to or contemporaneous with the performance of the services, might fairly be inferred. But if the fact was merely brought to his attention upon a single occasion and casually, if he had little opportunity to notify the other that he did not desire the work and should not pay for it, or could only do so at the expense of much time and trouble, the same inference might not be made. The circumstances of each case would necessarily determine whether silence with a knowledge that another was doing valuable work for his benefit and with the expectation of payment indicated that consent which would give rise to the inference of a contract.18

In other words, where B is doing work that will benefit A, and A knows or has reason to know that B expects payment, A has a duty to warn B that no payment will be made if the cost of warning is relatively low.19 This is another instance of the duty to rescue in contract law.

16.  119 Mass. 513 (1876). 17.  Id. at 515. 18.  Id. at 516; see also, e.g., Laurel Race Course, Inc. v. Regal Const. Co., 333 A.2d 319, 328–​29 (Md. 1975); E. Allen Farnsworth, Contracts 146 (4th ed. 2004) (if the offeree has a reasonable opportunity to reject services, he “is expected not only to refrain from taking affirmative action that would appropriate services to the offeree’s use, but also to speak up in protest”); John Edward Murray, Jr., Murray on Contracts 211-​13 (5th ed. 2011). 19.  There is an analogous rule in property law: if A observes that B is continually trespassing on A’s land to mine a mineral or other commodity, but stands by in silence, B will be liable in trespass, but only for the value of the commodity in its natural state under the ground, not for the significantly higher value of the commodity when extracted from the ground and ready to sell. See, e.g., Minerals & Chem. Phillip Corp. v. Millwhite Co., 414 F.2d 428, 431 (5th Cir. 1969) (remarking that the landowner’s silence “was tantamount to the creation of an implied contract”).

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In another recurring scenario, Seller’s salesperson solicits from Buyer an order for goods, subject to Seller’s acceptance. Although the order is on Seller’s form, legally it is an offer by Buyer. Seller does not communicate further with Buyer, and when Buyer requests delivery Seller informs Buyer that it never accepted Buyer’s order. Here, unlike the paradigm case, the offer occurs in the context of a prior interchange: the offeree (Seller) has both invited the offer and structured its terms. Furthermore, Seller knows or should know that Buyer will not be in a position to purchase the kind of goods in question from a third party while she awaits word from Seller, because if she does so and then Seller accepts the order Buyer will end up with an oversupply of goods. Under these circumstances Buyer will have a reasonable expectation that Seller will notify her within a reasonable time if it decides not to accept, so that Buyer will be free to make a purchase elsewhere. As a matter of fairness, therefore, Seller should be under a duty to give Buyer such notice, on penalty of being held liable on a contract based on the terms of the offer if it does not. That is indeed the legal rule.20 In a closely related kind of case, Applicant submits an application for insurance on Insurer’s form. The application is an offer. Insurer delays notifying Applicant one way or the other. Meanwhile, the casualty that was to be covered by the insurance occurs. Here again, the offeree (Insurer) has both invited the offer and structured its terms. Insurer also knows or should know that the offeror (Applicant) will not be in a position to purchase insurance from another insurer while she awaits word, either because she was required to enclose payment for the insurance with her application to Insurer, or because if she gets other insurance and Insurer then accepts her application she will end up overinsured, or both. As a matter of fairness, therefore, Insurer should be under a duty to notify Applicant within a reasonable time if it decides not to issue the policy, on penalty of being held liable on the policy if the casualty occurs during the interim period. Although the cases are divided, the better view, supported by a number of cases, is that Insurer is under such a duty. As stated by John Appleman, A claim . . . [in such cases] is not based on a contract of insurance; rather, it is based upon the damages produced by the failure of the insurer promptly to perform the duty which the facts imposed upon it. The better rule is to the effect that an insurer has a duty either to accept or to reject an application within a reasonable time, and is liable if it delays unreasonably in acting thereon. And if its action is adverse, if it delays unduly in notifying the applicant thereof, it may be held liable just as if it had accepted the risk. . . . . . . [H]‌ealth is a fragile thing. Over a period of unreasonable delay, one’s health may change adversely; death may occur, either from accident or from some theretofore undiscovered cause. It is important to an applicant that the insurer act with diligence and either accept him or reject him, in which latter event he can seek coverage elsewhere. Delay of any duration is prejudicial to him; unwarranted delay may inspire judicial intervention. And . . . while the older pronouncements look with greater regard upon the insurer’s need, more recent decisions, as a rule, cherish more highly those of the potential insured.21 20.  See, e.g., Ammons v. Wilson & Co., 170 So. 227, 228–​29 (Miss. 1936); T.C. May Co. v. Menzies Shoe Co., 113 S.E. 593, 594 (N.C. 1922); Sioux Falls Adjustment Co. v. Penn Soo Oil Co., 220 N.W. 146, 147 (S.D. 1928); Cole-​Mcintyre-​Norfleet Co. v. Holloway, 214 S.W. 817, 818 (Tenn. 1919); Hendrickson v. Int’l Harvester, 135 A. 702, 705 (Vt. 1927). 21. 12A John Alan Appleman & Jean Appleman, Insurance Law and Practice § 7216, at 107–​08, § 7217, at 116 (1981); see also 1A Steven Plitt, Daniel Maldonado, & Joshua D. Rogers, Couch on

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Silence may also constitute acceptance under the Uniform Commercial Code. Section 2-​207 of the Code provides that a definite and seasonable expression of acceptance that is sent within a reasonable time operates as an acceptance even though it states terms additional to those in the offer. If the offer is made by a merchant to a merchant, and if certain other conditions are satisfied, then unless the offeror notifies the offeree that he objects to the additional terms they become part of the contract.

B.  LATE ACCEPTANCE Another offer-​and-​acceptance context in which the law imposes a duty to rescue concerns late acceptance. Assume that A makes an offer to B and the offer does not state the time within which it must be accepted. In such a case the offer must be accepted within a reasonable time. Suppose B accepts the offer after the expiration of a reasonable time, but within a time that B could plausibly have believed and did believe was reasonable. The rule in such a case is that although the late acceptance does not form a contract, A, the offeror, is under a duty, imposed as a matter of fairness, to inform B, the offeree, that the acceptance was too late. If A fails to so notify B, A will be liable on a contract. As stated in Phillips v. Moor,22 It is true that an offer, to be binding upon the party making it, must be accepted within a reasonable time. . . . but if the party to whom it is made, makes known his acceptance of it to the party making it, within any period which he could fairly have supposed to be reasonable, good faith requires the maker, if he intends to retract on account of the delay, to make known that intention promptly. If he does not, he must be regarded as waiving any objection to the acceptance as being too late.23

C.  UNILATERAL CONTRACTS Where an offer calls for acceptance by an act, a contract is completed as soon as the act is performed. In some cases, the fact that the act has been performed will naturally come to the offeror’s attention within a reasonable time after performance occurs. In other cases—​for example, where the act is performed at a distant location—​it will not. In the latter type of case

Insurance § 11.8, at 11-​27–​11-​32 (2010 rev. ed.) (discussing the effect of delay in responding to an insurance application). Compare Bellak v. United Home Life Ins. Co., 211 F.2d 280 (6th Cir. 1954) (finding liability for unreasonable delay); Gorham v. Peerless Life Ins. Co., 118 N.W.2d 306 (Mich. 1962) (same); Kukuska v. Home Mut. Hail-​Tornado Ins. Co., 235 N.W. 403 (Wis. 1931) (same), with Killpack v. Nat’l Old Line Life Ins. Co., 229 F.2d 851 (10th Cir. 1956) (finding no liability for unreasonable delay); Schliep v. Commercial Cas. Ins. Co., 254 N.W. 618 (Minn. 1934) (same), and Hayes v. Durham Life Ins. Co., 96 S.E.2d 109 (Va. 1957) (same). 22.  71 Me. 78 (1880). 23.  Id. at 80; see also Kurio v. United States, 429 F. Supp. 42, 64 (S.D. Tex. 1970); Forbes v. Bd. of Missions of Methodist Episcopal Church, S., 110 P.2d 3, 9 (Cal. 1941); Sabo v. Fasano, 201 Cal. Rptr. 270, 271–​72 (Cal. Ct. App. 1984); Davies v. Langin, 21 Cal. Rptr. 682, 685–​86 (Cal. Ct. App. 1962); Restatement (Second) of Contracts § 70 (Am. Law Inst. 1981) [hereinafter, Restatement Second].

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the offeror may be prejudiced by the fact that a contract has been formed without his knowledge, because he may plan his affairs with the belief that he is not contractually bound to the offeree. Accordingly, even though a contract has been formed, and the contract does not by its terms require any further action by the offeree, where the performance would not naturally come to the offeror’s attention within a reasonable time, as a matter of fairness the offeree should be required to bestir himself to give the offeror notice of the performance so as to prevent prejudice to the offeror. That is the law. In such cases although a contract is formed when the act is completed the offeror’s duty to render performance under the contract is discharged if the offeree fails to notify the offeror within a reasonable time that a contract has been formed.24

I I I .   P E R F O RM A NCE A duty to rescue may also arise in various contexts in the area of performance. These contexts include the duty to warn a party that it may be about to breach, the duty to warn a party of a potential loss, and the duty to cooperate.

A.  THE DUTY TO WARN A PARTY THAT IT MAY BE ABOUT TO BREACH Often it is not entirely clear exactly what performance is required under a contract. For example, the terms of a contract may be insufficiently specified, or performance may look different on the ground than it does on paper, or performance may extend for a long time and one of the parties may fail to recollect some subsidiary contractual obligation or condition. In such cases, where A realizes that B may be about to breach without intending to do so, A should be obliged to warn B that B may be about to breach. As stated by Ariel Porat, [Q]‌uestions arise whenever the [potentially] aggrieved party chooses not to help the party [who may be] in breach to understand his obligations, although he could easily have done so. For instance, one party may simply forget to perform her duties on the date required by the contract and the other, although aware of it, stands idle; or one party may inadvertently render a defective performance on a matter that is a precondition for the performance of the other, who then fails to deliver counter-​performance without offering explanations. It is assumed that, had the first party drawn the second party’s attention to the defect, the latter could have corrected it or changed it in time. The potentially aggrieved party should not be required to go to unreasonable lengths to clarify misunderstandings, nor is she the other party’s guardian. [However, one party should not ref use] to meet with or speak to the other without a reasonable justification. . . when the other party appears to be acting in good faith, and knowing that clarification might prevent a breach. . . . [Imposing such a duty] would promote suitable behaviour in contract performance, and lead to more contracts being fulfilled. In fact, increasing the chances of fulfillment regarding a contract where performance has been riddled with misunderstandings will strengthen the parties’ reliance 24.  See, e.g., Bishop v. Eaton, 37 N.E. 665, 668 (Mass. 1894); Restatement Second § 54.

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and planning ability. They will be less fearful of drifting into ambiguous situations, and will trust each other’s help and support if and when such situations do emerge.25

The duty to warn a party that it may be about to breach is exemplified by the opinion of Judge Posner in Market Street Associates Ltd. Partnership v. Frey.26 In 1968, J.C. Penney Company, a retail chain, entered into a sale and leaseback arrangement with General Electric Pension Trust for the purpose of financing Penney’s growth. Under the arrangement the lessee [Penney] sold various properties to the Pension Trust, which the Trust then leased back to Penney for a term of twenty-​five years. Paragraph 34 of the lease gave the Lessee the right to “request Lessor [the Pension Trust] to finance the costs and expenses of construction of additional Improvements upon the Premises,” provided the amount of the costs and expenses was at least $250,000. The Pension Trust agreed that upon receiving such a request it would give reasonable consideration to finance the improvements, “and Lessor and Lessee shall negotiate in good faith concerning the construction of such Improvements and the financing by Lessor of such costs and expenses.” Paragraph 34 went on to provide that if the negotiations failed Penney would be entitled to repurchase the relevant property at a price roughly equal to the price at which Penney sold the property to the Pension Trust in the first place plus 6 percent a year for each year since the original purchase, for appreciation. Accordingly, if Penney had sold the property to the Pension Trust at the property’s then-​market value, then if the average annual appreciation in the property exceeded 6 percent, and there was a breakdown in negotiations over the financing of improvements, Penney would be entitled to buy back the property for less than its likely market value.27 One of the properties that Penney had sold to and leased back from the Pension Trust was a shopping center in Milwaukee. In 1987, Penney assigned the lease on this shopping center to Market Street, which succeeded to Penney’s rights and duties under the lease. In 1998, Market Street received an inquiry from a drugstore chain that wanted to open a store in the shopping center provided that Market Street built the store for it. Market Street initially sought financing for the project from sources other than the Pension Trust. These sources were unwilling to lend the necessary funds unless they were given a mortgage on the shopping center. However, Market Street could not give such a mortgage because it was only the lessee of the shopping center, not the owner.28 Market Street therefore decided to try to buy the property back from the Pension Trust. In June 1998, Market Street’s general partner, Orenstein, tried to call David Erb of the Pension Trust, who was responsible for the Milwaukee property. Erb did not return his calls, so Orenstein wrote to Erb, expressing an interest in buying the property, and asking Erb to “review

25.  Ariel Porat, Contributory Negligence in Contract Law: Toward a Principled Approach, 28 U. B.C. L. Rev. 141, 149–​50 (1994). Porat’s analysis is couched in terms of what kinds of inaction might be deemed contributory negligence under contract law, which would justify an adjustment of damages. However, his analysis is also relevant to the duty to rescue, because a party’s inaction can be deemed contributory negligence only if the party had a duty to act. Accordingly, while performance issues are approached in this chapter from a slightly different perspective than Porat’s, the underlying inquiry is basically the same, and this chapter draws heavily on Porat’s analysis. 26.  941 F.2d 588 (7th Cir. 1991). The statement of the facts is in substantial part taken verbatim from Judge Posner’s opinion. 27.  Id. at 591. 28.  Id.

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your file on this matter and call me so that we can discuss it further.”29 At first, Erb did not reply. Eventually Orenstein reached Erb, who promised to review the file and get back to him. A few days later, an associate of Erb called Orenstein and indicated that the Pension Trust would be interested in selling the property to Market Street for $3 million, a price that Orenstein considered much too high.30 On July 28, Market Street wrote a letter to the Pension Trust, formally requesting funding for $2 million in improvements to the shopping center. The letter made no reference to paragraph 34 of the lease. Indeed, the letter did not mention the lease. The letter asked Erb to call Orenstein to discuss the matter. Erb did not call. On August 16, Orenstein sent a second letter, again requesting financing and this time referring to the lease, although not expressly to paragraph 34. The heart of the letter was the following two sentences: “The purpose of this letter is to ask again that you advise us immediately if you are willing to provide the financing pursuant to the lease. If you are willing, we propose to enter into negotiation to amend the ground lease appropriately.”31 The next day, August 17, Market Street received a letter from Erb dated August 10, turning down the original request for financing on the ground that the request did not “meet our current investment criteria” because the Pension Trust was not interested in making loans for less than $7 million.32 On August 22, Orenstein replied to Erb by letter, noting that his letter of August 10 and Erb’s letter of August 16 had evidently crossed in the mails, expressing disappointment at the turndown, and stating that Market Street would seek financing elsewhere. That was the last contact between the parties until September 27, when Orenstein sent Erb a letter stating that Market Street was exercising the option granted under paragraph 34 to purchase the property at the original price, plus 6 percent per year, if negotiations over financing broke down, as they had.33 The Pension Trust refused to sell the property at that price, and Market Street sued to compel specific performance. The price computed by the formula in paragraph 34 was $1 million. The market value of the property presumably was higher, or Market Street would not have tried to force the Pension Trust to convey the property at the paragraph 34 price. The district court granted summary judgment for the Pension Trust. The court inferred that Market Street didn’t really want financing from the Pension Trust. Instead, it just wanted an opportunity to buy the property at a bargain price, and hoped that the Pension Trust wouldn’t realize the implications, under paragraph 34, of turning down Market Street’s request for financing. In the district court’s view, Market Street should have warned the Pension Trust that it was requesting financing pursuant to paragraph 34, so that the Trust would understand the penalty for refusing to negotiate.34 On appeal the Seventh Circuit, in an opinion by Judge Posner, agreed that under the duty to perform in good faith (see Chapter 52) there is a duty on a contracting party not to take deliberate advantage of an oversight by its contract partner concerning rights and duties under the contract: [I]‌t is one thing to say that you can exploit your superior knowledge of the market—​for if you cannot, you will not be able to recoup the investment you made in obtaining that 29.  Id. 30.  Id. 31.  Id. 32.  Id. 33.  Id. at 592. 34.  Id.

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knowledge—​or that you are not required to spend money bailing out a contract partner who has gotten into trouble. It is another thing to say that you can take deliberate advantage of an oversight by your contract partner concerning his rights under the contract. Such taking advantage is not the exploitation of superior knowledge or the avoidance of unbargained-​for expense; it is sharp dealing. Like theft, it has no social product, and also like theft it induces costly defensive expenditures, in the form of overelaborate disclaimers or investigations into the trustworthiness of a prospective contract partner, just as the prospect of theft induces expenditures on locks. . . . . . . . . . . [I]‌mmensely. sophisticated . . . enterprises make mistakes just like the rest of us, and deliberately to take advantage of your contracting partner’s mistake during the performance stage (for we are not talking about taking advantage of superior knowledge at the formation stage) is a breach of good faith. To be able to correct your contract partner’s mistake at zero cost to yourself, and decide not to do so, is a species of opportunistic behavior that the parties would have expressly forbidden in the contract had they foreseen it. The immensely long term of the lease amplified the possibility of errors but did not license either party to take advantage of them.35

(Having set out the applicable law, the Seventh Circuit reversed and remanded, because on the Pension Trust’s motion for summary judgment the district court had construed the facts as favorably to the Pension Trust as the record would permit, while the correct standard for summary judgment is to construe the facts as favorably to the nonmoving party (Market Street) as the record would permit. Under such a construction, the Seventh Circuit said, it was at least conceivable that Orenstein believed that Erb knew about paragraph 34 but simply had no interest in financing the improvements, regardless of the purchase option. If Orenstein believed that Erb knew, or would surely find out, about paragraph 34, it was permissible for Orenstein not to warn Erb about that paragraph. To decide what Orenstein believed, a trial was necessary.) A comparable kind of case is presented where one party knows that the other party is about to inadvertently fail to fulfill a condition. This kind of case is exemplified by Illustration 7 to Restatement (Second) of Contracts Section 205: A suffers a loss of property covered by an insurance policy issued by B, and submits to B notice and proof of loss. The notice and proof fail to comply with requirements of the policy as to form and detail. B does not point out the defects, but remains silent and evasive, telling A broadly to effect his claim. The defects do not bar recovery on the policy.36

This Illustration, like Judge Posner’s analysis in Market Street, is based on the principle of good faith in performance. Given both the generality of that principle, and the continuing controversy over the manner in which the principle should be articulated, it is preferable to base the analysis in such cases on the duty to rescue, which is more specific, easier to apply, and reaches pre-​contractual as well as post­-contractual activity.

35.  Id. at 594, 597. 36.  The Reporter’s Note states that this Illustration is based on Johnson v. Scottish Union Ins. Co., 22 S.W.2d 362 (Tenn. 1929).

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B.  THE DUTY TO WARN OF A POTENTIAL LOSS Under the principle of Hadley v. Baxendale a party who is injured by a breach of contract can recover only those damages that (1) arise “naturally, i.e., according to the usual course of things” from the breach; or (2) might “reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of . . . [a]‌breach.”37(See Chapter 19, infra.)Assume a contract between Seller and Buyer in which Seller is the potential breaching party. (As a practical matter, the principle of Hadley v. Baxendale normally operates only to cut off damages against breaching Sellers.) Under the first branch of the principle Buyer can recover all damages that flow from Seller’s breach and do not depend on Buyer’s particular circumstances—​for example, the difference between the contract price and the market price in a breach of contract for the sale of goods. Under the second branch of the principle Buyer can also recover any damages that result because of Buyer’s particular circumstances—​for example, a loss of profits that Buyer suffers because of Seller’s delay in delivering a machine that Buyer needs in his factory—​if but only if Seller is on notice of those circumstances at the time the contract is made.38 By the nature of the principle of Hadley v. Baxendale the cases under this principle usually do not address circumstances that arise after the contract is made. However, Ariel Porat has persuasively argued that in at least two types of cases an injured party who is the potential victim of a breach (“Buyer”) has a duty to warn the other party (“Seller”) of circumstances that arise after the contract is made. In the first type of case Buyer becomes highly certain that a given loss is impending if Seller breaches, and knows that although Seller is on notice of the possible loss, she views it as merely a distant possibility. In the second type of case at the time the contract was made a reasonable person would have foreseen Buyer’s specific loss if the contract was breached, but Seller did not foresee the loss. Buyer now realizes that the loss is impending and that Seller does not know this. In either type of case fairness requires Buyer to warn Seller of the impending loss.39 Similarly, Goetz and Scott argue that in some cases the potentially breaching party (Seller) has a duty to warn the other party (Buyer) that the latter will incur a certain kind of loss on Seller’s breach. Goetz and Scott exemplify this point with a hypothetical in which Seller agrees to install a compressor for Buyer at a fixed price: Assume . . . that [after the contract was made,] while making the calibrations necessary to design the compressor, Seller observed but did not react to the fact that Buyer was constructing a laboratory in which sensitive research experiments were to be thermostatically controlled. Assume further that, once the system was operational, malfunctions in the laboratory’s automated control processes caused $100,000 worth of experiments to be ruined. Upon examination, Seller discovered that the compressor’s thermostat was not calibrated with sufficient precision to control experiments of such sensitivity and thus the control processes malfunctioned. Accurate calibration is sometimes difficult, but imprecise settings of that magnitude are usually harmless. Buyer, unaware that thermostatic calibrations were so crucial, had not indicated the sensitive nature of

37.  Hadley v. Baxendale, (1854) 156 Eng. Rep. 145, 151; 9 Ex. Ch. 341, 355. 38.  See generally Melvin Aron Eisenberg, The Principle of Hadley v. Baxendale, 80 Cal. L. Rev. 563 (1992). 39. Porat, supra note 25, at 151.

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his research projects at the time of contract. Seller therefore argues that he will be responsible for any ordinary damages, but not for the $100,000 worth of ruined experiments which he claims were unforeseeable consequential damages. Seller’s argument under conventional contract rules seems powerful. Hadley v. Baxendale limits an obligor’s responsibility for the consequences of breach to those needs and circumstances he had reason to know at the time of contracting. This would include all ordinary consequences, but an obligor must be made aware of special or unforeseeable circumstances at the time the bargain is struck. . . . . . . . A more promising approach is to extend Hadley v. Baxendale to all those particular needs of which an obligee is unaware, if the obligor has reason to know of them at any time before performance is tendered. Thus, Seller’s failure to warn Buyer would be a breach of an implied duty to “rescue” a contracting partner. . . .40

In short, depending on the circumstances, A, a party to a contract, should be under a duty to warn and thereby rescue the other party, B, of impending losses that A knows B does not expect, where a warning is likely to prevent or reduce the loss.

C.  THE DUTY TO COOPERATE Cases such as Market Street41 involve a duty to warn. In other cases a party to a contract is under a duty to actively cooperate. Cases involving a duty to cooperate can be divided into two categories. In some cases a duty to cooperate may be derived through interpretation of the contract, on the ground that the parties must have contemplated that the cooperation of one was necessary to the performance of the other and would therefore be forthcoming.42 As Porat points out, [I]‌n some cases, it may become clear when the contract is created that performance is either impossible or extremely difficult without some measure of cooperation from the recipient. In such circumstances, it is a matter of interpretation whether a duty of cooperation is implied. If the contract is interpreted to mean that the recipient was required to cooperate, and that his failure to do so prevented the other party’s performance it is the recipient who will be considered the party in breach. . . .43

At least in theory, cases of this kind do not present an issue of the duty to rescue; instead, they simply present an issue of contract interpretation. A leading case that falls into this category is Vanadium Corp. v. Fidelity & Deposit Co.44 In 1939 and 1940, two mining leases of Navajo lands that held vanadium-​bearing ore had been granted to three lessees:  Horace Redington,

40.  Cf. Charles J. Goetz & Robert E. Scott, The Mitigation Principle: Toward a General Theory of Contractual Obligation, 69 Va. L. Rev. 967, 1012–​14 (1983). 41.  Mkt. St. Assocs., Ltd. P’ship v. Frey, 941 F.2d 588 (7th Cir. 1991). 42.  See, e.g., U.C.C. § 2–​311(3) (Am. Law Inst. & Unif. Law Comm’n 1989). 43. Porat, supra note 25, at 147. 44.  159 F.2d 105 (2d Cir. 1947).

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John Wade, and Thomas Curran. Because the lands belonged to the Navajos any transfer of the leases required approval by the secretary of the interior.45 Vanadium was a critical war material. After World War II had begun, Vanadium Corporation made a contract with Redington under which Redington assigned his interest in the two leases to Vanadium for $13,000, subject to approval by the Secretary of the Interior.46 The contract provided that if the assignments were not so approved, Redington would repay the $13,000 purchase price and the agreement would be cancelled. Vanadium requested the Interior Department to approve the assignments. Subsequently, however, Curran, one of the three lessees, notified Vanadium that Wade, another of the three lessees, acting for all the lessees, had made a contract to sell the entire output of ore from the properties to Metals Reserve Corporation for the duration of the war. This information cooled Vanadium’s desire for Redington’s interest in the leases. When the Interior Department asked Vanadium to provide assurance of its intent to cooperate with the other two lessees, Vanadium refused to give assurances. Subsequently, Vanadium withdrew its request for approval of the assignments.47 The Department then disapproved the assignments. Redington appealed. The Department responded that it was prepared to reconsider if Vanadium would go along, and wired Vanadium that the disapproval was “being reconsidered with view to approving assignments. Wire your position.” Vanadium answered, “Our position . . . must be to respectfully request no reconsideration of your position.” The Department then notified the parties that without “a joint request for reconsideration by both parties to the assignment, no further consideration could be given to approving the assignments.”48 Vanadium then sued Redington to recover the $13,000 it had paid Redington for his interest. Redington defended on the ground that Vanadium’s lack of cooperation prevented the assignments from being approved and therefore justified Redington in retaining the $13,000. The court held that Vanadium could not recover the $13,000 because it was under a duty to cooperate and had failed to do so: Here an obligation to attempt in good faith to secure the prerequisite of the Secretary’s approval would appear to rest upon both parties. Indeed plaintiff [Vanadium] may well have the heavier burden, for . . . it seems that the assignee must file the assignment for approval and apparently no one else can legally do so. It was surely not the intent of the parties when they made an apparently binding assignment that [Vanadium] should have the power to invalidate the assignment by not filing it for approval. On the contrary, it must have been assumed that plaintiff would reasonably file it and in good faith seek its approval.49

As the court in Vanadium saw the case, at the time the parties made the contract it must have been their intent that Vanadium would cooperate in obtaining the Secretary’s approval, because Vanadium’s cooperation was necessary for performance of the contract. In contrast, in the second category of duty-​to-​cooperate cases the cooperation of a party is not necessary 45.  Id. at 106. 46.  Id. 47.  Id. at 106–​07. 48.  Id. at 107. 49.  Id. at 108 (citations omitted).

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to performance of the contract. Rather, because of unanticipated circumstances that arise only as performance of the contract unfolds, it turns out that a slight amount of cooperation by one party can save the other party from incurring very high costs. In this kind of case the duty to cooperate is imposed not on the ground of interpretation, but on the ground of fairness. In such cases the duty to cooperate is a type of duty to rescue. Judge Posner has forcefully set out the duty to cooperate—​to rescue—​at least twice. In AM PAT/​Midwest, Inc. v.  Illinois Tool Works, Inc.,50 he stated that “[t]‌he parties to a contract are embarked on a cooperative venture, and a minimum of cooperativeness in the event unforeseen problems arise at the performance stage is required even if not an explicit duty of the contract.”51 He reiterated this position in Market Street: [C]‌ontracts do not just allocate risk. They also (or some of them) set in motion a cooperative enterprise, which may to some extent place one party at the other’s mercy. . . . . . . At the formation of the contract the parties are dealing in present realities; performance still lies in the future. As performance unfolds, circumstances change, often unforeseeably; the explicit terms of the contract become progressively less apt to the governance of the parties’ relationship . . . and with it the scope and bite of the good faith doctrine . . . grows.52

Hugh Collins gives a good example of the sort of a case in which the duty of cooperation requires a party to bestir himself to action based on fairness rather than on interpretive considerations: Consider a case of a contract of carriage of goods by road, where the owner of the goods hears on the radio that the main road is blocked due to an accident. Should the owner give this information to the carrier so that the delivery is not delayed, or can the owner simply leave the carrier to fend for itself, with the result that the carrier breaks the contract by delivering the goods late? Here, the economic analysis points towards a duty to disclose the information. The failure to disclose the information would simply increase the costs of performance to the carrier to the extent of the damages payable for delay and the opportunity costs caused by having a lorry stuck in a traffic jam, with no benefit to the owner of the goods. Since these costs could be avoided at the price of a telephone call, the criterion of wealth maximization suggests that an implied duty of disclosure of this information should be imposed. A similar conclusion emerges from an alternative analysis of this example in terms of the value of co-​operation. If we assume that the common law recognizes a basic value that the legal rules should be structured to promote the proper performance of contracts by requiring, where necessary, an implied duty of co-​operation, then again we should expect the law to impose an implied duty to disclose information in these circumstances. The duty to disclose information would assist the successful completion of contracts by requiring a minimal and inexpensive mutual duty to safeguard the other contracting party’s interests.53

50.  896 F.2d 1035 (7th Cir. 1990). 51.  Id. at 1041. 52.  Mkt. St. Assocs., Ltd. P’ship v. Frey, 941 F.2d 588, 595–​96 (7th Cir. 1991). 53.  Hugh Collins, Implied Duty to Give Information during Performance of Contracts, 55 Mod. L. Rev. 556, 556–​57 (1992).

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I V.   S U M M A RY A duty to rescue—​that is, a duty that is imposed by law upon one actor, A, to bestir himself to take a low-​cost, low-​risk, and otherwise reasonable action that will forestall a major loss to another actor, B, although B’s peril of prospective loss is not caused by A’s fault—​is an important, albeit implicit, principle of American contract law. A number of the rules that instantiate this duty have been considered in this Section. These rules are illustrative rather than exhaustive. For example, suppose A and B make a contract that includes Expression E. A attaches the meaning Alpha to Expression E, while B attaches the meaning Beta. Alpha is a more reasonable meaning than Beta, but A knows that B attaches the meaning Beta, and B does not know that A attaches the meaning Alpha. In such a case Expression E will be interpreted to mean Beta, although that meaning is less reasonable than Alpha, because A should have warned B that the meaning he attached was unreasonable. Similarly, if B makes a mechanical error in formulating an offer, such as a mistake in computing a bid, and A is aware of the error, A cannot take advantage of the error by accepting the offer, and instead should warn B of the mistake. What accounts for the differing treatment of the duty to rescue in contract law, on the one hand, and tort and criminal law, on the other? One explanation is that the courts have chosen not to extend an unsound rule any further than precedent requires. Another explanation is that a duty to rescue in tort and criminal law would often entail significant physical activity by the rescuer, together sometimes with a degree of physical risk, whereas the duty to rescue in contract law usually entails only a communication by the rescuer rather than physical activity and physical risk. Moreover, if we look at the law as a whole, the picture is not simply one of competing rules in contract law on the one hand, and tort and criminal law on the other. The no-​duty rule in tort and criminal law is riddled with exceptions. For example, the rule does not apply where the defendant and the victim are in a special relationship, such as innkeeper-​guest or employer-​employee. As a result of these many exceptions it is fair to conclude that a duty to rescue is imposed in tort and criminal law in most cases where a reasonable person should act. Accordingly, even if the duty to rescue in contract law is incongruent with the no-​duty rule in tort and criminal law, it is congruent with the many exceptions to that rule. More important, a duty to rescue is congruent with other areas of law—​in particular, admiralty law and the law of restitution. Under admiralty law there is a duty to rescue life in peril on the sea.54 Under the law of restitution an actor is under a duty to return a mistaken payment although he has no relationship to the payor, has not undertaken to make a repayment, and was not at fault in receiving the payment. Viewed globally, therefore, what is both socially and systemically incongruent is not the duty to rescue in contract law but the failure of tort and criminal law to impose such a duty as a general principle.

54.  46 U.S.C. § 2304 (2016); United Nations Convention on the Law of the Sea, Art. 98, 1833 U.N.T.S. 435–​ 36; Brussels Salvage Convention of 1910, art.11, reprinted in Ina H. Wildeboer, The Brussels Salvage Convention 266 (1965); Thomas J.  Schoenbaum with the assistance of Jessica L.  McClellan, Admiralty and Maritime Law § 13-​8, at 872–​74 (5th ed. 2012).

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The Mitigation Principle The Mitigation Principle is as follows: If (1) A and B are significant

relationship, (2) A is at risk of incurring a significant loss growing out of this relationship, and (3) B could prevent or reduce A’s loss by taking a very low-​cost, low-​risk action, then B should take that action. In the area of contract-​law remedies this principle is primarily exemplified by the rule that a promisee is under a duty to mitigate (reduce) the damages payable by a breaching promisor if the promisee can do so in a low-​cost, low-​risk way. As Restatement Second Section 350(1) provides, “[d]‌amages are not recoverable for loss that the injured party could have avoided without undue risk, burden or humiliation.” The mitigation principle is a special case of the duty to rescue in contract law, discussed in Chapter 9. In the area of contract-​law remedies the principle is supported by fairness, causation, and efficiency. In terms of fairness, the duty to mitigate is supported by the same considerations that support the broader duty to rescue in contract law: parties to a contract are in a relationship and owe each other at least modest duties of respect and care. In terms of causation, if the promisee fails to take a low-​cost, low-​risk step to limit his injury, then it can be said that this failure, rather than the promisor’s breach, is the proximate cause of the promisee’s injury.1 In terms of efficiency, a failure to mitigate would often result either in the production of a socially wasteful product, where the issue is whether a promisee should stop performing after being ordered to do so by the promisor, or a waste of socially productive capacity, where the issue is whether the promisee should have stood idle after the breach. So, for example, under the mitigation principle if A and B have a contract and A breaches by wrongfully ordering B to stop performing, B should stop performing even though A’s order is wrongful.2 This iteration of the mitigation principle is exemplified by Rockingham County v. Luten Bridge Co.3 Rockingham County and Luten had entered into a contract under which Luten would construct a bridge for

1.  See, e.g., McClelland v. Climax Hosiery Mills, 169 N.E. 605, 609 (N.Y. 1930) (Cardozo, J., concurring). 2.  There is an exception where A commits a material breach and continuing to perform would actually reduce B’s damages. “For example, if a buyer breaks a contract to buy manufactured goods after manufacture has begun, the seller may be better able to avoid loss [to the buyer] by continuing manufacture and selling the finished goods than by ceasing manufacture and attempting to salvage the work in progress.” E. Allan Farnsworth, Contracts 809 (3d ed. 1999). 3.  35 F.2d 301 (4th Cir. 1929). Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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the County. After Luten had begun to construct the bridge the County changed its mind and ordered Luten to stop work. Luten disregarded the order and completed the bridge. The court held that Luten was not entitled to damages attributable to work performed after the countermand. Cases such as Rockingham County, in which a service-​provider could reduce the service-​ purchaser’s loss by stopping work on the contract when ordered to do so, seem very easy, because if the service-​provider continues to perform normally the provider would increase the purchaser’s loss without increasing its own gain. Here is the reason: the standard formula for measuring expectation damages for breach by a service-​purchaser is the contract price minus the costs remaining to be incurred by the service-​provider at the time of breach.4 Assume that in a case such as Rockingham County the contract price is $100,000, Luten’s total cost to build the bridge would be $80,000, and the County breached when Luten had incurred costs of $40,000. In that case, if Luten stops work when it is instructed to do so, Luten’s recovery would be $60,000—​the $100,000 contract price minus the $40,000 costs remaining to be incurred by Luten. However, Luten’s gain would be only $20,000, because $40,000 of its recovery would merely reimburse it for costs incurred. Now assume that instead of stopping when ordered to do so, Luten drives the project through to completion. If Luten was allowed to do that, its recovery would be $100,000—​the $100,000 contract price minus the zero costs remaining to be incurred. However, Luten’s gain would still be only $20,000, because $80,000 of the $100,000 recovery would merely reimburse Luten for its costs. Accordingly, Luten’s continuation of work after the countermand would increase the County’s loss from $60,000 to $100,000 but would not increase Luten’s gain. Strictly speaking, cases such as Rockingham do not involve a duty to mitigate, because in such cases the promisee is only obliged not to needlessly increase the promisor’s damages. However, the duty to mitigate damages should and normally does go well beyond that obligation. For example, a buyer of goods should not be able to, and cannot, sue a breaching seller for consequential damages if the buyer could have prevented those damages by covering, that is, by making a substitute purchase.5 The same rule should and does apply to contracts for the provision of services, as exemplified by Illustration 6 to Restatement Second Section 350: A contracts to supervise the production of B’s crop for $10,000, but breaks his contract and leaves at the beginning of the season. By appropriate efforts, B could obtain an equally good supervisor for $11,000, but he does not do so and the crop is lost. B’s damages for breach of contract do not include the loss of his crop. . . .

An even more onerous duty to mitigate is imposed on an employee whose employer breaches a contract of employment. In such cases the duty to mitigate requires the employee to actively seek other employment of like kind even though such a search may and often will frequently require the employee to engage in an emotionally difficult and time-​consuming endeavor for the sole purpose of reducing the damages of an employer who has treated the employee wrongfully.

4.  An alternative, algebraically equivalent, formula is based on the service-​provider’s profit (contract price minus total out-​of-​pocket costs) plus the out-​of-​pocket costs already incurred by the service-​provider at the time of breach. Both measures need to be adjusted if the service-​purchaser has made payments prior to the breach. 5.  See U.C.C. § 2-​715 (Am. Law Inst. & Unif. Law Comm’n 1977).

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The question then arises: What rule determines whether an employee’s duty to mitigate has been satisfied? The traditional rule frames the issue in objective terms: an employee has a duty to take a replacement job if, but only if, it involves “similar employment, with similar conditions of employment and rank and in the same locality.”6 The problem with this iteration of the duty to mitigate is that a job that is objectively comparable to the job originally contracted for may not satisfy the plaintiff for good subjective reasons ranging from the quality of management to the cleanliness of the workplace. In such cases, a rule that in effect forces the employee to take the replacement job despite its unsatisfactory nature violates the Indifference Principle—​that a contract-​law remedy should make the injured party indifferent between performance, on the one hand, and breach and the remedy on the other—​because it places the employee in a worse position than he would have been in if the employer performed the original contract, which presumably involved a subjectively satisfactory job. The preferable approach, therefore, is to treat a wrongfully discharged employee in the same manner as a covering buyer, so that the employee’s process of finding a replacement job—​his search—​is reviewed under a standard of reasonableness but his substantive choice to accept or reject a job is reviewed under a standard of good faith.7 If the employee fails to make a reasonable search and it can be shown that such a search would have discovered an objectively comparable job, he should bear the uncertainty of whether he would have accepted the job. However, if the employee does make a reasonable search he should not be constrained to accept an alternative job that he in good faith deems unsatisfactory. Like any subjective standard, this test is subject to abuse, but the likelihood of abuse seems small. Given normal economic and psychological needs, few persons are likely to turn down a satisfactory job in favor of inactivity and a chance of recovering damages that would put them in no better financial position than the replacement job.8 Self-​regard will therefore normally control bad faith, and in any event whether an employee who turns down a replacement job did so in good faith can be directly reviewed by the court. The leading case of Parker v.  Twentieth Century-​Fox Film Corp.9 supports this bifurcated standard for search and choice. Shirley MacLaine had contracted with Fox to play the female lead in a movie, Bloomer Girl, for a minimum compensation of $750,000. Before production started Fox decided not to produce the movie and offered MacLaine the lead in another movie, Big Country, Big Man, for identical compensation. Big Country was to be filmed at the time

6.  Dan B. Dobbs, Handbook on the Law of Remedies, 926 (1973). 7.  See infra Chapter 52. 8.  Cf. Robert Pear, Few of the Poor Quitting Jobs to Get Back on Welfare Rolls, N.Y. Times, Oct. 25, 1982, at A1, col. 5: Critics of President Reagan’s budget cuts, including Democrats and welfare rights advocates, had said that under changes in the law enacted last year, poor people would often find it profitable to quit their jobs and depend entirely on welfare payments. Welfare recipients are automatically eligible for free or low-​cost medical care under the Medicaid program, which they often lose when they leave the welfare rolls. State officials said last week that the new law did contain “work disincentives,” but that those cut off from welfare were trying to hold onto jobs or increase their earnings, even in a time of high unemployment. “In purely economic terms, it did not make sense for some of these people to continue working,” said Barbara Salisbury, budget director of the Massachusetts Department of Public Welfare. “But the people who were working want to work. They are not making decisions solely on the basis of what benefits them most in dollars and cents.”

9.  474 P.2d 689 (Cal. 1970).

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scheduled for Bloomer Girl, but Bloomer Girl was to be a musical while Big Country was to be a dramatic western, and Bloomer Girl was to be filmed in California while Big Country was to be filmed in Australia. Also, the Bloomer Girl contract gave MacLaine the power to approve the director and the screenplay while the proposed Big Country contract provided only that Fox would consult with MacLaine on these issues. MacLaine rejected Big Country and brought suit for breach of contract. Fox defended on the ground that by refusing to accept Big Country MacLaine had failed to mitigate damages. The California Supreme Court affirmed a summary judgment for MacLaine. The court made obeisance to the traditional statement of the mitigation rule by holding that the Big Country role was not equivalent to the Bloomer Girl role and that the differences in the contracts’ provisions made Big Country “an offer of inferior employment.”10 The thrust of the opinion, however, went considerably further. First, the court seemed to eviscerate the traditional test by effectively suggesting that any distinction between two jobs could render them different in kind as a matter of law:11 The mere circumstance that “Bloomer Girl”‘ was to be a musical review calling upon plaintiff ’s talents as a dancer as well as an actress, and was to be produced in the City of Los Angeles, whereas “Big Country”‘ was a straight dramatic role in a “Western Type”‘ story taking place in an opal mine in Australia, demonstrates the difference in kind between the two employments. . . .

Second, the court properly drew a sharp distinction between search and choice: In the present case defendant has raised no issue of reasonableness of efforts by plaintiff to obtain other employment. . . . Despite defendant’s arguments to the contrary, no case . . . holds or suggests that reasonableness is an element of a wrongfully discharged employee’s option to reject, or fail to seek, different or inferior employment. . . . 12

A footnote added, “Instead, in each case [relied on by Fox] the reasonableness referred to was that of the efforts of the employee to obtain other employment that was not different or inferior; his right to reject the latter was declared as an unqualified rule of law.”13 Contracts for services other than employment, such as construction contracts, should be treated the same way as employment contracts. Take, for example, the following hypothetical: Busy Plumber. Plumber is in the business of upgrading plumbing in old commercial buildings. He operates at full capacity and must often turn down jobs. On January 1, Plumber enters into a contract to do a plumbing job for Owner A for $6,000, the work to begin on February 1 and to be completed in two weeks. On January 30, Owner A repudiates the contract. On January 31, Plumber makes a contract to do a plumbing job for Owner B for $7,600, the work to begin on February 1 and to be completed in two weeks. Since Plumber was operating at full capacity he could not have accepted the job with Owner B but for the breach by Owner A. Plumber’s out-​of-​ pocket costs for performing his contract with Owner A would have been $3,400, so that his profit

10.  Id. at 694. 11.  Id. at 693–​94. 12.  Id.at 692–​93 (emphasis in original). 13.  Id. at 693 n.5 (emphasis in original).

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on that contract would have been $2,600. His out-​of-​pocket costs for performing his contract with Owner B are $2,900, so that his profit on that contract is $4,700. Plumber now sues Owner A.

Under the expectation principle, Plumber’s profit on the contract with Owner B should offset Plumber’s damages against Owner A—​otherwise damages would place Plumber in a better position than performance would have done. Traditionally, however, the courts did not apply an offset in this kind of case. For example, in Grinnell Co. v.  Voorhees14 Grinnell entered into a contract with Willys under which Grinnell agreed to install a fire-​extinguishing system in a Willys plant. When Grinnell had completed 78 percent of the work Willys became insolvent and fell into receivership. Durant Motor Company then purchased the Willys plant and employed Grinnell to complete the fire-​extinguishing system. Grinnell apparently earned the same profit under the Durant contract that it would have earned under the Willys contract. Nevertheless, Grinnell sued the Willys receivers to recover the profits it would have earned under the Willys contract if it had been allowed to complete that contract. The court declined to reduce Grinnell’s damages by—​or offset—​the amount of the profits Grinnell earned under the Durant contract. When a contract for services is breached, the court said, “the claim of the plaintiff accrues at once and the law does not inquire into later events” unless personal services are involved.15 The difference between the treatment given to employment-​and nonemployment-​services cases is both anomalous and unjustified. For one thing, an employment contract is only a special case of a contract for the provision of services. For another, if employment-services contracts were to be treated differently than nonemployment-services contracts, we would expect the law to be more tenderhearted to employees than to business organizations, not the reverse. In short, the standard of review should be the same in all services cases. The efforts of a nonemployee service-​provider to find a substitute job should be reviewed under a reasonability standard, but its decision to turn down a job should be reviewed under a good-​faith standard. That standard would allow a contractor to base his decision whether to take a substitute job on factors similar to those that bear on an employee’s decision, as well as factors that are relatively unique to contractors, such as the financial risks presented by a potential substitute contract. In support of the traditional rule, Professor Edwin Patterson argued that “As an enterpriser, [a]‌builder may take on an indefinite number of contracts and make a profit on all of them.”16 This argument is incorrect. Many factors, such as managerial and supervisory capacity, working capital, and bonding limits, constrain the number of jobs a contractor can take on. Of course, often a contractor can expand capacity, within limits. Often, therefore, a service-​purchaser’s breach may not enable a contractor to make a replacement contract he could not otherwise have made, because he could have made and performed both contracts. That is no reason, however, to prohibit a service-​purchaser from establishing that in his case the breach did enable the contractor to take on a replacement job that he could not otherwise have taken on. The rule traditionally applied to nonemployment-​services contracts is triply anomalous: it is inconsistent with the principle of mitigation, with the rules governing contracts for the sale of goods, and with the rules governing employment contracts. Therefore, it is not surprising that

14.  1 F.2d 693 (3d Cir. 1924). 15.  Id. at 695. 16.  Edwin W. Patterson, Builder’s Measure of Recovery for Breach of Contract, 31 Colum L. Rev. 1286, 1306 (1931).

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the rule seems to be eroding. For example, in M. & R. Contractors & Builders v. Michael17 the court said that if a contractor “could not have worked on another job or project unless he had been discharged from the performance of the defendant’s contract then the gains from the other employment or undertaking must be deducted from [its] damages.”18 Similarly, Restatement Second Section 358 Comment e provides: e. Substitute transactions. When a party’s breach consists of a failure to . . . furnish services . . . it is often possible for the injured party to secure similar . . . services on the market. . . . Similarly, when a party’s breach consists of a failure to receive . . . services . . . it is often possible for the aggrieved party to dispose of the . . . services on the market. . . . In such cases as these, the injured party is expected to make appropriate efforts to avoid loss by arranging a substitute transaction. If he does not do so, the amount of loss that he could have avoided by doing so is subtracted in calculating his damages. . . .

It is often said that mitigation of damages is not really a duty because an actor’s failure to mitigate damages does not make him liable, but instead simply reduces the amount of damages that he can collect.19 This argument is misconceived. To begin with, conduct by a promisee who is under a duty to mitigate damages may actually increase damages. If a promisee who is under a duty to mitigate incurs costs in a reasonable effort to mitigate he should be able to and can recover those costs from the promisor even if the attempt to mitigate is unsuccessful and therefore increases rather than decreases the promisor’s damages, because where the promisee has a duty to mitigate it is only fair that he be compensated for his costs in carrying out that duty. Thus in West Haven Sound Development Corp. v.  West Haven,20 the City of West Haven sold part of a large parcel of land to R, who planned to use the land for a restaurant. The City agreed with R that the rest of the parcel would be developed with residential and commercial buildings, which would provide a clientele for the restaurant. The City broke its promise. R sued the City for breach and recovered, among other

17.  138 A.2d 350 (Md. 1958). 18.  Id. at 358 (emphasis in original); see also Kearsarge Computs., Inc. v. Acme Staple Co. 366 A.2d 467, 471 (1976); McMullen v.  Wel-​Mil Corp., 209 S.E.2d 507 (N.C. 1974). H.A. Steen Indus., Inc. v.  Richer Commc’ns, 314 A.2d 319 (Pa. 1973), involved a comparable problem. Steen had rented two billboards from Richer for a two-​year term, but defaulted after several months. Judgment by confession for unpaid rentals was entered in Richer’s favor, and Steen moved to reopen the judgment to introduce evidence showing that Richer had re-​rented the billboards. The lower court declined to reopen, but its decision was reversed: It is true that there are situations in which a non-​breaching party is entitled to recover lost profits with no duty to mitigate damages. For example, where the product is manufactured, and two are as easily manufactured as one, a non-​breaching seller may get two profits from the combination of one default and one sale. See, e.g., U.C.C. § 2-​708(2). . . . Thus, in this case, if appellee had a potentially unlimited supply of billboards, so that it could accommodate as many customers as it could find . . . it would be entitled to lost profits without mitigation. . . . There is no indication that appellee “had [such] other space,” and the fact that the billboards were rather quickly re-​leased indicates that it did not. Id. at 321–​22.

19.  See, e.g., McClelland v. Climax Hosiery Mills, 169 N.E. 605, 609 (N.Y. 1930) (Cardozo, J., concurring). 20.  514 A.2d 734 (Conn. 1986).

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elements of damages, $200,000 for the expenses he incurred in an unsuccessful attempt to mitigate the City’s damages by keeping the restaurant afloat. Similarly, in Mr. Eddie v.  Ginsberg,21 Ginsberg was wrongfully dismissed by his employer early in the term of a three-​year employment contract. Immediately after the dismissal, Ginsberg took another job, which he held for thirty-​four weeks, earning $13,760. After Ginsberg left that job he spent $1,340 unsuccessfully seeking further employment. The court held that Ginsberg was entitled to recover the remaining salary under his contract, minus the $13,760 earned on the other job, but plus the $1,340 expended unsuccessfully looking for further employment. As to that expense, the court said that the rule in such cases is . . . as follows:  “the expenses for which a recovery may be had include necessary and reasonable disbursements made in an effort to avoid or mitigate the injurious consequences of the defendant’s wrong . . . If such expenses are the result of a prudent attempt to minimize damages they are recoverable even though the result is an aggravation of the damages rather than a mitigation.”22

More fundamentally, under modern contract law the principle of mitigation is not confined to requiring the victim of breach to take reasonable actions to mitigate the breaching party’s damages. Instead, the principle requires the victim to take reasonable actions to mitigate the breaching party’s losses. Thus in The Mitigation Principle: Toward a General Theory of Contractual Obligation, Goetz and Scott conceptualize mitigation as a principle that requires each party to a contract to act “so as to minimize the joint costs of providing performance or its equivalent.”23 So, for example, where A sells and delivers defective goods to B, and the goods will continue to lose value unless B takes some easy action to prevent the further loss, B must take the action. This rule is exemplified by Restatement Second Section 350, Illustration 3: A sells oil to B in barrels. B discovers that some of the barrels are leaky, in breach of warranty, but does not transfer the oil to good barrels that he has available. B’s damages for breach of contract do not include the loss of the oil that could have been saved by transferring the oil to the available barrels.

Similarly, Uniform Commercial Code Section 2-​203(1) provides that if a merchant buyer rightfully rejects goods that are in his control at the time of the rejection, the goods are perishable or threaten to speedily decline in value, and the seller has no place of business or agent at the place of rejection, the buyer is under a duty to follow any reasonable instructions received from the seller with respect to the goods. Furthermore, in the absence of such an instruction the buyer is under a duty to make reasonable efforts to sell the goods for the seller’s account. If a buyer fails to satisfy this duty he will be liable to the seller for any loss in the value of the goods that would have been prevented if the buyer had made reasonable efforts to sell the goods.

21.  430 S.W.2d 5 (Tex. Civ. App. 1968). 22.  Id. at 12; see also Automated Donut Sys. v. Consol. Rail Corp., 424 N.E.2d 265, 270–​71 (Mass. App. Ct. 1981); Restatement Second § 347 cmt. c and illus. 3, § 350 cmt. H (Am. Law Inst. 1981). 23.  Charles J. Goetz & Robert E. Scott, The Mitigation Principle: Toward a General Theory of Contractual Obligation, 69 Va. L. Rev. 967, 969 (1983).

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Behavioral Economics and Contract Law I .   I N T R O DUCT I ON One set of criteria for contract-​law rules concerns experience. The most essential criterion in this category is human psychology. Classical contract law was implicitly based on a rational-​actor or expected-​utility model of psychology. Under this model actors who make decisions in the face of uncertainty rationally maximize their subjective expected utility, with all future benefits and costs properly discounted to present value. Rationality, in turn, requires that when consequences are uncertain their likelihood must be evaluated without violating the basic rules of probability theory. This was a very impoverished model of the psychology of contracting actors. As Thomas Ulen observes, the expected-​utility model requires the strong assumption that decision-​makers “know, or can know, all the feasible alternative actions open to them, that they know, or can easily discover, all relevant prices, and that they know their wants and desires.”1 As applied to choices made under conditions of uncertainty, additional strong assumptions about cognitive abilities must be made, namely that individual decisionmakers can compute (subjective) probability estimates of uncertain future events; that they perceive accurately the dollar cost or outcome of the uncertain outcomes; that they know their own attitudes toward risk; that they combine this information about probabilities, monetary values of outcomes, and attitudes toward risk to calculate the expected utilities of alternative courses of action and choose that action that maximizes their expected utility.2

These assumptions are not only strong, they are too strong—​that is, wrong. Accordingly, although expected-​utility psychology is the foundation of the traditional economic model of choice it is a woefully erroneous modal of the psychology of contracting actors. Within the last half century a great body of theoretical and empirical work in cognitive psychology, known as behavioral economics, has shown that due to limits of cognition, the traditional model often 1.  Thomas S. Ulen, Cognitive Imperfections and the Economic Analysis of Law, 12 Hamline L. Rev. 385, 386 (1989). 2.  Id.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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diverges from the actual psychology of choice.3 As Amos Tversky and Daniel Kahneman (who founded the school of behavioral economics) point out, expected-​utility (or rational-​actor) theory “emerged from a logical analysis of games of chance rather than from a psychological analysis of risk and value. The theory was conceived as a normative model of an idealized decision maker, not as a description of the behavior of real people.”4 Modern behavioral economics has established that some of the decision-​making rules (heuristics) that people use yield systematic errors, and that other aspects of peoples’ cognitive capabilities are also systematically defective.5 “[T]‌he deviations of actual behavior from the normative model are too widespread to be ignored, too systematic to be dismissed as random error, and too fundamental to be accommodated by relaxing the normative system.”6 In this book, the deviations from rationality will be referred to collectively as the limits of cognition.

A. INVARIANCE For example, a basic assumption of expected-​utility theory, sometimes called invariance, is that a decision-​maker’s preference between choices should not depend on how the choices are framed, that is characterized and presented.7 Instead, invariance requires that actors make choices based on real consequences,8 so that different characterizations or presentations—​different framings—​ of the same option should lead to the same choice.9 It has been repeatedly shown, however, that

3.  See John R. Anderson, Cognitive Psychology and Its Implications (2d ed. 1985); Thomas S. Ulen, Cognitive Imperfections and the Economic Analysis of Law, 12 Hamline L. Rev. 385 (1989); Christine Jolls, Cass R. Sunstein & Richard Thaler, A Behavioral Approach to Law and Economics, 50 Stan. L. Rev., 1471 (1998); Cass R. Sunstein, Behavioral Analysis of Law, 64 U. Chi. L. Rev. 1175 (1997). 4.  Amos Tversky & Daniel Kahneman, Rational Choice and the Framing of Decisions, 59 J. Bus. S251 (1986) [hereinafter Tversky & Kahneman, Rational Choice]. 5.  See, e.g., Colin .Camerer, Individual Decision Making, in The Handbook of Experimental Economics 587, 590–​616 (John H. Kagel & Alvin E. Roth eds., 1995). 6.  Tversky & Kahneman, Rational Choice, supra note 4, at S252; see also Colin F. Camerer & Howard Kunreuther, Decision Processes for Low Probability Events: Policy Implications, 8 J. Pol’y Anal. & Mgmt. 565, 568 (1989) (“The [expected-​utility] model. . . . has been shown to be an inadequate description of individual choices in many ways. . . . Many descriptive violations arise because people use heuristic rules to estimate probabilities—​rules that yield systematic errors”). Ulen has observed: There is a mounting body of evidence that . . . many, perhaps most, individuals routinely make errors in the routine processing of information. The [implication] of this finding is “that individuals may make many more errors in their attempts to maximize their utility or profit than the rational choice model assumes; that these errors are not due to the standard sorts of market imperfections but rather to a novel set of individual imperfections I call ‘cognitive imperfections’; [and] that these errors are systematic, not randomly distributed with mean zero. . . .”

Ulen, supra note 1, at 387–​88. 7.  See Kenneth J. Arrow, Risk Perception in Psychology and Economics, 20 Econ. Inquiry, 1, 1–​9 (1982). 8.  See Reid Hastie & Robyn M. Dawes, Rational Choice in an Uncertain World 300–​02 (2001) (discussing the framing effect as a violation of invariance). 9.  Daniel Kahneman & Amos Tversky, Choices, Values, and Frames, 39 Am. Psychologist 341, 343 (1984) [hereafter Kahneman & Tversky, Choices, Values, and Frames].

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in reality choice often depends on how options are framed.10 For example, whether substantively identical options are framed as gains or losses has a decisive effect on actors’ choices.11 Most people are risk-​averse when contemplating gains but risk-​preferring when contemplating losses.12 Accordingly, given a choice between a sure gain of $800 and an 85 percent chance to win $1,000, most people prefer the sure gain over the chance even though the chance has a higher expected value. In contrast, given a choice between a sure loss of $800 and an 85 percent chance of a loss of $1,000, most people prefer the chance over the sure loss, even though the chance has a worse expected mathematical value.13 These contrasting preferences are not in themselves irrational, but they can be manipulated by the use of framing to produce irrational choices. In a famous experiment Tversky and Kahneman presented subjects with two problems concerning a choice of alternative programs to combat a disease that would otherwise kill 600 people.14 In Problem I the subjects were told that Program A  would save 200 lives while Program B carried a one-​third probability of saving 600 lives. In Problem II the subjects were told that Program A would cost 400 lives while Program B carried a two-​thirds probability of losing 600 lives. A  moment’s reflection shows that the two Program As are identical, as are the two Program Bs. Nevertheless, because Problem I was framed in terms of gains—​lives saved—​and therefore invoked risk-​averse behavior, while Problem II was framed in terms of losses—​lives lost—​and therefore invoked risk-​preferring behavior, 72  percent of the respondents chose program A in Problem I while only 22 percent chose Program A in Problem II.15 Another example of framing results from the characterization of an option as insurance or as gambling. When offered a hypothetical choice between a sure loss of $50 and a 25 percent chance of a loss of $200, most people chose the former when the choice was posed as a question of insurance and the latter when the choice was presented as a question of gambling.16 The framing effect is so strong that many people will stand by their inconsistent choices even when they know of the inconsistencies. On several occasions Tversky and Kahneman presented the same respondents with the two versions of the disease problem.17 After Tversky and Kahneman explained to their respondents the inconsistent preferences evoked by the two 10.  See, e.g., Camerer & Kunreuther, supra note 6, at 572–​74; Kahneman & Tversky, Choices, Values, and Frames, supra note 9, at 343–​44; Richard G. Noll & James E. Krier, Some Implications of Cognitive Psychology for Risk Regulation, 19 J. Legal Stud. 747, 753–​54 (1990). 11.  See, e.g., Kahneman & Tversky, Choices, Values, and Frames, supra note 9, at 349. 12. Amos Tversky & Daniel Kahneman, The Framing of Decisions and the Psychology of Choice, 211 Science 453, 453 (1981). Risk preference in the case of losses may not apply at the extreme ends of the spectrum, that is, where the probability of winning or losing is small, on the one hand, or the loss would be catastrophic, on the other. See Tversky & Kahneman, Rational Choice, supra note 4, at S255, S258. 13.  Kahneman & Tversky, Choices, Values, and Frames, supra note 9, at 342; see also Noll & Krier, supra note 10, at 752 (presenting algebraic formulas for the proposition that people are loss-​averse as to gains but risk-​preferring as to losses). 14.  See Tversky & Kahneman, Rational Choice, supra note 4, at 453–​55. 15.  See id. at 453. 16.  Baruch Fischoff, Cognitive Liabilities and Product Liability, 1 J. Prod. Liab. 207, 213 (1977); Kahneman & Tversky, Choices, Values, and Frames, supra note 9, at 349; Paul Slovic, Baruch Fischoff & Sarah Lichtenstein, Response Mode, Framing, and Information-​Processing Effects in Risk Assessment, in Question Framing and Response Consistency 21, 22–​28 (Robin M. Hogarth ed., 1982). 17.  See Kahneman & Tversky, Choices, Values, and Frames, supra note 9, at 343; Tversky & Kahneman, Rational Choice, supra note 4, at 453.

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versions, many chose to remain risk-​averse in the lives-​saved version and risk-​preferring in the lives-​lost version even though they wanted their answers to be consistent.18 A similar study by Scott Lewis found that even after researchers showed a group of undergraduate students that they had made inconsistent choices on the basis of framing effects, half the students refused to change their responses to make them consistent.19 As Kahneman and Tversky comment: The failure of invariance is both pervasive and robust. It is as common among sophisticated respondents as among naive ones, and it is not eliminated even when the same respondents answer both questions within a few minutes. . . . In their stubborn appeal, framing effects resemble perceptual illusions more than computational errors.20

The framing effect is a particularly dramatic illustration of the limits of cognition. The effect is relevant to contract law because, for example, it may help explain how door-​to-​door sellers can manipulate the preferences of buyers by the way they frame consumer choices and may therefore justify rules such as the cooling-​off period in door-​to-​door sales, which gives consumers several days to reconsider and cancel their orders.21 The balance of this chapter, however, will emphasize three other systematic limits on cognition: bounded rationality, irrational disposition, and defective capability.

I I .   B O U N D E D RAT I ONA L I T Y Suppose an actor needs to make a choice, and before he makes the choice he will search out competing alternatives. Assume that one of the alternatives would best reflect the actor’s preferences, and call this the optimal choice. If the costs of searching for and processing (that is, evaluating and deliberating on) information were zero and human information-​processing capabilities were perfect then the actor would search for all relevant information, would perfectly process all the information he acquired, and would then make the optimal choice. In reality, of course, searching for and processing information does involve costs, in the form of time, energy, and perhaps money. Most actors therefore recognize that comprehensive search and information-​processing is not achievable at any realistic cost, and therefore rationally decide to not acquire and process—​to remain ignorant of—​some information concerning possible alternative choices. The ability to process information is also constrained by limitations on an actor’s ability to calculate consequences, organize and utilize memory, understand implications, and make comparative judgments about complex alternatives,22 and these limitations become

18.  Kahneman & Tversky, Choices, Values, and Frames, supra note 9, at 343. 19.  See Hastie & Dawes, supra note 8, at 306. 20.  Kahneman & Tversky, Choices, Values, and Frames, supra note 9, at 343. 21.  See, e.g., 16 C.F.R. § 429.1 (2016). 22.  See James G. March, Bounded Rationality, Ambiguity, and the Engineering of Choice, 9 Bell J. Econ. 587, 590 (1978); see also Herbert A. Simon, Rational Decisionmaking in Business Organizations, 69 Am. Econ. Rev. 493, 502–​03 (1979).

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more severe as decisions become more complex.23 Accordingly, actors will often imperfectly process even the information they do acquire. In short, the rationality of human choice is normally bounded both by limited information and limited and imperfect information-​processing capabilities.24 These limits are referred to as bounded rationality, because rationality can only operate within the bounds of information that is acquired and correctly processed. Although the concept of bounded rationality suggests that actors will adopt selective search and processing procedures, it does not dictate what those procedures will be. Under a model developed by George Stigler, an actor invests in search until the cost of further search equals the marginal returns from further search.25 At that point, the actor terminates search. Under this model an actor optimally bounds his search and then makes a decision, based on his bounded search, that may or may not be the optimal choice. This model can also be applied to the amount of information processing that an actor engages in. In either event, the model assumes that actors will often make decisions in a state of rational ignorance of alternatives and consequences that could have been discovered and considered if search and processing had continued. There are other models of choice26 but for simplicity of exposition it will be assumed that Stigler’s model normally governs the amount of search and processing in which actors engage. Nevertheless, this model does not exhaust the concept of bounded rationality. The model describes only the amount, not the quality, of search and processing. In contrast, the concept of bounded rationality accepts that actors often will process information imperfectly. In short, the utility that an actor derives from a choice depends on both the substantive merits of the choice and the costs of making the choice. Limits on search and processing may maximize an actor’s overall utility, because the utility that is gained by limiting search and processing may offset the utility that is lost by not searching and processing thoroughly. In such cases the actor’s ignorance of undiscovered information or his failure to completely process acquired information will often or usually be rational. Nevertheless, the actor may end up failing to make the optimal choice.

I I I .   I R R AT I O N AL DI S POS I T I ON: U N R E A L I S T I C OPT I M I S M Although bounded rationality does not necessarily lead to irrational decisions, two bodies of empirical evidence show that under certain circumstances actors are often systematically irrational; that is, they often fail to make rational choices even within the boundaries of the

23.  See James G. March & Herbert A. Simon with Harold Guetzkow, Organizations 191–​92 (2d ed. 1993). 24.  See Herbert A. Simon, Administrative Behavior 79–​109 (3d ed. 1976). 25.  George J. Stigler, The Economics of Information, 69 J. Pol. Sci. 213, 216 (1961). 26.  For example, Herbert Simon developed a model that he called satisficing. Simon, supra note 22, at 502–​03; Herbert A. Simon, Theories of Bounded Rationality, in Decision and Organization 161, 170–​71 (C.B. McGuire & Roy Radner eds., 2d ed. 1986). Under Simon’s model, prior to searching for information an actor sets an initial target level of aspiration or satisfaction. When the actor discovers an alternative that meets his predetermined level of aspiration, he terminates his search and chooses that alternative. Id.

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information that they have acquired and processed. One body of evidence concerns disposition. This body of evidence shows that people are irrationally optimistic as a systematic matter.27 For example, one study showed that nearly 90 percent of drivers believe they drive better than average.28 Another showed that 97 percent of consumers believe that they are either average or above average in their ability to avoid accidents involving bicycles and power mowers.29 In a study by W. Kip Viscusi and Wesley A. Magat, in which consumers were informed of the true average risks presented by bleach and drain cleaner, only 3 percent of consumers considered their homes to present an above-​average risk of hand burn and child poisoning from the use of drain cleaner, or of poisoning or injury to children from the use of bleach. Roughly half the consumers considered their homes to be about average in risk, and the other half believed their household had lower-​than-​average risk. The consumers were particularly optimistic about child poisoning from drain cleaner, which in reality was by far the most severe risk. Almost two-​thirds considered that their family’s risk from this hazard was below average, while only 3  percent considered that their family’s risk from this hazard was above average.30 Similarly, when people rate their chances for personal and professional success, most believe that their chances are better than average.31 In one study, Neil D. Weinstein asked college students whether they believed their chances of experiencing certain favorable or unfavorable life events differed from the average chances of all other students of the same sex at the same college. Six times the number of students thought they were more likely than their average classmate to own their own home than thought they were less likely. Seven times as many students thought they were less likely than their average classmate to have a drinking problem than thought they were more likely. Six times as many students thought they were more likely than their average classmate to like their postgraduate job than thought that they were less likely. More than nine times as many students thought they were less likely than their average classmate to divorce a few years after marriage than thought they were more likely. Answers about all other life events skewed in the same optimistic direction.32 Similarly, actors tend to be overconfident of their ability to make judgments about uncertain factual issues, and are particularly likely to be overconfident where the judgments are difficult.33 The dispositional characteristic of irrational optimism is strikingly illustrated in a study by Lynn A. Baker and Robert E. Emery, appropriately titled When Every Relationship Is Above

27.  Neil D. Weinstein, Unrealistic Optimism about Future Life Events, 39 J. Personality & Soc. Psychol. 806 (1980). 28. Ola Svenson, Are We All Less Risky and More Skillful than Our Fellow Drivers Are?, 47 Acta Psychologica 143, 146 (1981), cited in Colin F. Camerer & Howard Kunreuther, Decision Processes for Low Probability Events: Policy Implications, 8 J. Pol’y Anal. & Mgmt. 565, 569 (1989). 29.  W. Kip Viscusi & Wesley A. Magat, Learning about Risk: Consumer and Worker Responses to Hazard Information 95 (1987). 30.  Id. at 94–​95. 31. Weinstein, supra note 27, at 809–​14. 32.  Id.; see also Camerer & Kunreuther, supra note 6, at 569 (discussing the empirical evidence of systematic optimism); Richard G. Noll & James E. Krier, supra note 10, at 757–​58 (providing a mathematical model of the optimism effect on decision-​making). 33.  Ward Edwards & Detlof von Winterfeldt, Cognitive Illusions and Their Implications for the Law, 59 S. Cal. L. Rev. 225, 239 (1986).

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Average.34 Baker and Emery asked respondents who were soon to be married about their own perceived divorce-​related prospects as compared to the prospects of the general population. The disparities between respondents’ perceptions about the general population and about themselves were enormous and were almost invariably in the direction of undue optimism. For example, the respondents estimated that 50 percent of American couples will eventually divorce. (This estimate was correct at the time.) In contrast, the respondents estimated that their own chance of divorce was zero.35 Similarly, the median estimate of the female respondents was that courts award alimony to 40 percent of divorced women who requested it. In contrast, 81 percent of the female respondents expected that a court would award them alimony if they requested it.36 The respondents’ median estimate of how often spouses pay alimony when ordered by a court to do so was that 40 percent paid. In contrast, 100 percent of the respondents predicted that their own spouse would pay all court-​ordered alimony.37 These figures were not broken down by sex. The same optimism permeated views on child custody. The median estimate of the female respondents was that children from divorced families live mostly with their mothers 80 percent of the time. In contrast, more than 95 percent of the women expected that they would get primary custody in a divorce. The median estimate of the male respondents was that children from divorced families live mostly with their fathers 20 percent of the time. In contrast, more than 40 percent of the men expected that they would get primary custody in a divorce.38

I V.   D E F E C T I VE CA PA BI L I T Y Because human information-​processing ability is limited, actors who have acquired information that is relevant to a decision employ heuristics—​that is, decision-​making rules that take the form of mental shortcuts or rules of thumb—​to solve problems and make judgments quickly. The use of heuristics is not in itself irrational. However, cognitive psychology has established that actors commonly use heuristics that are irrational in the sense that they produce systematic errors. As Tversky and Kahneman observed, “[T]‌he deviations of actual behavior from the normative model are too widespread to be ignored, too systematic to be dismissed as random error, and too fundamental to be accommodated by relaxing the normative system.”39

34. Lynn A. Baker & Robert E. Emery, When Every Relationship Is Above Average:  Perceptions and Expectations of Divorce at the Time of Marriage, 17 Law & Hum. Behav. 439 (1993). 35.  Id. at 443. 36.  Id. 37.  Id. The median male respondent estimated that courts award alimony to only 50 percent of divorcing women, but 83 percent of the male respondents expected that a court would award alimony to their wives if it was requested. Id. In their article Baker and Emery characterize this response as overly optimistic,] see id., but Baker now believes that the response might better be characterized as an overestimation of the relevant likelihood. Letter from Lynn Baker to author (Sept. 30, 1993) (on file with the author). 38.  Baker & Emery, supra note 34, at 443. 39.  Tversky & Kahneman, Rational Choice, supra note 4, at S252.

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A. AVAILABILITY One of these irrational heuristics is known as availability.40 Actors who make choices that requires a judgment about the probability of an event commonly judge that probability on the basis of data and scenarios that are readily available to their memory rather than on the basis of all relevant data. This heuristic leads to systematic biases because factors other than objective frequency and probability often affect the salience of scenarios and data and therefore affect the ease with which an actor imagines a scenario or retrieves data from memory.41 For example, in one experiment researchers recited lists of well-​known personalities to groups of subjects. All the lists contained names of both men and women, but in some lists the men were more famous than the women whereas in other lists the women were more famous than the men. When asked to determine whether men or women were more numerous on a particular list the subjects erroneously concluded that the gender represented in the list by more famous personalities was more numerous.42 Similarly, recent occurrences are usually easier to retrieve from memory than earlier occurrences. As Tversky and Kahneman pointed out, “It is a common experience that the subjective probability of traffic accidents rises temporarily when one sees a car overturned by the side of the road.”43 Independent significance (like fame in the list experiment) and spatial or temporal proximity (as in the traffic-​accident example) are two elements that may make data salient and therefore more easily retrievable. In addition, data and scenarios that are instantiated, vivid, and concrete will normally be more salient than data and scenarios that are general, pallid, and abstract, such as statistical findings and generalized probabilities.44 Borgida and Nisbett gave information about psychology courses to psychology majors trying to choose their classes. Some students were given information orally by two or three other students who had taken the course; others received statistical summaries of the reports of dozens of students who had taken the same course. The oral communications had a much greater effect than the statistical summaries. In short, actors systematically give undue weight to instantiated evidence as compared to general propositions, to vivid evidence as compared to pallid evidence, and to concrete evidence as compared to abstract evidence.45 For example, Lichtenstein, Slovic, Fischoff, Layman, and Combs asked a large number of respondents to estimate the frequency of forty-​one causes 40.  See Hastie & Dawes, supra note 8, at 78–​80; Susan T. Fiske & Shelley E. Taylor, Social Cognition 168–​69 (2d ed. 1991); Amos Tversky & Daniel Kahneman, Availability: A Heuristic for Judging Frequency and Probability, in Judgment under Uncertainty: Heuristics and Biases 163, 164, 166, 174–​75 (Daniel Kahneman, Paul Slovic & Amos Tversky eds., 1982) [hereinafter Tversky & Kahneman, Availability]; Amos Tversky & Daniel Kahneman, Judgment under Uncertainty: Heuristics and Biases, in Judgment under Uncertainty:  Heuristics and Biases 3, 3, 11 [hereinafter Tversky & Kahneman, Judgment]. 41.  Hastie & Dawes, supra note 8, at 78–​80; cf. Daniel Kahneman & Dale T. Miller, Norm Theory: Comparing Reality to Its Alternatives, 93 Psychol. Rev. 136, 141–​42 (1986) (expanding on the availability heuristic by analyzing the relationship between a stimulus and those past experiences or ad hoc constructions that constitute the “norm” against which the stimulus is compared). 42.  Tversky & Kahneman, Judgment, supra note 40, at 1127. 43.  Id. 44.  See Richard Nisbett & Lee Ross, Human Inference: Strategies and Shortcomings of Social Judgment 43–​62 (1980). 45.  See Hastie & Dawes, supra note 8, at 80–​94.

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of death in the United States.46 The respondents overestimated the frequency of memorable and dramatic killers, such as homicide, accidents, and natural disasters, and underestimated the frequency of quiet killers, such as asthma, emphysema, and diabetes.47 Similarly, an actor may assess the risk of heart attack among middle-​aged people by recalling such occurrences among his middle-​aged acquaintances. Or an actor may evaluate the likelihood that a given business venture will fail by canvassing those potential business failures that come readily to mind.48 In gen­ eral, “[v]‌ibrant examples simply outweigh more reliable, but abstract base rate information.”49

B. REPRESENTATIVENESS Another irrational heuristic is representativeness, which involves the manner of making judgments concerning the adequacy of search. As the concept of bounded rationality implies, actors seldom collect all relevant data before making decisions. Rather, they usually make decisions on the basis of some subset of the data that they judge to be representative of all the data.50 In making that judgment, however, actors systematically and erroneously view unduly small samples as representative.51 In particular, actors are systematically insensitive to sample size and quality and therefore often erroneously assume that a small sample of present events is representative and therefore predictive of future events.52 In this way, as Arrow has observed, “[t]‌he individual judges the likelihood of a future event by the similarity of the present evidence to it,” while ignoring other evidence, such as prior occurrences and the quality of the sample.53

C.  FAULTY TELESCOPIC FACULTIES Another defect in capability concerns the ability of actors to make rational comparisons between present and future states: actors systematically give too little weight to future benefits and costs as compared to present benefits and costs.54 Thus Feldstein concludes that “some or all individuals have, in Pigou’s . . . words, a ‘faulty telescopic faculty’ that causes them to give too

46.  Sarah Lichtenstein, Paul Slovic, Baruch Fischoff, Mark Layman & Barbara Combs, Judged Frequency of Lethal Events, 4 J. Experimental Psychol.: Hum. Learning & Memory 551 (1978). 47.  Id. at 555–​57, 556 tbl. 2. Eugene Borgida & Richard E. Nisbett, The Differential Impact of Abstract vs. Concrete Information on Decisions, 7 J. Applied Soc. Psychol. 258 (1977); see also Nisbett & Ross, supra note 44, at 52, 57–​58. 48.  Tversky & Kahneman, Judgment, supra note 40, at 1127. 49.  Fiske & Taylor, supra note 40, at 184. 50.  See, e.g., id. at 165–​67; Tversky & Kahneman, Judgment, supra note 40, at 1124. 51.  See Amos Tversky & Daniel Kahneman, Belief in the Law of Small Numbers, in Judgment under Uncertainty:  Heuristics and Biases 23, 24–​25 (scientists and laypersons alike tend to view small random samples as highly representative of populations). 52.  See Arrow, supra note 7, at 5. 53.  Id.; see also Fiske & Taylor, supra note 40, at 165–​67. 54.  Martin Feldstein, The Optimal Level of Social Security Benefits, 100 Q. J. Econ. 303, 307 (1985).

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little weight to the utility of future consumption.”55 For example, a major rationale for social security is that because of faulty telescopic faculties most people lack the foresight to adequately save for retirement.

D.  FAULTY RISK-​ESTIMATION FACULTIES A defect related to faulty telescopic faculties is the systematic underestimation of risks.56 Based on the work of cognitive psychologists, especially Tversky and Kahneman, Kenneth Arrow observes that “[i]‌t is a plausible hypothesis that individuals are unable to recognize that there will be many surprises in the future; in short, as much other evidence tends to confirm, there is a tendency to underestimate uncertainties.”57 In fact, empirical evidence shows that people often not only underestimate but often ignore low-​probability risks. In interviews with 2,055 homeowners living in flood-​prone areas throughout the United States and 1,006 homeowners in earthquake-​prone areas in California, Kunreuther and Slovic found that many residents had little idea of the real probability of a future disaster or of their own potential damage from such an occurrence.58 Of the uninsured subjects in the flood-​prone-​area survey, 29 percent said they expected that they would suffer no damage in a severe flood and 26 percent said they expected that their damage would be $10,000 or less. Of the uninsured respondents in the earthquake-​ prone-​area survey 12 percent said they expected that they would suffer no damage in a severe earthquake and 19 percent said they expected that they would suffer damages of only $10,000 or less.59 Even many respondents who had informed conceptions of expected losses and premium costs declined to buy insurance in the manner predicted by the expected-​utility model.60 Similarly, laboratory results consistently demonstrate that even when offered subsidized premiums people tend to insure only against high-​probability low-​loss hazards and tend to reject insurance against low-​probability high-​loss hazards.61 When asked about their insurance decisions, participants in both survey and laboratory studies indicated a disinclination to worry about low-​probability hazards.62

55.  Id. (quoting, although slightly incorrectly, A.C. Pigou, The Economics of Welfare (1920). The actual quote is: “[O]‌ur telescopic faculty is defective, and . . . we, therefore, see future pleasures, as it were, on a diminished scale.” A.C. Pigou, The Economics of Welfare 25 (4th ed. 1932)). 56.  See Thomas H. Jackson, The Logic and Limits of Bankruptcy Law 237–​40 (1986). 57. Arrow, supra note 7, at 5. 58.  Howard Kunreuther & Paul Slovic, Economics, Psychology, and Protective Behavior, 68 Am. Econ. Rev.64, 66–​67 (1978). 59.  Howard Kunreuther, Limited Knowledge and Insurance Protection, 24 Pub. Pol’y 227, 234–​35 (1976). 60.  Kunreuther & Slovic, supra note 58, at 66–​67. 61.  Id. at 67. 62.  Id.; see also Camerer & Kunreuther, supra note 6, at 565–​92 (reviewing empirical evidence that people ignore or underestimate low-​probability, high-​consequence risks); Albert R. Karr, False Sense of Security and Cost Concerns Keep Many on Flood Plains from Buying Insurance, Wall St. J., Aug. 31, 1993, at A12 (citing statistics and field interviews for the proposition that most people in flood-​prone areas do not purchase flood insurance due in part to an it-​can’t-​happen-​here attitude).

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Furthermore, there is evidence that people have difficulty estimating low-​probability risks.63 Prospect theory, a mathematical treatment of the limits of cognition, predicts that actors either will entirely ignore or overestimate low probabilities64 so that their estimation of low-​probability risks will be very unstable.65 Although prospect theory does not predict the conditions under which low probabilities will be either overweighed or ignored, it seems likely that actors will ignore low-​probability risks unless they are highly salient.66 Viscusi and Magat hypothesize that when actors are forced to confront a low-​probability risk they tend to overestimate the risk; when they are not forced to confront the risk they tend to ignore it.67 Thus as Howard Latin points out, overestimation “may be applicable when people must consider low-​probability risks, but bounded rationality and non-​availability considerations may induce people to disregard many unlikely risks in everyday life.”68 Still another possibility, which is consistent with most or all of the empirical evidence, is that actors tend to overestimate low-​probability risks of personal physical injury of which they are made aware but tend to ignore or underestimate other low-​probability risks. On balance, it is clear that accurate risk estimation is often or even usually unlikely, and the evidence strongly suggests that people systematically underestimate most risks, including low-​probability risks of economic losses. _​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​ The defects in cognition are closely related and interactive. For example, actors may underweigh future costs in part because the future involves a great number of risks and actors underestimate risks, and in part because the future is pallid, abstract, and general while the present is vivid, concrete, and instantiated. Similarly, actors may underestimate risks in part because many risks are pallid, abstract, and general and in part because risks relate to the future and actors underweigh future costs. Irrational heuristics are also closely related to and interact with the dispositional problem of undue optimism. If actors are unrealistically optimistic they will systematically underestimate risks; if actors systematically underestimate risks they will be unduly optimistic. The defects in capability are also closely tied to bounded rationality. For example, the problems of availability and representativeness would not even come into play if search and processing were unbounded: only where actors rely on selective incomplete information does undue emphasis on available and unrepresentative data pose a problem.

63.  Viscusi & Magat, supra note 29, at 90–​93. 64.  Camerer & Kunreuther, supra note 6, at 572. 65.  Kahneman & Tversky, Choices, Values, and Frames, supra note 9, at 345. 66.  See Camerer & Kunreuther, supra note 6, at 570; Howard Latin, “Good” Warnings, Bad Products, and Cognitive Limitations, 41 UCLA L. Rev. 1193, 1245–​47 (1994). 67.  Viscusi & Magat, supra note 29, at 91. 68. Latin, supra note 66, at 1246.

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THE ROLE OF FAULT IN CONTRACT LAW

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liability. It is an accepted maxim that pacta sunt servanda, contracts are to be kept. The obligor is therefore liable in damages for breach of contract even if he is without fault. . . .”1 Similarly, Farnsworth’s treatise states that “contract law is, in its essential design, a law of strict liability, and the accompanying system of remedies operates without regard to fault.”2 These statements, and many others like them, are incorrect. As a normative matter, fault should be a building block of contract law. One part of the human condition is that we hold many moral values concerning right and wrong. Contract law cannot and does not escape this condition. Recall two of the basic principles of contract law developed in Chapter 3: First. If appropriate conditions are satisfied, and subject to appropriate constraints, the law should effectuate the objectives of parties to promissory transactions. Second. The rules that determine the conditions to and the constraints on the legal effectuation of the objectives of parties to promissory transactions, and the way in which those objectives are to be ascertained, should consist of those rules that best take into account all relevant policy, moral, and empirical propositions.

Other chapters of this book discuss the decisive role of fault in the areas of unconscionability, unexpected circumstances, interpretation, and mistake. Since fault plays an important role in morality, it is only to be expected that fault would play a significant role in contract law, and so it does. Why then do some prominent authorities deny the clear fact that fault plays a heavy role in contract law? That can’t be known. One possible reason is that the sins of the fathers have been visited on the sons—​since prior authorities took this position, their successors respectfully followed along. Here is another possibility. Many areas of contract law do not turn on fault but instead turn on policy and empirical considerations with fault playing little or no role (for example, 1.  Restatement (Second) of Contracts ch. 11, intro. note (Am. Law Inst. 1981). 2. 3 E. Allan Farnsworth, Farnsworth on Contracts § 12.8, at 195–​96 (3d ed. 2004).

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consideration, the mailbox rule, the parol evidence rule, and the Statute of Frauds), and in areas in which fault does play a role, it is a supporting role that might be easy to miss. For example, in the area of interpretation the leading role is played by rules about what meaning should be attached to contractual terms. Where fault plays a role, it is in rules that determine that interpretation A will prevail over interpretation B if the actor holding interpretation B is at fault for doing so. This secondary role might make it easy, although not acceptable, to overlook the importance of fault in contract law. In short, the existence of some contract-​law rules that are not fault-​based does not mean that fault doesn’t play an important role in contract law, any more than the existence of some strict-​liability rules in tort law does not mean that fault doesn’t play an important role in tort law. In areas of law other than contracts the role of fault is blatant. For example, in torts the role of fault hits us between the eyes in the case of wrongs such as intentional infliction of mental distress, injuries to person caused by lack of due care, injury to reputation caused by libel or slander, and so forth. In contrast, the role of fault in contract law is often subtle—​for example, in the area of interpretation the focus is often on what the parties’ language means, but in fact interpretation cases often turn on whether a party was at fault in using an expression whose reasonable meaning is different from the meaning he intended to convey. A major reason various authorities conclude that contract law is based solely on strict liability is that these authorities have in mind not contract law as a whole but only one area of contract law—​liability for defective performance, including both imperfect performance and nonperformance. The proposition that liability for defective performance is strict, not fault-​ based, has a superficial appeal. In torts a plaintiff usually prevails only if the defendant acted wrongfully by inflicting an injury intentionally or through a failure to exercise due care. In contrast, in contracts a plaintiff usually prevails simply by showing that a contract was formed and the defendant’s performance was defective, even though her defective performance did not result from her fault. It is therefore tempting to reach the conclusion that liability in contract for defective performance is strict, not fault-​based. However, that would be an oversimplified view of both the morality of promising and the basis of liability for defective performance. Morally, a promise is a commitment to take a certain action, such as the achievement of a given result, even if, when the time comes for the action to be taken, the promisor would prefer not to keep her promise, all things considered. Correspondingly, it is not a moral excuse for nonperformance that when the time comes to perform it would hurt to do so. To believe that either of these reasons are moral excuses for not performing a promise would be to misunderstand the nature of promising. The moral commitment of a promisor is to render full performance in the absence of a moral excuse. Correspondingly, defective performance of a promise may be morally permissible if there is a moral excuse for not performing. One such excuse is that performance would not only hurt, but hurt very badly. As Thomas Scanlon says, Saying “I promise to . . .” normally binds one to do the thing promised, but it does not bind unconditionally or absolutely. . . . It does not bind absolutely because, while a promise binds one against reconsidering one’s intention simply on grounds of one’s own convenience, it does not bind one to do the thing promised whatever the cost to oneself and others.3

3.  Thomas M. Scanlon, Promises and Practices, 19 Phil. & Pub. Aff. 199, 214 (1990).

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Similarly, the fact that performance of a promise hurts very badly may be a legal excuse under the doctrine of impracticability. In short, it is inaccurate to say that liability for defective performance is established simply by showing defective performance. To that showing must be added the lack of an acceptable excuse for the defective performance. Liability for defective performance is not strict liability, because it builds on the moral structure of promising. If I promise you that I will meet you for lunch, I don’t show up, and I have no acceptable excuse, such as falling ill, I am at fault—​not as a result of strict liability, but because of a morally unexcused breach of my moral obligation to keep my promise. The same is true if I promise to sell you one hundred widgets and don’t deliver, unless I have a good excuse. Of course, what constitutes a good excuse in the widgets hypothetical may be different from what constitutes a good excuse in the lunch hypothetical, but that is largely because of the different context and subject matter, not because one defective performance is judged under a fault standard and the other is judged under a strict liability standard. The fault basis of liability for defective contractual performance is well summarized by Barry Nicholas: Fault is . . . absent from the conventional common law conception of liability for breach of contract only because it is in substance incorporated in the meaning of “contract”. So in a formulation such as that in Restatement 2d Contracts, § 235(2): “When performance of a duty under a contract is due any non-​performance is a breach”, the part played by fault is incorporated in the duty.4

4.  Barry Nicholas, Fault and Breach of Contract, in Good Faith and Fault in Contract Law 337, 345 (Jack Beatson & Daniel Friedmann eds., 1995) (emphasis added).

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EXPECTATION DAMAGES Under the expectation measure in contract law, damages for breach of contract should put the promisee in the position he would have been in if the contract had been performed. This measure is seldom applied directly. Instead, a number of more specific formulas mediate between the expectation measure, on the one hand, and recurring scenarios of breach—​such as breach by a buyer or a seller of goods—​on the other. Often, two or even three different and conflicting formulas, each based on the expectation measure, can be applied to a given scenario, so that expectation damages in a given case might vary significantly depending on which formula is applied. This Part will develop the major formulas for measuring expectation damages, show how those formulas conflict, and explore how those conflicts should be resolved. Chapter 13 introduces the basic building blocks of expectation-​damage formulas. Chapters 14 and 15 analyze the standard formulas that apply to breach of contracts for services and goods, respectively. Chapter  16 considers two important scenarios of breach in which the standard formulas are inappropriate.

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one of three major building blocks: replacement cost, diminished value, and lost profit. Replacement-​cost damages are based on the difference between the contract price and the actual or imputed cost of a replacement transaction. If a seller of goods or services breaches and the buyer makes an actual replacement purchase, his replacement-​cost damages are referred to as cover damages. If a buyer breaches and a seller makes an actual replacement sale, his replacement-​cost damages are referred to as resale damages. If the buyer does not make a replacement purchase, or the seller does not make a replacement sale, replacement-​cost damages are normally measured by the difference between the contract price and the price the buyer would hypothetically have paid, or the seller would hypothetically have received, if he had made a replacement transaction. In those cases replacement-​cost damages are referred to as market-​ price damages. In the case of thickly traded homogeneous commodities, such as wheat or shares of stock, the term market price is a real entity, which usually can be established by checking published sources. However, in the case of differentiated commodities, such as used equipment, market price is a construct, which is usually established by determining the prices at which comparable commodities were sold at comparable times and places, and then extrapolating from those prices. Diminished-​value damages are based on the difference between the value of the performance that a breaching seller rendered and the value of the performance that she promised to render. Lost-​profit damages are based on the difference between the contract price a breaching buyer agreed to pay and the seller’s variable costs. The term lost profit is somewhat misleading in this context. For business and financial purposes a seller’s profit on the sale of a given commodity is determined by subtracting, from the contract price, the variable costs the seller incurred to produce or acquire the commodity and the portion of the fixed costs allocable to the production or acquisition. In contrast, for the purposes of contract law a seller’s lost-​profit damages should

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be and are determined by subtracting, from the contract price, only the seller’s variable costs. Accordingly, in contract law, the term lost surplus would be more accurate than the term lost profit. However, because the latter term is much more commonly used, it will be used in this book, and correspondingly the term costs will be used in this book to mean variable costs.

I.   C O M PA R I N G EXPECTAT I ON A N D R E L I A N C E DA M A GES Expectation damages, which are the most basic type of damages in contract law, look forward to a hypothetical state in which a broken promise was performed. Reliance damages are backward-​ looking: the aim of such damages is to put the promisee back to the position he was in before he relied on the broken promise. If the purpose of reliance damages is achieved an actor is equally well off whether there is no promise, on the one hand, or a promise, reliance, breach, and reliance damages, on the other. If the purpose of expectation damages is achieved an actor is equally well off whether a contract is performed, on the one hand, or a contract is breached and expectation damages are paid, on the other. The difference between the two measures can be illustrated by the well-​known case of Hawkins v. McGee.1 Hawkins had an injured and disfigured hand resulting from a childhood injury. Dr.  McGee, a surgeon, induced Hawkins to submit to an operation on the hand by promising to make the hand perfect. In fact, however, the operation made the hand irreversibly worse. Hawkins provides a stage for illustrating how the elements of a recovery under reliance and expectation damages play out when those measures are applied to facts on the ground.

A.  RELIANCE DAMAGES First, consider the elements of Hawkins’s reliance damages if he had recovered damages based on that measure. To begin with, Hawkins would be entitled to the difference between the value of his hand before the operation (Before Hand) and the diminished value of his hand after the operation (After Hand). This difference would be measured primarily by the diminution in Hawkins’s earning power with After Hand and the pain and suffering that resulted from After Hand. (Giving Hawkins damages based on his lost future earnings might seem to put him forward rather than back. However, prior to the operation Hawkins had an opportunity to generate income with Before Hand, but after the operation he could generate income only with his diminished After Hand, so that the operation resulted in a diminution of his assets.) Next, Hawkins would be entitled to damages for the pain and suffering of the useless operation, both because such damages would be necessary to restore him to his pre-​promise condition and because the pain and suffering of the operation was wasted. As stated in a comparable case, Sullivan v. O’Connor,2 “[I]‌t can be argued that the very suffering or distress ‘contracted for’ 1.  146 A. 641 (N.H. 1929). 2.  296 N.E. 2d 183, 189 (Mass. 1976).

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[that is, the suffering and distress of the operation] . . . should . . . be compensable . . . [because] that suffering is ‘wasted’ if the treatment fails. Otherwise stated, compensation for this waste is arguably required in order to complete the restoration of the status quo ante.” For comparable reasons Hawkins would be entitled to recover from Dr. McGee any fee he had paid to the doctor, any amount he had paid to the hospital, his lost earnings while he was in the hospital leading up to and during the operation, and his lost earnings while he was recuperating from the operation. Hawkins would also be entitled to recover the emotional distress resulting from the postoperative condition of his hand. Although damages for emotional distress usually aren’t awarded in contract law an exception is made in the case of contracts that concern personal interests, as was the case in Hawkins v. McGee.

B.  EXPECTATION DAMAGES Now consider the elements of Hawkins’s expectation damages. To begin with, Hawkins would be entitled to the difference between the value of the hand Dr. McGee promised, Perfect Hand, and the value of After Hand, rather than the usually smaller difference between the value of Before Hand and the value of After Hand. Again, this difference would be measured on the basis of Hawkins’s earning power with each condition of his hand, plus pain and suffering resulting from the operation, including emotional distress. Unlike reliance damages, however, under the expectation measure Hawkins would not be entitled to the return of Dr. McGee’s fee, the hospital charges that Hawkins paid, the wasted pain of the operation, lost wages during the period Hawkins would have been in the hospital if the operation had achieved the promised result, or lost wages during the recuperative period that would have ensued if the operation had achieved the promised result (the reliance damages elements). The reason is this: if the operation had achieved the promised result, Hawkins would not have been entitled to the return of Dr. McGee’s fee, to the hospital charges for a normal stay, to the pain of the operation, or to the lost earnings during a normal recuperative period. But once Hawkins recovers the difference between the values of After Hand and Perfect Hand, then in principle he is put in the position that he would have been in if the operation had achieved the promised result. (In reality, of course, money cannot substitute for a permanent bodily injury. However, in many cases of wrongdoing, including Hawkins v. McGee, after the injury occurs it is no longer possible to really make things right—​the law cannot give Hawkins a perfect hand. Accordingly, the law does what it can do, which is to award money damages and treat the money as if that made things right.) Therefore, Hawkins should not be able to recover Dr. McGee’s fee or the other reliance damages elements, because expectation damages, albeit fictitiously, put him in the position he would have been in if the operation had achieved the promised result. Similarly, Hawkins should not recover expectation damages for the pain of the operation because if the operation had given Hawkins a perfect hand he would have undergone that pain, and Hawkins is getting the economic equivalent of a perfect hand. Hawkins would, however, be entitled to recover the earnings he lost during any portion of the convalescence that exceeded the convalescence period that was to be expected if all had gone as promised.3

3.  Hawkins, 146 A. at 644.

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I I.   E XP E C TAT I O N D A M A GES V.   R EL I A NCE D AMA G E S I N   A B A RGA I N CONT EXT Against this background, consider whether the expectation or the reliance measure is the appropriate remedy for breach of a bargain promise, assuming for the moment that the choice lies only between those two measures. In some cases, selecting between the expectation and reliance measures in a bargain context is unnecessary, because the two measures will yield virtually identical results. In particular, in a perfectly competitive market reliance damages normally will be equal or virtually equal to expectation damages. According to the traditional model of business conduct, in such a market a seller of a given commodity will produce the commodity until his incremental cost of production equals the market price of the commodity. Buyers, in turn, will purchase all of the seller’s production. Consequently, the market clears in each period, and everyone buys and sells as much as he wants at the same price. By definition, a perfectly competitive market has many similar buyers and sellers. Therefore, if, for example, Buyer makes a contract with Seller One in such a market to purchase Commodity C at 15¢/​pound, Buyer could alternatively have made a contract with Seller Two to purchase Commodity C at that price. Passing up that alternative contract is an opportunity cost, and therefore would provide the baseline of Buyer’s reliance damages against Seller One, provided the probability that Seller Two would also have breached is negligible.4 Since 15¢/​pound is also the baseline for expectation damages, in this context the two measures will produce the same or virtually the same result. Often, however, reliance and expectation damages significantly diverge, as they would in Hawkins v. McGee. When this divergence occurs, which measure should normally be employed for breach of a bargain promise? Begin with the concepts of injury and compensation. In ordinary usage a person is said to be injured if an event occurs that causes him to suffer economic or personal costs or, to put it differently, causes a diminution in his economic or human wealth. The objective of remedies in most areas of private law is to compensate a wrongfully injured person for the effects of the injury by restoring him to the position that he was in before his economic or human wealth was wrongfully diminished. This kind of remedy is therefore referred to as compensatory damages. Normally a compensatory-​damages regime implements what may be called the cost principle, because such a regime makes the injured person whole for the costs that resulted from the wrongful injury and therefore restores him back to his pre-​injury state. Reliance damages fit well with this principle. In contrast, expectation damages put a promisee forward to where he would have been if the contract had been performed, even if the promisee suffered little or no costs—​that is, little or no diminution of his economic or human wealth. In such cases reliance damages would be close to zero. However, the expectation measure implements what may be called the Indifference Principle because, as Richard Craswell has observed, the stated goal of expectation damages is to award the plaintiff “the amount necessary to leave the plaintiff absolutely indifferent, in subjective terms, between having the defendant breach and pay damages or having the defendant 4.  See L.L. Fuller & William R. Perdue, The Reliance Interest in Contract Damages (pt. 1), 46 Yale L.J. 52, 62–​63 (1936); Charles J. Goetz & Robert E. Scott, Enforcing Promises: An Examination of the Basis of Contract, 89 Yale L.J. 1261, 1284 (1980).

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perform.”5 In the remainder of this book the objective of effectuating this goal will be referred to as the Indifference Principle. Accordingly, although the expectation measure in contract law is usually characterized as compensatory,6 it is not compensatory in the ordinary sense of that term, because it is not aimed at restoring a promisee’s loss of wealth and indeed does not even require that the promisee has lost any wealth. As classically stated by Fuller and Perdue, “[O]‌ne frequently finds [expectation damages] . . . treated as a mere corollary of a more fundamental principle, that the purpose of granting damages is to make ‘compensation’ for injury. Yet in this case we ‘compensate’ the plaintiff by giving him something he never had. This seems on the face of things a queer kind of ‘compensation.’ ”7 That the expectation measure is not compensatory is not a reason to reject it. In contracts, as in any area of law, the choice of remedial regime should depend not on whether a given regime is compensatory but on whether the regime is more efficient and fair than alternative regimes. Begin with efficiency considerations, and more particularly, incentive effects. In a bargain context the three most important incentive effects of a damage measure concern decisions whether to perform or breach—​that is, the efficient rate of performance; decisions how much to invest in precaution to ensure the ability to perform when the time comes—​that is, the efficient rate of precaution; and decisions how much to invest in surplus-​enhancing reliance, that is, incurring expenses that will increase the value of a contract, like advertising.

A.  THE EFFICIENT RATE OF PERFORMANCE It is always possible that events will give a bargain-​promisor an incentive not to perform. For example, the cost of performance may increase significantly, or a new and more profitable opportunity may arise that is available to the promisor only if she does not perform her contract with the promisee. If promisors were liable only for the promisee’s costs—​that is, if promisors faced only reliance damages for breach—​the full value of the contract to promisees would not enter into purely self-​interested calculations by promisors whether to perform or breach, and promisors therefore might breach too often. In contrast, at least in principle the expectation measure places on the promisor liability for the full value of the contract to the promisee, thereby 5.  Richard Craswell, Contract Remedies, Renegotiation, and the Theory of Efficient Breach, 61 S. Cal. L. Rev. 629, 636 (1988). 6.  See, e.g., Hawkins v. McGee, 146 A. 641, 643 (N.H. 1929) (“By ‘damages,’ as that term is used in the law of contracts, is intended compensation for a breach. . . .”); Restatement (Second) of Contracts ch. 16, intro. note (Am. Law Inst. 1981) [hereinafter Restatement Second] (“The traditional goal of the law of contract remedies has . . . [been] compensation of the promisee for the loss resulting from breach.”). 7.  Fuller & Perdue, supra note 4, at 52–​53. Expectation damages might be viewed as compensatory in the ordinary sense of that term if a promisee’s expectation is a type of property, so that by breaching her promise the promisor takes from the promisee something that he owned. The approach is certainly plausible, and some scholars have adopted it, but in the end the approach seems incorrect. Whether a class of things constitutes property is largely a matter of social norms. Under prevailing social norms an expectation of gain under a contract is usually not conceived as property. For example, if A takes B’s property A commits a criminal offense and B can require A to return the property. In contrast, if A breaches her contract with B, A commits only a private wrong and normally B cannot require A to perform the contract, but only to pay damages. See Chapter 15, infra.

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efficiently sweeping that value into the promisor’s calculus of self-​interest if and when she makes a perform-​or-​breach decision. Accordingly, expectation damages provide efficient incentives for the promisor’s performance, whereas reliance damages do not.

B.  THE EFFICIENT RATE OF PRECAUTION Where a promisor breaches a contract because the contract has become unprofitable due to an increase in her cost of performance, or some other unexpected circumstance that does not rise to the level of a legal excuse for nonperformance, it is often possible that the promisor could have forestalled this motivation for breach if she had taken appropriate precautions against the unexpected circumstance. For example, suppose that Yachtmaker contracts to build a customized yacht for Yachtsman. There are many types of precaution that Yachtmaker could take to decrease the probability of her breach, such as ordering materials well in advance, hiring extra workers to protect against some workers quitting or falling ill, and reserving in advance the dry-​dock facilities that will be needed in the final stages of construction. Precaution involves costs in terms of money, time, and effort. From an efficiency standpoint these costs must be balanced against the resulting benefit—​a reduction in the probability of breach and a consequent enhancement of the likelihood that the value of the contract will be realized. The expectation measure provides appropriate incentives for the efficient rate of precaution for the same reason that it provides appropriate incentives for the efficient rate of performance. Incentives for precaution are efficient if they compel the promisor to balance the cost of precaution against the cost of failing to take precaution, including the increased risk to the promisee of losing his share of the contract’s value. Under the reliance measure that element would not enter into a self-​interested calculation by the promisor, and the promisor’s incentive for precaution would therefore be inadequate. By placing on the promisor the promisee’s risk of losing his share of the contract’s value in the event of breach, that risk can be swept into the promisor’s calculus of self-​interest in making decisions on how much to invest in precautions. Accordingly, the expectation measure also creates efficient incentives for precaution.

C.  THE EFFICIENT RATE OF SURPLUS-​ ENHANCING RELIANCE Once a contract has been made a party may take various actions in reliance upon it. Some of these actions constitute either performance or necessary preparation for performance. For most practical purposes, these actions are not within a contracting party’s rightful discretion:  the very purpose of a bargain contract is to commit each party to perform. If a promisor does not perform she is in breach and also unable to establish rights against her contracting partner. Necessary preparation is not discretionary because to perform, a party must do whatever is necessary to prepare for performance. In fact, a party may be in breach even before performance if due to lack of appropriate preparation she is prospectively unable to perform.8

8.  See UCC § 2-​609; Restatement Second, § 251.

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There is, however, a type of reliance whose nature or extent is discretionary. The most important reliance of this type consists of reliance that will enable the relying party to increase the surplus that he derives from the contract. Goetz and Scott developed this concept and called it beneficial reliance. In this book, this concept will be referred to by an equivalent term, surplus-​ enhancing reliance. Here are two examples: The Seafarer. Boatmaker contracts to build a vessel, to be named The Seafarer, for Charterer, who plans to charter out the vessel to cruise lines. The parties agree that Boatmaker is not responsible for providing or installing furnishings, navigational equipment, safety equipment (such as lifeboats), or other ancillary items. Boatmaker has a backlog of orders and promises delivery in six months. The navigational equipment that Charterer wants for The Seafarer must be ordered sixty days in advance. Charterer might choose to wait to order this equipment until The Seafarer is delivered. However, Charterer prefers to order the equipment sixty days before delivery of The Seafarer so that he can charter out The Seafarer as soon as it is delivered, thereby increasing the value of the contract to him. The advance purchase of navigational equipment constitutes surplus-​ enhancing reliance. The Blue Angels. The Blue Angels, a rock group, contracts with Promoter to give a concert in three months. Promoter can greatly increase box-​office receipts, and therefore the value of the contract, by advertising the concert in advance. Advance advertising constitutes surplus-​enhancing reliance.

Expectation damages provide the promisee with more efficient incentives to engage in surplus-​enhancing reliance than do reliance damages. In the event of breach by the promisor, reliance damages will often return to the promisee only the amount of the investment that he made in surplus-​enhancing reliance. In contrast, expectation damages will return to the promisee the surplus that the investment would have generated if the contract had not been broken. Knowing that expectation damages give promisors strong and appropriate incentives to perform, promisees will be more confident that their investment in surplus-​enhancing reliance will not expose them to undue risk. Promisees can therefore plan more effectively, because once a contract is made they can order their affairs with some degree of confidence that they will realize its value, whether by performance or damages. Indeed, a promisee’s ability to confidently invest in surplus-​enhancing reliance is often in the promisor’s interest, because some of the projected surplus may be impounded into the contract price that the promisee is willing to pay to the promisor. In The Blue Angels, for example, Producer is likely to pay the group a higher fee if he can confidently spend money on an advertising campaign, which will increase his ticket sales and therefore his profits. In short, as Steven Shavell states, “Given any proposed remedy for breach of contract other than the expectation measure, one can replace the proposed remedy with the expectation measure and adjust the contract price such that both the buyer and the seller would prefer the expectation measure and the modified price to the proposed remedy and the initial price.”9 These ideas can also be expressed in institutional terms. The purpose of the social institution of bargain is to create joint value through exchange and to facilitate private planning. The legal institution of contract supports the social institution of bargain with official sanctions.

9.  Steven Shavell, Foundations of Economic Analysis of Law 345 (2004).

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It is rational to design the legal sanctions for breach so that the joint value from exchange is maximized and private planning is best facilitated. These goals are better achieved by expectation damages than by reliance damages. Turn now to considerations of fairness. If a bargain promise by B has induced A to engage in a certain course of conduct, it would be unfair for B to give A less than she had promised. Take, for example, Hawkins v.  McGee. Surgery is painful, risky, and costly. We know that Hawkins was willing to undergo the pain, risk, and cost in exchange for a perfect hand. We cannot know whether Hawkins would have been willing to undergo that pain, risk, and cost for anything less. It would therefore be unfair to require Hawkins to accept less than he was promised, or its financial equivalent, after he has undergone the pain, risk, and cost. Similarly, if A promises to buy a widget from B for $600 and B delivers the widget, A cannot fairly pay B anything less than $600 in the absence of fraud, duress, unconscionability, or the like. Even where the promisee has only partially performed he may have done so only because he expected full payment at the end, and even where the promisee has not begun to perform, he may have either passed up or forborne the exploration of other opportunities that are no longer available and whose value is now difficult to quantify. Finally, many contracts are intended to shift the risks of market-​price movements from one actor to another. In contracts of this type, allowing a promisor to measure damages by anything less than the promised price or performance would have the same unfair quality as allowing a person who has lost a bet to renege. In short, as a matter of fairness a bargain promisee should be entitled to measure damages based on the promised price or performance that induced him to fully or partially perform, to forbear from taking or exploring competing opportunities, or both. As between the expectation and reliance measures for breach of a bargain contract, the expectation measure therefore is preferable both because it provides better incentives for the efficient rates of performance, precaution, and surplus-​enhancing reliance and on fairness grounds. Accordingly, in Hawkins v. McGee the court properly awarded expectation damages.10

A P P E NDI X The reliance and expectation measures are graphically illustrated in Figure 13.1. The horizontal axis in Figure 13.1 indicates the range of possible conditions of Hawkins’s hand. The vertical axis indicates the range of damages. The Reliance and Expectation Curves on the graph delineate the relationship between the condition of Hawkins’s hand and the amount of money that should be awarded to him under the reliance and expectation measure, respectively, because of Dr. McGee’s breach of his promise to give Hawkins a perfect hand. Each Curve is constructed so that a change in the condition of Hawkins’s hand from one point to another on the same Curve leaves Hawkins’s well-​being under the relevant measure unchanged, because a change in the hand’s condition is exactly offset by a change in the amount of damages under the measure that the Curve exemplifies. Thus the curves are lines of constant utility, or

10.  In the well-​known case of Sullivan v. O’Connor, 296 N.E.2d 183 (Mass. 1973), which involved facts very much like those of Hawkins v. McGee, the court awarded reliance damages, but the force of that result is very limited because the plaintiff only sought reliance damages. Id. at 185.

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Reliance Curve

$10,000

B

Damages

$5,000

A Expectation Curve

$0 0% (Totally Disabled)

25% (Post-Operative Condition)

50% (Pre-Operative Condition)

100% (Perfect)

Condition of the Hand

Figure 13.1.  Reliance and Expectation Damages in Hawkins v. McGee. indifference curves, because once the appropriate conception of damages is determined, Hawkins is theoretically indifferent between any combination of damages and well-​being that lies on the relevant Curve. Consider first reliance damages in Hawkins v. McGee, which are graphed by the Reliance Curve. Under the reliance conception of damages, the baseline for measuring damages on the facts of Hawkins v. McGee is the condition that Hawkins’s hand would have been in if Hawkins had not made the contract with Dr.  McGee. Assume that before the operation Hawkins had a 50 percent perfect hand, but as a result of the operation his hand was now only 25 percent perfect. Reliance damages are then the amount of money needed to make up for the loss in the condition of Hawkins’s hand from 50 percent of perfect to 25 percent of perfect.11 The Reliance Curve is constructed to represent, in a stylized fashion, the relationship between the deterioration in the hand’s condition and the amount of money needed to make up for the deterioration. 11.  It is assumed here that the operation performed by Dr. McGee did not cause Hawkins to lose an opportunity to go to another doctor who would perform the operation successfully. Accordingly, the Curve does not reflect opportunity costs.

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The Curve touches the horizontal axis at the point where Hawkins’s hand is 50 percent perfect, that is, the point locating the condition of Hawkins’s hand before Dr.  McGee’s promise and the operation. To measure reliance damages, move up the Reliance Curve to Point A, which corresponds to the condition of Hawkins’s hand on the horizontal axis after the operation. Then move over from Point A to the vertical axis to determine the dollar amount corresponding to the condition of Hawkins’s hand at Point A—​$5,000. Assuming that money values can be assigned to physical injuries, then under the reliance conception of damages Hawkins is equally well off with a 25 percent useful hand and $5,000 in damages or a 50 percent useful hand and no damages. Thus reliance damages on these stylized facts are $5,000, because that amount restores Hawkins’s hand to its pre-​promise condition. In contrast, under the expectation conception of damages the baseline for measuring damages on the facts of Hawkins v. McGee is the 100 percent perfect condition that the hand would have been in if Dr.  McGee had kept his promise. Expectation damages are then the amount of money needed to make up for the shortfall between the 100 percent perfect condition that Dr. McGee promised and the actual condition of Hawkins’s hand after the operation. The Expectation Curve is constructed to represent the amount of money needed to move from the actual condition of the hand to the perfect condition. The Curve touches the horizontal axis at the point where Hawkins’s hand is 100 percent perfect. To measure expectation damages, move up the Expectation Curve to Point B, which corresponds to the condition of Hawkins’s hand on the horizontal axis after the operation. Then move over from Point B to the vertical axis to determine the dollar amount corresponding to the condition of Hawkins’ss hand at Point B—​$10,000. So under the expectation conception of damages, Hawkins is equally well off with a 25 percent perfect hand and $10,000 in damages or a 100 percent perfect hand and no damages. Thus expectation damages, on these stylized facts, are $10,000 because that amount puts Hawkins’s hand into the equivalent of the promised condition.12 Hawkins v. McGee concerns a loss in Hawkins’s well-​being. Economists measure the well-​ being of an individual by the amount of satisfaction or utility that he enjoys, and measure the well-​being of a firm by its profits. The Curves in Figure 1 show the amount of damages that are required to either make Hawkins whole for various degrees of loss (the Reliance Curve) or give Hawkins his expected gain (the Expectation Curve). This analysis can be applied to firms, as opposed to individuals, by substituting profit for satisfaction. The Curves would then be interpreted as lines of constant profit rather than lines of constant satisfaction.

12.  The Expectation Curve, and the resulting $10,000 figure, illustrate the logic of expectation damages, not the damages that were actually awarded in Hawkins v. McGee.

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Formulas for Measuring Expectation Damages for Breach of a Contract for the Sale of Goods I .   B R E A C H B Y   A BUY ER OF   GOODS Where a buyer breaches a contract for the sale of goods, one of three formulas may measure the seller’s damages. If the seller resells the goods on the market he should normally be entitled to the difference between the resale price and the contract price, provided the resale is conducted reasonably and in good faith. This formula is embodied in UCC Section 2-​706. If the seller does not resell the goods he should normally be entitled to recover the difference between the market price of the goods and the contract price. This formula is embodied in UCC Section 2-​708(1). Both formulas are replacement-​cost formulas—​in the former case the actual replacement cost, and in the latter case a constructed replacement cost. A third formula is based on the seller’s lost profit measured by the difference between the contract price and the seller’s cost of performance. This formula is embodied in UCC Section 2-​708(2), which provides that if the market-​price measure “is inadequate to put the seller in as good a position as performance would have done then the measure of damages is the profit (including reasonable overhead) which the seller would have made from full performance by the buyer.” If Seller’s supply is elastic and the goods are standardized, the lost profit on the sale to Buyer One will not be made up by a subsequent sale to Buyer Two, because Seller could have made the sale to Buyer Two even if Buyer One had performed. This kind of case is captured by the Fishing Model: Normally, losing one fish does not enable a commercial fisherman to catch another, so that if the fisherman hadn’t lost a fish, his catch, and therefore his profits, would have been one fish larger. So too, if contracted-​for goods are standardized and a seller’s supply is sufficiently elastic to satisfy all persons who are likely to purchase from the seller, losing one buyer does not enable the seller to make another sale; he would have made that sale—​caught that fish—​anyway.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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The situation is different where a good is differentiated rather than standardized. In that type of case Buyer Two probably would not have made a purchase from the seller if the seller didn’t have that very good in stock. For example, in Lazenby Garages Ltd. v. Wright,1 Wright contracted to purchase a used BMW from Lazenby, a dealer, for £1,670, but changed his mind the next day. Lazenby retained the BMW in its showroom, and two months later sold the car to another buyer for £1,700. Lazenby then sued Wright for its lost profit, measured by the difference between the contract price of £1,670 and the amount Lazenby had paid for the car, £1,325. The court, in an opinion by Lord Denning, rejected Lazenby’s claim: The cases show that if there are a number of new cars, all exactly of the same kind, available for sale, and the dealers can prove that they sold one car less than they otherwise would have done, they would be entitled to damages amounting to their loss of profit on the one car. . . . But it is entirely different in the case of a secondhand car. Each secondhand car is different from the next, even though it is the same make. The sales manager of the garage admitted in evidence that some secondhand cars, of the same make, even of the same year, may sell better than others of the same year. Some may sell quickly, others sluggishly. You simply cannot tell why. But they are all different.   In the circumstances the cases about new cars do not apply.2

Where a seller is operating under the Fishing Model damages under the lost-​profits formula are known as lost-​volume damages, because by virtue of the buyer’s breach, the seller earns one less profit than it would have. A well-​known example is Neri v. Retail Marine Corp.3 Neri contracted to purchase from Retail Marine a new boat, of a specified make and model, for $12,587.40. Neri paid $40 down and Retail Marine promised delivery in approximately four to six weeks. Retail Marine planned to fill Neri’s contract by purchasing a boat of the specified make and model from the manufacturer. Shortly after Neri entered into the contract, he increased his deposit to $4,250 in return for Retail Marine’s agreement to arrange with the manufacturer for immediate delivery of the boat. Six days later, Neri’s lawyer sent Retail Marine a letter rescinding the revised contract on the ground that Neri was about to undergo hospitalization and surgery and therefore it would be impossible for him to make any payments. Meanwhile, the manufacturer had delivered the boat to Retail Marine. Subsequently Retail Marine sold the boat to another buyer. Neri sued to recover the amount of his deposit. Under UCC Section 2-​718 he was entitled to recover most of his deposit, subject to an offset for Retail Marine’s damages. The issue was how to measure those damages. Neri argued that Retail Marine suffered no damages, because it sold to another buyer the very boat that Neri had contracted to purchase. The court held that Neri’s breach did not enable Retail Marine to make a replacement profit on the sale to the other buyer because Retail Marine could have sold an identical boat to the other buyer even if Neri had performed. Therefore, Retail Marine’s damages consisted of its lost profits on the contract with Neri (that is, the difference between the

1.  [1976] 1 W.L.R. 459 (Ct. App.) (U.K.). 2.  Id. at 462. 3.  285 N.E.2d 311, 314 (N.Y. 1972).

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contract price and the amount Retail Marine had to pay for the boat) and incidental damages (insurance, interest, and the like). 4 The lost-​volume formula has occasionally been criticized on the ground that it does not really effectuate the expectation principle. In general, these criticisms are based on imagined scenarios that are in a zone between extremely unlikely and totally implausible. In one such scenario the seller and the breaching buyer are partly in competition. For example, Seller manufactures and sells both sheet steel and fabricated steel parts, Buyer manufactures and sells fabricated steel parts. Buyer agrees to purchase sheet steel from Seller, and Buyer breaches. The argument against lost-​volume damages in this scenario is that if Buyer breaches it will have less steel with which to make fabricated parts, and therefore will make fewer parts and offer less competition to the seller’s fabricated-​parts business. As a result of the decreased competition, the seller will make more profits, which will fully or partially offset the seller’s loss from the buyer’s breach. This scenario is implausible. To begin with, some sellers are in competition with their buyers, but not many are. Next, there will be no price impact on Seller’s fabricated-​ steel business as a result of Buyer’s breach unless Buyer is a significant player in that market. Furthermore, if Buyer doesn’t buy the steel from Seller, that may be because Buyer decided not to fabricate steel parts for a while. In that case, Buyer’s breach would not reduce the number of Seller’s competitors, because Buyer would no longer be a competitor anyway. Similarly, if Buyer has some other reason for breaching, such as a fall in the market price of sheet steel below the contract price, Buyer’s breach will also not reduce the number of Seller’s competitors, because Buyer will simply buy the steel from another producer at the lower market price and fabricate at least as many parts as it would have fabricated if it had bought the steel from Seller at the higher contract price. Another implausible scenario was imagined by the Seventh Circuit in R.E. Davis Chemical Corp. v. Diasonics, Inc.5: [U]‌nder “the economic law of diminishing returns or increasing marginal costs . . . as a seller’s volume increases, then a point will inevitably be reached where the cost of selling each additional item diminishes the incremental return to the seller and eventually makes it entirely unprofitable to conclude the next sale. . . . Thus, under some conditions, awarding a lost volume seller its presumed lost profit will result in overcompensating the seller, and 2-​708(2) would not take effect because the damage formula provided in 2-​708(1) does place the seller in as good a position as if the buyer had performed. Therefore, on remand, [the seller] must establish, not only that it had the capacity to produce the breached unit in addition to the unit resold, but also that it would have been profitable for it to have produced and sold both. [The seller] carries the burden of establishing these facts because the burden of proof is generally on the party claiming injury to establish the amount of its damages; especially in a case such as this, the plaintiff has easiest access to the relevant data.6

4.  See also, e.g., Famous Knitwear Corp. v. Drug Fair, Inc., 493 F.2d 251, 253–​54 (4th Cir. 1974) (holding that the lost-​profits measure of damages outlined in UCC Section 2-​708(2) was intended to apply to a lost-​ volume seller); Snyder v. Herbert Greenbaum & Assocs., Inc., 380 A.2d 618, 625 (Md. Ct. Spec. App. 1977). 5.  826 F.2d 678 (7th Cir. 1987). 6.  Id. at 684.

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The Seventh Circuit here overdosed on Chicago S​ chool economics. In the real world a seller’s variable costs in lost-​volume cases will almost invariably remain the same across a great number of sales. For example, if a retail camera store sells a camera to Buyer One, who breaches, it is almost inconceivable that the store’s variable costs for selling the camera to Buyer Two would be greater by a nickel. Indeed, in Neri itself it’s hard to see how Retail Marine’s costs for selling the boat to the second buyer would have been a nickel more than its costs for selling the boat to Neri.7 In short, where a seller has a relatively elastic supply of a standardized good, the formula for measuring the seller’s damages should normally be the contract price minus the Seller’s variable costs. The more difficult issue is whether the expectation measure should be applied in all lost-​ volume cases. That issue will be discussed in Chapter 16.

II.   BR E A C H B Y   A S E L L ER OF   GOODS If a seller of goods breaches one of several damage formulas may be applied. If the seller delivers the goods and the buyer accepts them, but the goods are defective, the buyer can recover damages for the defect. Typically, these will be damages for breach of warranty. UCC Section 2-​714(2) provides that the measure of damages for such a breach is the difference between the value of the goods as accepted and the value they would have had if they had been as warranted, unless special circumstances show damages of a different amount. Although in form this is a diminished-​value formula, in practice the buyer’s damages in such cases will often be measured by the cost of completion, that is, the cost to put the goods in their warranted state. In contrast, if a seller fails to deliver the goods, or the goods are defective and the buyer either rightfully rejects them or accepts them but then rightly revokes his acceptance, the buyer initially has a choice whether to sue for market-​price damages or to cover and sue for cover damages.8 What if the buyer covers but the market price exceeds the cover price, so that market-​price damages would be higher than cover-​price damages? (This phenomenon may occur because the buyer made an exceptionally good deal when he covered, or because a cover price is an actual price while a market price is a construct arrived at through 7.  See also Charles J. Goetz & Robert E. Scott, Measuring Sellers’ Damages: The Lost Profits Puzzle, 31 Stan. L. Rev., 323, 338–​40 (1979). Goetz and Scott argue that when a buyer’s circumstances change so that he no longer needs the contractual good he may accept delivery and then resell the good, and resale by the performing buyer may spoil the market for the seller. More precisely, Goetz and Scott argue that if (1) a seller regularly sells in the spot market; (2) the environment is frictionless, so that a buyer can resell purchased goods in the spot market under the same conditions the seller faces; and (3) there are no costs to the buyer associated with the resale, then a breach of X units by a buyer produces a corresponding shift of X units in the demand curve faced by the seller. The problem with the argument is that few markets are likely to satisfy either the second or the third conditions, let alone both. 8.  See James J. White, Robert S. Summers & Robert A. Hillman, 1 Uniform Commercial Code 578–​80 (6th ed. 2010) (buyer who covers is not entitled to sue for market-​price damages). But see Ellen A. Peters, Remedies for Breach of Contracts Relating to the Sale of Goods under the Uniform Commercial Code: A Roadmap for Article Two, 73 Yale L.J. 199, 260 (1963) (arguing that a “non-​restrictive reading of the various [UCC] remedies sections [would] preserve full options to use or to ignore substitute transactions as a measure of damages”).

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extrapolation.) In such a case the buyer would prefer to sue for market-​price damages. However, a buyer who has covered should not be allowed to sue for market-​price damages. Since a covering buyer ends up with a replacement for the breached commodity, the only loss he suffers is the difference between the cover price and the contract price. Therefore, allowing a covering buyer to recover higher market-​price damages would put the buyer in a better position than performance by the seller would have done, because the act of cover coupled with cover damages puts the buyer in the position he would have been in if the seller had performed. This view is reflected in UCC Section 1-​305(a) and the Official Comment to Section 2-​ 713. Section 1-​305(a) provides that “the remedies provided by [this Act] must be liberally administered to the end that the aggrieved party may be put in as good a position as if the other party had fully performed.” (Emphasis added.) The Comment to Section 2-​713, which allows an injured buyer to sue for market-​price damages, states that “[t]‌he present section provides a remedy which is completely alternative to cover under the preceding section and applies only when and to the extent that the buyer has not covered.” (Emphasis added.) Also, as White and Summers point out, the competing view “would allow a buyer to learn of a breach on September 2 when the market is at $25,000, wait until September 15 to cover, when the market is at $23,000, and then sue under 2-​713 for the higher damages of contract-​market differential, all contrary to the general principle of [Section] 1-​305(a). . . .”9 Ellen Peters has argued against restricting a covering buyer to cover damages on the ground that doing so would discourage cover, because a covering buyer would lose his market-​price-​damages remedy, which could be more favorable.10 This argument has two flaws. First, although the buyer would indeed lose his market-​price-​damages remedy, that is fair, because by hypothesis market-​price damages would exceed his loss. Second, cover is not easy to discourage. If a buyer is purchasing for resale to a specific purchaser and does not cover, he will be liable to his own purchaser for nondelivery. If a buyer is purchasing for use, under UCC Section 2-​715 failure to cover will bar him from consequential damages. Furthermore, a buyer will almost invariably prefer to make an advantageous cover purchase now rather than take his chances on a favorable market-​price-​damages award in the murky future. Peters also argues that market-​price damages should always be recoverable because they should be viewed as liquidated damages.11 However, market-​price damages are not liquidated damages:  liquidated damages are an amount or formula that the parties fix; market-​price damages are a formula that the law fixes. Furthermore, in many states liquidated damages are unenforceable if the promisee’s actual loss is significantly less than the amount of liquidated damages. If market-​price damages are liquidated damages then under the rule in those states market-​price damages would not be awarded when the promisee’s loss is significantly less than market-​price damages. This is just the opposite of the result Peters wants to achieve. Finally, if a liquidated-​damages provision is enforceable, it is exclusive. Therefore, if market-​price damages are liquidated damages a buyer in a sale-​of-​goods transaction could recover only market-​price

9.  White, Robert Summers, & Hillman, supra note 8, at 578. 10.  See Peters, supra note 8, at 259–​61. 11.  Id. at 259.

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damages, and therefore could not recover cover damages, consequential damages, or incidental damages. That result would be both anomalous and unjustified.12

I II .   C A S E S I N   W HI CH M A R KET-​ P R I C E D A M A G ES EXCEED THE   P R O M I S E E ’ S A CT UA L   L OS S A vexing problem is whether market-​price damages should be awarded for breach of a contract for the sale of goods even if damages so measured would exceed the promisee’s actual loss. The significance of this problem should not be exaggerated. In most cases market-​price damages and the promisee’s actual loss are closely comparable. In many of the remaining cases the buyer’s actual loss exceeds his market-​price damages—​as where the promisee is a buyer who incurs consequential damages that he cannot review under the principle of Hadley v. Baxendale. In still other cases there appears to be a divergence between market-​price damages and the buyer’s actual loss but in fact there is none.13 For example, consider the following hypothetical, derived from an article by David Simon, who argues that market-​price damages should serve as a floor on a buyer’s recovery even where such damages exceed the buyer’s actual loss or indeed even if the buyer has no actual loss. Stock Problems. A contracts to sell to B 1,000 shares of stock owned by A at a price of $10 per share, for a total of $10,000. The shares are freely traded in the market. On the delivery date, when the market price is $6 per share [so that the shares are worth $6,000], B breaches and refuses to accept delivery. A does not supply any proof that he sold at $6 per share or suffered any other actual loss.14

In analyzing a comparable hypothetical Simon concludes that (1) A should recover $4,000, but (2) A will not recover $4,000 unless either he proves that as a result of the breach he was compelled to sell the stock at $6 per share (or less) or the market-​price formula sets a floor on damages. The first proposition is correct, but the second is not. Simon here confuses an income effect with a wealth effect. If A did not sell the stock at $6 per share he may not have realized a $4,000 loss in income as a result of the breach, but he clearly has lost $4,000 in wealth, because as a result of B’s breach A holds stock worth only $6,000 instead of receiving $10,000. Therefore, even if the market-​price-​damages formula does not set a floor on damages, A should recover the $4,000 decrease in his wealth resulting from B’s breach. Consider another hypothetical, which is loosely based on another example that Simon formulates: Copper Trouble. Seller is a copper-​mining company. Buyer manufactures copper pipe and does not engage in copper trading. Seller agrees to sell Buyer 1,000 tons of copper at $60 per ton. On the delivery 12.  Suppose the buyer replaces the breached contract on the market with a good that is inferior to the good the seller promised to deliver? In that case, the buyer has not covered and therefore can recover market-​ price damages. 13.  This point is made, and elaborated in depth, in David W. Carroll, A Little Essay in Partial Defense of the Contract-​Market Differential as a Remedy for Buyers, 57 S. Cal. L. Rev. 667 (1984). 14.  David Simon, The Critique of the Treatment of Market Damages in the Restatement (Second) of Contracts, 81 Colum. L. Rev. 80, 87 (1981).

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date, when the market price is $80 per ton, Seller tells Buyer it does not intend to perform. In the interim, Buyer has unexpectedly reduced its output of copper pipe, and therefore does not need Seller’s copper.

Although Buyer does not engage in copper trading, nothing stops him from doing so. Accordingly, Buyer should recover $20,000 in expectation damages even if he no longer needs the copper, and even though the market-​price formula does not set a floor on damages, because if Seller performed Buyer could have either taken delivery of Seller’s copper for $60,000 and resold it to a third party for $80,000 or assigned his rights under the contract to a third party for $20,000. Whenever there is a ready market for a homogeneous commodity, a decision to hold rather than sell the commodity is functionally equivalent to a decision to invest in the commodity at the prevailing market price. For example, if Corporation C common stock sells for $6 per share on January 15, a person who holds C common on January 15, and does not sell the stock, effectively makes a decision to invest $6 per share that day in C common. So in Stock Problems if A continued to hold his 1,000 shares of C stock after the delivery date he effectively made a series of daily decisions to invest in 1,000 shares of C stock at the prevailing daily market prices. Both the positive and the negative risks of those investment decisions should lie with A, and it is irrelevant, in A’s action against B, whether C stock went up or down after the delivery date or what A did with the stock. Indeed, A should recover $4,000 even if, by reason of a later market rise, he sold his C stock at more than $6 per share, or even if A still owned his C stock at the time of trial and it was then worth $10 per share. Cases do arise in which market-​price damages exceed the promisee’s actual loss. These cases fall into several patterns. In one pattern a seller-​promisor breaches and either (1) the buyer-​promisee covers and the market price is higher than the cover price because the cover price is real whereas the market price is a construct, or (2) a seller-​promisor resells and the market price is lower than the resale price for the same reason. For example, suppose the contract price is $6, the seller breaches when the market price is $8, and the buyer is able to cover at $7. If market-​price damages should set a floor on the buyer’s recovery, the buyer would recover $2. However, the buyer should and will recover only $1, because that is all he has lost. In this pattern, therefore, the argument that market-​price damages should set a floor on recovery is incorrect both as a normative matter and as a matter of law. In another pattern, market-​price damages exceed the promisee’s actual loss because the promisee had made a contract with a third party whose effect is to limit either the promisee’s profit if the promisor performed or the promisee’s loss if the promisor breached. Many such cases involve back-​to-​back transactions—​that is, transactions in which either before or immediately after making a contract to purchase a given commodity a buyer contracts to sell the commodity to a third party for the price the buyer pays to the seller plus a designated increment. In effect, the buyer in such cases is a broker and the increment is a brokerage commission. If the seller performs the buyer earns only the commission. If the seller breaches, the buyer loses only the commission. Simon argues, however, that in a transaction between market traders, “the contract can be read as if it embodied a bet by both parties to pay a dollar sum measured by the difference between the contract price and the future market price at a specific date.”15 This argument has bite 15.  Id. at 92.

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where a given contract is a bet on the market, but most contracts are not bets either primarily or at all. For example, consumer contracts are rarely bets on the market. Similarly, in many commercial contracts the objective of one or both parties is to stabilize the supply of inputs and outputs, rather than to bet on the market. A contract by a construction company to build a new plant for an auto manufacturer is usually not a bet on the market by either party; rather, it is a way to order a complex and otherwise shifting future. The same is true of a partnership contract, a contract of employment between a CEO and a corporation, a contract between a utility and an oil company to buy and sell gasoline at the oil company’s posted price, or a joint-​venture contract between a soft-​drink manufacturer and a chemical company to develop a new sweetener. The list goes on. Simon also argues that “[a]‌s a practical matter the market can function only on the basis of either (1) immediate delivery on the date fixed for performance, or (2) immediate payment of market damages by the same date.”16 This is because “[b]y allowing a welcher to renege on the bet and keep the market advantage for himself, [rejection of the argument that market-​price-​ damages are a floor] would make it impossible for the market to function.”17 This argument is empirically incorrect. Delivery is often delayed, and payment of market-​price damages, or indeed any damages, on the date a breached delivery is due almost never occurs. Nevertheless, markets function. A comparable idea was put forth in Tongish v. Thomas,18 where the court said that a buyer’s damages should not be limited to its actual loss because market-​price damages encourage a more efficient market and discourage breach. “This generates stability in the market by discouraging the seller from breaching the contract when the market fluctuates to his advantage.”19 But it is unclear, to say the least, why choosing one expectation-​damages formula over another would destabilize the market. It is true that higher damages will lead to fewer defaults, but this argument has no stopping point. For example, the argument would support punitive damages for breach of contract as well as cost-​of-​completion damages even where the promisee has no intention to complete. In short, the major normative arguments for awarding market-​price damages even when they exceed the promisee’s actual loss are seriously flawed. Turn now to positive law. Damages for breach of a contract for the sale of goods are governed by the Uniform Commercial Code. However, the UCC can be interpreted either to support or negate the award of market-​price damages that would put the promisee in a better position than performance would have done. UCC Section 2-​708(1) provides that upon a buyer’s breach the seller can sue for market-​price damages, and Section 2-​713(1) provides that upon a seller’s breach the buyer can sue for market-​ price damages. However, Section 1-​106(1) provides that “[t]‌he remedies provided by this Act shall be liberally administered to the end that the aggrieved party may be put in as good a position as if the other party had fully performed” (emphasis added). A handful of modern (post-​1980) cases address the question whether market-​price damages should set a floor on recovery in contracts for the sale of goods, so that damages measured that way should be awarded even though they exceed the promisee’s actual loss. A few cases hold 16.  Id. 17.  Id. 18.  829 P.2d 916 (Kan. Ct. App. 1992). 19.  Id. at 921.

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that they should. For example, in Tongish v. Thomas20 Tongish had contracted to sell to Coop all the sunflower seeds that Tongish grew on 117 acres. Tongish was to make delivery in three installments from December 1988 to May 1989 at a price of $13 per one hundred pounds for large seeds and $8 per one hundred pounds for small seeds. Coop made a back-​to-​back contract to sell to Bambino all the sunflower seeds that Coop purchased from farmers at the price Coop paid the farmers plus a handling charge. By January 1989 the market price of sunflower seeds was about $20 per one hundred pounds, and Tongish repudiated the contract with Coop. In May 1989, Tongish sold its sunflower seeds to a third party for $14,715, presumably the market price at the time. Coop brought suit. Under the market-​price formula Coop would have been awarded about $9,600. However, by virtue of Coop’s back-​to-​back contract with Bambino, Coop’s lost profit consisted of only the handling charges: $456. The court held that Coop could recover market-​price damages. The market-​price formula, the court said, “encourages a more efficient market and discourages the breach of contracts,” thereby generating stability in the market.21 KGM Harvesting Co. v.  Fresh Network22 is another case in which the court awarded market-​ price damages although they exceeded the promisee’s actual loss. KGM was a lettuce grower and distributer. It contracted to deliver fourteen loads of lettuce per week to Fresh Network, a lettuce broker. As KGM knew, Fresh Network had a contract with Castellini to sell all the lettuce it obtained from KGM to Castellini at Fresh Network’s cost plus a small commission. KGM breached, and Fresh Network covered by purchasing lettuce in the market, which it then sold to Castellini at its cost—​that is, the cover price—​plus the commission. Cover-​price damages were $650,000–​$700,000. However, Fresh Network did not lose that amount, because it recouped from Castellini most of the difference between the contract price and the cover price. As a result, Fresh Network’s loss was only $70,000, the amount Castellini did not pick up. Nevertheless, the court held that Fresh Network was entitled to cover-​price damages. A cover purchase, the court said, “gives the buyer the benefit of its bargain. What the buyer chooses to do with that bargain is not relevant to the determination of damages . . .”23 However, a majority of the modern sale-​of-​goods cases reject the position that market-​price damages should be awarded even if they exceed the promisee’s actual loss. For example, in H-​ W-​H Cattle Co. v. Schroeder24 Schroeder contracted to sell cattle to H-​W-​H for a price of $67 per hundredweight. H-​W-​H made a back-​to-​back contract with Western Trio to sell 2,000 head of cattle for $67.35 per hundredweight—​that is, the price H-​W-​H agreed to pay Schroeder plus a commission of 35¢ per hundredweight. Schroeder failed to deliver 603 of the promised cattle. H-​W-​H’s market-​price damages would have been around $62,000. However, H-​W-​H’s lost profit was only $1,372, because if Schroeder had supplied all the promised cattle, H-​W-​H would have earned only its 35¢ per hundredweight commission.25 The court held that to award market-​price

20.  829 P.2d 916 (Kan. Ct. App. 1992). 21.  Id. at 921. 22.  42 Cal. Rptr. 2d 286 (Ct. App. 1995). 23.  Id. at 293. 24.  767 F.2d 437 (8th Cir. 1985). 25.  H-​W-​H argued that it should receive market-​price damages because it was liable to Western Trio for its failure to deliver the 603 cattle and Western Trio’s damages would be measured by the difference between the market price and the contract price. However, Western Trio had made no demand on H-​W-​H to fulfill the remainder of the contract, probably because Western Trio would at best have broken even on the resale

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damages in the case “would result in granting [H-​W-​H] a windfall, and thus violate the general principle concerning remedies underlying [UCC § 1-​106].”26 A comparable result was reached in Allied Canners & Packers, Inc. v. Victor Packing Co.27 Victor was in the business of packing and processing fruits, and Allied was in the business of exporting food products. Pursuant to a federal marketing order the Raisin Administrative Committee (RAC), controlled the raisin market and determined (1) the amount of domestic raisins that could be sold anywhere in the world (known as free raisins), and (2) the amount that could be sold only outside the Western Hemisphere or to certain government-​sponsored programs (known as reserve raisins). Packer members of RAC could purchase reserve raisins from RAC. Victor, as a packer, was a member, but Allied, as an exporter, was not. A packer who wanted to buy reserve raisins had to apply to RAC and deposit 95 percent of the price. From September 1, 1976, until early on September 10 packer members could purchase reserve raisins from RAC for 22¢ per pound, well below the market price for free raisins. Between those dates, Victor contracted to sell Allied 35,000 pounds of reserve raisins for 29.75¢ per pound, minus a discount of 4 percent. Allied made back-​to-​back contracts to resell the raisins to two Japanese firms, also at 29.75¢ per pound, but without any discount. Therefore, Allied’s expectation was to make a 4 percent profit on resale of the raisins. During the night of September 9, heavy rains severely damaged the raisin crop and adversely affected the raisin supply. On September 10, RAC withdrew its offer to sell reserve raisins to members, such as Victor, who had not yet paid the full price. Victor then notified Allied that it would not deliver under its contract. The earliest that either party could have purchased raisins on the market was October, when the market price was 80–​87¢ per pound, so that Allied’s market-​price damages would have been $150,281. However, Allied incurred no loss because one Japanese buyer agreed to rescind its contract and the other let the statute of limitations expire. Allied sued Victor for market-​price damages rather than its much smaller actual loss. The court rejected Allied’s claim, holding that “the policy of [UCC § 1-​106(1)] that the aggrieved party be put in as good a position as if the other party had performed, requires that the award of damages to the buyer be limited to its actual loss, the amount it expected to make on the transaction.”28 In Nobs Chemical, U.S.A., Inc. v. Koppers Co., Inc.29 Koppers contracted to purchase 1,000 metric tons of cumene, a fuel additive, from Nobs and Calmon-​Hill (Sellers) for $540,000. Subsequently the market price of cumene dropped, and Koppers breached. Sellers’ market-​ price damages would have been $276,000–​$320,000. However, Sellers had arranged to purchase the cumene in Brazil for $400,000 and transport it to Koppers for $45,000. Accordingly, the Sellers’ lost profit was only $95,000—​the difference between the $540,000 contract price and the $445,000 cost of performance. The court held that the Sellers were limited to their lost profit: No one insists, and we do not think they could, that the difference between the fallen market price and the contract price is necessary to compensate the plaintiffs for the breach. Had the transaction

of cattle delivered under the contract due to the fall in cattle prices in the autumn of 1979. In addition, Western Trio was managed by the same family that owned H-​W-​H. 26.  H-​W-​H Cattle, 767 F.2d at 439–​40. 27.  209 Cal. Rptr. 60 (Ct. App.1984). 28.  Id. at 66. 29.  616 F.2d 212 (5th Cir. 1980).

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been completed, the Sellers’ “benefit of the bargain” would not have been affected by the fall in market price, and they would not have experienced the windfall they otherwise would receive if the market price-​contract price rule contained in [UCC] § 2.708(a) is followed.30

Similarly, in Diversified Energy, Inc. v. Tennessee Valley Authority31 Diversified contracted to sell to the Tennessee Valley Authority (TVA) 10,000 tons of coal per week from August 1990 to March 1996. Under its contract with the TVA Diversified was required to obtain the coal from Sigmon Coal Company. Under its contract with Sigmon, Diversified was required to pay Sigmon the price TVA paid to Diversified less a commission of 98¢ per ton. TVA breached. Diversified’s market-​price damages were $5.13 per ton. However, Diversified’s lost profit was only 66¢ per ton—​the 98¢ per ton commission it would have received from Sigmon less 22¢ per ton that Diversified had agreed to pay a third party. The court limited Diversified’s damages to its lost profit on the ground that a promisee is not entitled to more than the benefit of his bargain.32 Cases such as Tongish and KGM are wrong; cases such as H-​W-​H, Allied Canners, Nobs, and Diversified are right. Considerations of both efficiency and fairness support the rule that if a promisor breaches a bargain contract the promisee should be put in the position he would have been if the promisor had performed. In contrast, it is difficult to summon up considerations of efficiency and fairness that would support a rule giving a promisee a windfall by making him better off if the promisor breached than he would have been if the promisor had performed.

30.  Id. at 215. 31.  339 F.3d 437 (6th Cir. 2003). 32.  Id. at 446. Since the market-​price formula is the normal measure of damages in sale-​of-​goods cases, a promisor who wants to limit damages to the promisee’s actual loss is required to prove that the promisee’s loss was less than market-​price damages. See, e.g., Trans World Metals, Inc. v. Southwire Co., 769 F.2d 902, 908 (2d Cir. 1985), See also Union Carbide Corp. v. Consumers Power Co., 636 F. Supp. 1498, 1502 (E.D. Mich. 1986); Unlimited Equip. Lines, Inc. v.  The Graphic Arts Ctr., Inc., 889 S.W.2d 926, 940–​41 (Mo. Ct. App. 1994). In some cases, a seller breaches for the purpose of reselling the contracted-​for goods at a better price. In these cases, the appropriate measure of damages is normally not expectation damages, but disgorgement—​that is, the profit that the seller makes from breach—​because the buyer will have paid a premium for the seller’s implicit promise not to resell the goods to a later overbidder.

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fifteen

Formulas for Measuring Expectation Damages for Breach of a Contract to Provide Services Supp ose A   and B make a c ontr act u n der w hi ch A   ag rees to provide—​that is, sell—​services to B, either as the sole purpose of the contract or as part of a more complex performance. In cases of this type A will be referred to as a service-​provider and B will be referred to as a service-​purchaser. Section (A)  considers the standard formulas for measuring expectation damages for breach by a service-​purchaser. Section (B)  considers the standard formulas for measuring expectation damages for breach by a service-​provider.

I .   B R E A C H B Y   A S ERVI CE-​P UR CHA S ER A.  THE CORE FORMULA: LOST PROFIT The core formula for measuring damages for breach by a service-​purchaser is a lost-​profit formula. The formula is expressed in two formally different but substantively identical ways. Under one expression the service-​provider is entitled to his lost profit plus the out-​of-​pocket costs he incurred prior to the breach. This expression is embodied in Comment h to Restatement Section 346: [A]‌common form of stating the measure of recovery [for breach by a service-​purchaser] is as follows:  Damages, measured by the [service-​purchaser’s] actual expenditure to date of breach less the value of materials on hand, plus the profit that he . . . would have been realized from full performance . . .  The service-​purchaser has a right to his expenditures as well as his profits, because payment of the full price would have reimbursed those expenditures in full and given him his profit in addition. . . .

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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Under the alternative expression the service-​provider is entitled to the contract price minus the out-​of-​pocket costs remaining to be incurred by the service-​provider at the time of breach. This expression is embodied in the text of Section 346: (2) For a breach by one who has promised to pay for [services] . . . if it is a total breach [the service-​ provider] can get judgment . . . for the entire contract price . . . less . . . the cost of completion that the [service-​provider] can reasonably save by not completing the work. . . .1

Although these two expressions look very different they are algebraically equivalent and yield the same amount of damages.2 For example, suppose the contract price is $800,000, the service-​provider’s variable costs if the contract had been performed would have been $600,000, and the service-​provider’s variable costs incurred at the time of the breach were $250,000. Under these conditions the service-​provider’s profit if the contract had been performed would have been $200,000 (contract price of $800,000 minus variable costs of $600,000). Damages under the first expression—​profit plus costs incurred—​therefore would be $450,000, consisting of the lost profit of $200,000 plus the costs incurred of $250,000. Damages under the second expression—​ contract price minus costs remaining to be incurred—​would also be $450,000, consisting of the $800,000 contract price minus the $350,000 costs remaining to be incurred. Although the two expressions are equivalent, the second is more commonly employed because it is easier to administer. Under the first expression the court must determine lost profit. Since profit equals contract price minus total variable costs, to apply the first expression the court must calculate both the variable costs the service provider incurred prior to the purchaser’s breach and the variable costs remaining to be incurred at that time. In contrast, to apply the second expression the court need only calculate the variable costs remaining to be incurred at the time of breach.

B.  THE TREATMENT OF FIXED COSTS (OVERHEAD) Both expressions of the core formula for determining a service-​provider’s damages paper over an important problem: What is meant by lost profit in the context of contract damages? In the financial and business worlds profit means revenue minus costs, and in those worlds costs include both variable costs (costs that vary with output, such as supplies and hourly wages) and allocable fixed costs, or overhead (costs that are invariant to output, such as rent and management salaries). Under the expectation measure, however, for the purpose of determining damages a 1.  Comment h and the text of Section 346 use the terms construction contract and builders. However, the elements of recovery set out in those provisions are applicable to contracts for the provision of any type of services. 2.  Under the first expression, a service-​provider’s damages are its lost profits plus the out-​of-​pocket costs it incurred prior to the breach. Lost profits, in turn, equal contract price minus total variable costs. Total variable costs at any given time, including the time of breach, equal the variable costs that were incurred before that time plus the out-​of-​pocket costs remaining to be incurred to fulfill the contract. Algebraically, therefore, the first expression is D (damages) = K –​[Cr (variable costs remaining to be incurred at the time of breach) + Ci (variable costs incurred prior to breach)], or D = K –​Cr –​Ci + Ci. If minus Ci and plus Ci are canceled out on the right side of this formula, then under the first expression, D = K –​Cr. But that is also the second expression. See Petropoulos v. Lubienski, 152 A.2d 801, 804–​05 (Md. 1959) (describing how the results are the same whether the first or the second expression is applied).

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service-​provider’s lost profit should be and is based on the contract price minus only variable costs. The reason is that if fixed costs were deducted from the contract price the provider would be left short of where he would have been if the contract had been performed. For example, assume that Animator is in the business of producing supplemental animation for video games. This work is very time-​consuming. Animator normally takes on one job a year and delivers the supplemental animation when it is completed. Producer is in the business of producing video games. Animator enters into a contract with Producer under which Animator agrees to supply supplemental animation for Producer’s proposed new video game at a price of $5 million, payable when the supplemental animation is delivered. During the year, Animator incurs variable costs of $3 million and fixed costs of $1 million. If Producer performs—​that is, if Producer pays the contract price—​then at the end of the year Animator’s wealth would be increased by $1 million ($5 million from Producer minus $4 million in total costs). Suppose Producer breaches. If Animator’s lost profit is calculated by deducting only its variable costs from the contract price, then under the first expression of the basic formula Animator would recover $5 million ($2 million for lost profit plus $3 million for costs incurred prior to Producer’s breach), which would put Animator in the same position as if Producer had performed. In contrast, if Animator’s lost profit is calculated by deducting both variable and fixed costs from the contract price then its recovery would be $4 million ($1 million in lost profit plus $3 million for costs incurred prior to the breach). Since Animator’s total costs for the year were $4 million, if it recovers only $4 million then at the end of the year its wealth would not have been increased, and the purpose of the expectation measure would not have been achieved3 because Animator 3.  Here is a more complex example, involving a sale of goods:  Seller has contracted to sell one widget apiece to each of Buyers 1, 2, 3, and 4 at a price of $250,000 per widget. Seller has annual fixed costs (overhead) of $200,000. Seller’s variable costs per widget are $150,000, and Seller’s allocable fixed costs per widget are $50,000 (200,000 ÷ 4). If no Buyer breaches, Seller’s income per widget is $50,000 ($250,000 revenue minus $200,000 variable and allocable fixed costs). Correspondingly, Seller’s income at the end of the year will be $200,000:  $1,000,000

revenue

   –​600,000

variable costs for widgets 1, 2, 3, and 4

   –​200,000

fixed costs



(4 x $50,000 revenue per widget)

= $200,000

Now assume that Buyer 2 breaches, but Buyers 1,3, and 4 perform. Then Seller’s income at end of the year, without regard to damages from Buyer 2, will be $100,000:    $750,000

revenue

   –​450,000

variable costs for widgets 1, 3, and 4

   –​200,000

fixed costs



= $100,000

If damages from Buyer 2 consisted of contract price minus only variable costs, then Seller would recover $100,000 from Buyer 2 ($250,000 contract price minus $150,000 variable costs). If that amount was added to Seller’s $100,000 income on his sales to Buyers 1, 3, and 4, then at the end of the year Seller would clear $200,000, and therefore would be in the same position as if Buyer 2 had performed. If Seller’s damages against Buyer 2 consisted of contract price minus both variable costs and allocable fixed costs, then his recovery would be $50,000 ($250,000 contract price—​$200,000 variable costs and allocable fixed costs). That would not put Seller where he would have been at the end of year if Buyer 2 had performed, because $100,000 in business profits from selling to Buyers 1, 3, and 4, plus $50,000 in damages from Buyer 2 equals $150,000, which is less than the $200,000 Seller would have cleared if Buyer 2 had performed.

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would not be in as good a position as it would have been in if Producer had performed and Animator’s wealth was increased by $1 million. This point is illustrated by Vitex Manufacturing Corp., Ltd. v. Caribtex Corp.4 Vitex contracted to showerproof 125,000 yards of material for Caribtex at 26¢ per yard. However, no material was forthcoming from Caribtex, and Vitex sued for breach. Vitex alleged that its gross revenue under the contract would have been $31,250 and its variable costs would have been $10,136, and requested damages of $21,114 equal to the difference between these two amounts. Caribtex argued that Vitex’s damage formula was erroneous because it failed to include Vitex’s overhead in Vitex’s costs—​an inclusion that would have reduced Vitex’s lost profit and therefore its damages. The court disagreed: [N]‌ormally, in a claim for lost profits, overhead . . . should not be considered as part of the seller’s costs. . . . The soundness of the rule is exemplified by this case. Before negotiations began between Vitex and Caribtex, Vitex had reached a lull in business activity and had closed its plant. . . . When this opportunity arose to process Caribtex’s wool, the only additional expenses Vitex would incur would be those of re-​opening its plant and the direct costs of processing, such as labor, chemicals and fuel oil. Overhead would have remained the same whether or not Vitex and Caribtex entered their contract and whether or not Vitex actually processed Caribtex’s goods. Since this overhead remained constant, in no way attributable-​to or affected-​by the Caribtex contract, it would be improper to consider it as a cost of Vitex’s performance to be deducted from the gross proceeds of the Caribtex contract.5

C.  DEDUCTIONS FROM THE CORE FORMULA Depending on the circumstances, a service-​provider’s damages under the core formula may need to be reduced by one or both of two special factors. First, any payments made by the service-​purchaser before she breached should and will be deducted from the service-​provider’s damages, because otherwise the provider would be better off from breach than from performance. For example, using the figures in the video-​game hypothetical, if Producer (the purchaser) paid Animator (the provider) $1 million prior to breach, then unless that amount was deducted from Animator’s damages, at the end of the day Animator’s wealth would be increased by $2 million—​$1 million in damages plus the $1 million already paid. This would make Animator better off than if the contract had been performed because in that case at the end of the day Animator’s wealth would have been increased by only $1 million. Second, a service-​provider’s damages should be reduced by any gains to the provider made possible by the service-​purchaser’s breach—​in particular, by the provider’s profit on a new contract that he could not have entered into but for the breach. Take, for example, the following hypothetical: Busy Plumber. Plumber, a sole entrepreneur, is engaged in the plumbing business. He operates at full capacity and therefore must often turn down jobs. On January 1, Plumber enters into

4.  377 F.2d 795 (3d Cir. 1967). 5.  Id. at 798.

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a contract to do a plumbing job for A for $6,000. This work is to begin on February 1 and be completed in two weeks. On January 30, A  repudiates the contract. On January 31, Plumber enters into a contract to do a plumbing job for B for $7,600. This work also is to begin on February 1 and is to be completed in two weeks. But for the breach by A, Plumber could not have accepted the job with B. Plumber’s out-​of-​pocket costs for performing his contract with A  would have been $3,400. His out-​of-​pocket costs for performing his contract with B are $2,900. Plumber now sues A.

Under the expectation measure Plumber’s damages should be reduced by his profit on the contract with B. Otherwise, Plumber would be better off from breach than from performance. Since Plumber’s capacity was inelastic, if A had performed, Plumber could not have made the contract with B. Present law applies this concept unevenly. If an employer breaches an employment contract, which is simply a special type of service contract, and the employee finds a new job of any kind whose duration coincides with any part of the duration of the breached contract, the wages on the new job are deducted from the employee’s damages. Furthermore, an employee is under a duty to mitigate the employer’s damages by trying to find a comparable replacement job, and if he could have found such a job but did not try to do so, the wages he would have earned on the job are deducted from his damages. In contrast, traditionally the courts usually did not reduce the damages of nonemployee service-​providers by the profit on a replacement contract made possible by the breach. For example, in Grinnell Co. v.  Voorhees6 Grinnell contracted with Willys to install a fire-​extinguishing system in a Willys plant. When Grinnell had completed 78 percent of the work Willys fell into receivership and canceled the contract. Durant then purchased the Willys plant and contracted with Grinnell to complete the fire-​extinguishing system. Grinnell sued Willys’ receivers to recover the profit it would have made under the Willys contract. The court held that the profit Grinnell made on the Durant contract should not be deducted from the profit it would have made under the Willys contract. When a contract for services is breached, the court said, “the claim of the plaintiff accrues at once and the law does not inquire into later events, unless ‘personal services’ are involved.”7 Why not? This difference in treatment between employment and nonemployment cases is anomalous and unjustified. Frequently, a service-​purchaser’s breach will not make possible a replacement gain for a nonemployee service-​provider because a nonemployee service-​provider frequently has elastic capacity and could have contracted with a second service-​purchaser even if there had been no breach by the first. A striking example is Wired Music, Inc. v. Clark.8 Wired Music was in the business of distributing recorded music to commercial locations through wires rented from a phone company. Clark contracted with Wired Music for three years of music service at his business premises. The contract provided that it could not be assigned without Wired Music’s consent. After seventeen months, Clark moved his business and discontinued the Wired Music service. A new tenant then rented the premises Clark had occupied. The new tenant asked Wired Music to consent to an assignment of Clark’s contract to him, but Wired Music refused. Thereafter, the

6.  1 F.2d 693 (3rd. Cir. 1924). 7.  Id. at 695. 8.  168 N.E. 2d 736 (Ill. App. Ct. 1960).

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new tenant entered into a new contract with Wired Music for music service at Clark’s former premises, at a higher monthly charge than Clark had been paying. Wired Music then sued Clark for lost profits on its contract with him. Clark argued that Wired Music had no damages because under the contract with the new tenant Wired Music would realize more profits from Clark’s former premises than it would have realized if Clark had not relocated. The court concluded that Wired Music could supply any number of additional customers without incurring further expenses except for wire rental.9 Therefore, the court properly held, Wired Music’s profit on the contract with the new tenant did not reduce its damages against Clark, because if Clark had not relocated the new tenant could have found other nearby premises and contracted with Wired Music for music service at those premises. In some cases, however, a service-​purchaser’s breach will make possible a replacement gain to the service-​provider—​for example, when the service-​provider’s capacity is capped as a result of limited working capital or limited managerial resources, or because the service-​provider is a contractor, its surety company limits the amount of work it will bond, and the service-​provider has reached that limit. Where the service-​purchaser can prove this is the case the service-​ provider’s damages should be reduced by the amount of the replacement gain.

I I.   B R E A C H B Y   A S E RVI CE-​P R OVI DER When a service-​provider breaches a contract for the sale of services the normal response of the service-​purchaser is to make a contract with a replacement service-​provider who agrees to render, complete, or remediate the performance promised by the original service provider. Accordingly, the normal formula for measuring the service-​purchaser’s damages in such a case is the difference between the original contract price and the price paid to the replacement service-​ provider, adjusted by any payments made to the original service-​provider before the breach. This formula is a replacement-​cost formula and is usually referred to as cost-​of-​completion damages. There is, however, an alternative formula for determining a service-​purchaser’s damages—​ the difference between the value of the performance that the service-​provider promised to render and the value of the performance that it actually rendered. This is a diminished-​value formula, and is commonly referred to by that name. This Section discusses these two formulas and how it should be determined which formula should be applied when the two formulas would yield different results.

A.  THE CORE FORMULAS: COST-​OF-​COMPLETION AND DIMINISHED-​VALUE DAMAGES In a market with perfect cost-​free information there would seldom be a difference between cost-​ of-​completion and diminished-​value damages. This point is most easily exemplified by contracts for the sale of goods. UCC Section 2-​714(2) provides that if a seller of goods breaches a warranty the buyer can recover the difference between the value of the goods as warranted and the value 9.  Id. at 738.

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of the goods as delivered and accepted. Although this is a diminished-​value formula, usually the difference in value is measured by the cost to repair the goods so that they conform to the warranty—​a cost-​of-​completion formula. The reason, as pointed out in Manouchehri v. Heim,10 is that “if it costs $200 to fix [a]‌machine so that [the machine performed as warranted], then one could assume that the unrepaired machine (the ‘goods accepted’) was worth $200 less than the repaired machine (the goods ‘as warranted’). Thus, the cost of repair is commonly awarded as . . . damages” for breach of warranty in lieu of measuring diminished value directly.11 The same reasoning applies to services cases. A striking example is Louise Caroline Nursing Home, Inc. v. Dix Construction Corp.12 Dix contracted with Louise Caroline to build a nursing home. Dix did not complete the nursing home, and Louise Caroline found a substitute contractor to do so. Louise Caroline then sued Dix for a form of diminished-​value damages measured by the difference between the contract price and the market value of the nursing home if Dix had completed the job. The court held that Louise Caroline was not entitled to any damages because the amount that Louise Caroline had paid to Dix before Dix breached plus the amount Louise Caroline paid to the substitute contractor was less than the contract price with Dix, so that Louise Caroline suffered neither diminished-​value nor any other damages.13 Although the cost-​of-​completion formula is the basic measure of damages for breach by a service-​provider, in certain cases the courts must, should, or do use a diminished-​value measure instead. In some of these cases, diminished value must be used because the completion is unattainable. Hawkins v. McGee14 is an example. As described in Chapter 13, Dr. McGee, a surgeon, promised to give Hawkins a perfect hand. However, the surgery not only made Hawkins’s hand worse but precluded the possibility of repairing the damage done to the hand. In such cases, the diminished-​value formula must be employed. In Hawkins that was the difference between the value of the perfect hand that Dr. McGee promised and the value of the hand that Hawkins ended up with. The same result would follow if, for example, a diamond cutter contracted to recut a diamond in a certain way that would enhance the diamond’s value, but botched the job and ended up with diamond shards. Completion is then unattainable, and the diamond owner should recover the difference between the value of the shards and the value the diamond would have had if it had been recut as promised. In another, more difficult kind of case, completion is attainable but the cost of completion is much greater than the added value that completion would yield. For example, in Eastern S. S. Lines, Inc. v. United States15 the Government requisitioned Eastern’s vessel, Acadia, for use in World War II. The Government promised that before redelivery of the Acadia it would either restore the vessel to the condition it was in when Eastern delivered it or pay Eastern to have the 10.  941 P.2d 978 (N.M. Ct. App. 1997). 11.  Id. at 981. 12.  285 N.E.2d 904 (Mass. 1972). 13.  Louise Caroline incidentally illustrates the asymmetric nature of damages for breach of contract. If a breach leaves the promisee less well off than performance would have done, the promisee can sue for damages. However, if a breach leaves the promisee better off than performance would have done, as happened in Louise Caroline, the promisor cannot sue for the amount by which the promisee was made better off, presumably because the promisee did not commit a wrongful act and is not unjustly enriched by a benefit the promisor conferred upon him. Id. at 907–​08. 14.  146 A. 641 (N.H. 1929). See supra Chapter 13. 15.  112 F. Supp. 167 (Ct. Cl. 1953).

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restoration performed. The Government did neither and Eastern brought suit for the expected cost of restoration. The court assumed, for purposes of its opinion, that restoration would cost $4 million and that a restored Acadia would be worth $2 million. Based on this assumption the court limited Eastern’s damages to the value that the Acadia would have if it was restored, rather than the cost of restoration.16 Jacob & Youngs, Inc. v. Kent raised an analogous issue.17 Jacob & Youngs had contracted to build a country house for Kent. The contract specified that all the wrought-​iron pipe used in the house “must be . . . of the grade known as ‘standard pipe’ of Reading manufacture.”18 Jacobs & Young used Cohoes pipe instead, but Cohoes pipe was equal to Reading pipe in quality, appearance, market value, and cost—​“indeed, the same thing, though manufactured in another place.”19 When the house was completed Kent refused to make the final payment because the piping did not comply with the contract. The court held that Jacob & Youngs was entitled to the final payment, with an offset equal to the difference in the value of the house with Reading pipe and with Cohoes pipe (that is, diminished-​value damages), rather than an offset equal to the cost of tearing out the Cohoes pipe and replacing it with Reading pipe (cost-​of-​completion damages).20

B.  WHEN DIMINISHED-​VALUE DAMAGES SHOULD BE USED IN LIEU OF COST-​OF-​COMPLETION DAMAGES Although it is well-​settled that under certain conditions a service-​purchaser’s damages should be measured by diminished-​value rather than cost of completion, it is not well-​settled what those conditions should be. Several competing rules have been employed, including an unreasonable-​ economic-​waste rule, an unreasonable-​disproportion rule, a diminished-​satisfaction rule, and a likelihood-​of-​completion rule. These rules will be discussed in turn. One possible rule, embodied in Restatement First Section 346(1)(a)(i), is that diminished-​ value damages should be awarded if cost-​of-​completion damages would involve unreasonable economic waste (the unreasonable-​economic-​waste rule).21 This rule is unintelligible. An award of damages cannot in itself involve waste; it merely redistributes wealth between the parties.22 It is true that the service-​purchaser may use the proceeds of a damage recovery, however measured, 16.  Id. at 176. 17.  129 N.E. 889 (N.Y. 1921); see also Avery v.  Fredericksen & Westbrook, 154  P.2d 41, 45 (Cal. Ct. App. 1944) (affirming award of diminished-​value damages rather than cost-​of-​completion damages). 18.  Jacob & Youngs, 129 N.E. at 890. 19.  Id. 20.  Id. at 891. 21.  Restatement First of Contracts § 346(1)(a)(i) (Am. Law Inst. 1932) [hereinafter Restatement First]; see also Hansen v. Andersen, 71 N.W.2d 921, 924 (Iowa 1955); 11 Joseph M. Perillo, Corbin on Contracts § 60.2 (rev. ed. 2005) (economically wasteful remedies to be avoided with respect to construction contracts). 22.  See Robert L. Birmingham, Damage Measures and Economic Rationality: The Geometry of Contract Law, 1969 Duke L.J. 49, 69 (arguing that in situations in which cost of completion is greater than diminished-​ value damages, the issue is not “whether unwanted work will be carried out, but how unexpected benefit will be distributed”).

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to engage in activity the court regards as wasteful, but that cannot be a criterion for selecting among diverging damage formulas. For example, the law does not refuse to award damages for breach of contract because the plaintiff plans to use the award to enter a high-​stakes poker game in Las Vegas that he lacks the skill to play. A competing rule is that diminished-​value damages should not be awarded if such damages would be grossly and unfairly out of proportion to the result to be attained (the unreasonable-​ disproportion rule). However, a disparity between the cost and value of completion should not in itself be a ground for refusing cost-​of-​completion damages. For example, assume that Homeowner makes a contract with Painter under which Painter will paint Homeowner’s vacation home a certain shade of brown for $3,000. Through a mix-​up, Painter paints the home green. Repainting the house in Homeowner’s desired shade of brown would cost $3,000 but would actually decrease the home’s market value because the brown is ugly whereas the green is beautiful. Here the cost of completion is infinitely disproportionate to the value of completion. Nevertheless, Homeowner should be able to recover the cost of repainting and a court would undoubtedly grant that remedy.23 Because the unreasonable-​economic-​waste and disproportion rules are unsound, courts applying these rules often reach unsound results. For example, in the famous (or infamous) case Peevyhouse v. Garland Coal & Mining Co.,24 Willie and Lucille Peevyhouse leased part of a farm to Garland for the purpose of strip-​mining coal. In return, Garland agreed to pay royalties and to perform restorative work at the end of the lease. Garland failed to perform the restorative work and the Peevyhouses sued for cost-​of-​completion damages. The cost of the restorative work would have been about $29,000 but, the restoration would have increased the market value of the land by only $300, and the value of the restored land would have been only about $3,200.25 The jury awarded the Peevyhouses $5,000, but on appeal the Oklahoma Supreme Court held that the Peevyhouses were limited to diminished-​value damages of $300. The decision in Peevyhouse was incorrect for two reasons. First, the court improperly treated value and market value as synonymous. They aren’t. Because the leased land was part of a family farm, the Peevyhouses almost certainly placed a subjective value on the land that exceeded its objective market value. Second, there was evidence that the leased farm had a special strategic value to the Peevyhouses.26 Apparently, the farm that the Peevyhouses leased to Garland was flanked by two other farms the Peevyhouses owned, and one reason the Peevyhouses wanted the leased farm restored so that they could then run equipment between the two adjacent farms. Accordingly, the leased farm, if restored, would have had a strategic value to the Peevyhouses

23.  Restatement First § 346, illus. 4 provides an example: A contracts to construct a monumental fountain in B’s yard for $5000, but abandons the work after the foundation has been laid and $2800 has been paid by B. The contemplated fountain is so ugly that it would decrease the number of possible buyers of the place. The cost of completing the fountain would be $4000. B can get judgment for $1800, the cost of completion less the part of price unpaid.

24.  382 P.2d 109 (Okla. 1962). 25.  This amount is derived as follows: The court stated that (1) restoration of the farm would cost $29,000; (2) the restoration would increase the value of the farm by $300; (3) the jury verdict for $5,000 was more than the value of the farm if the restoration was done; and (4) $29,000 was about nine times the total value of the farm. Dividing $29,000 by nine yields a value of about $3,200. 26.  382 P.2d at 117.

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that exceeded the farm’s market value. (The court refused to consider strategic value on the ground that this theory had not been argued at trial.27) H.P. Droher & Sons v. Toushin28 is another case in which a court incorrectly declined to use the cost-​of-​completion formula. Droher agreed to build a home for Toushin for just under $44,000. When the house was completed, a steel post in the basement, which supported a beam on which the floor joists rested, was too low. As a result, the floor and other parts of the house sagged noticeably. To correct this defect it would have been necessary to jack up the beam. If that were done, the plaster would crack and parts of the home would need to be rebuilt, so that the cost of repair would exceed $20,000. The diminution in the value of the house resulting from the defect was apparently much less than $20,000. The court held that the homeowners were only entitled to diminished-​value damages. But who would want to live in a home with dipsy-​doodle floors? Another candidate formula when cost of completion is significantly higher than diminished value is the value of the service-​purchaser’s lost satisfaction (the diminished-​satisfaction rule). This rule was adopted by the House of Lords in Ruxley Electronics & Construction Ltd v. Forsyth.29 Ruxley contracted to build a swimming pool for Forsyth for £70,000. The pool was to have a maximum depth of 7’ 6”. After the work was completed, Forsyth discovered that the pool’s maximum depth was only 6’ 9”, and at the point where swimmers would dive in the depth was only 6’. Forsyth therefore refused to pay the balance of the price. Ruxley sued for the balance and Forsyth counterclaimed for breach of contract. The trial judge found that: (1) The pool as constructed was safe for diving because a depth of 6’ is adequate even for a beginner, and according to an official handbook the minimum safe depth for diving is 5’. (2) Because the pool was safe for diving, the shortfall in depth did not decrease the value of the pool. (3) The only way to increase the depth of the pool was to demolish the existing pool and start again, at a cost of £21,560. (4) Forsyth had no intention of building a new pool. Accordingly, the trial judge concluded, if Forsyth was awarded cost-​of-​completion damages he would end up with both the existing pool, which was in substantial compliance with the contract, and a windfall of £21,560. However, the judge awarded £2,500 to Forsyth for diminished satisfaction—​specifically, loss of the pleasure and amenity he would suffer by reason of not being able to dive to a depth of 7’ 6”, as opposed to 6’: In the course of his written submissions Mr. Forsyth reminded me that “This is not a matter of commerce to be nicely measured in money. Swimming pools are not necessities, they are for fun. Due to [the contractor’s] default I have lost some fun.” I think that where a contract is for the provision of a pleasurable amenity, such as a swimming pool, it is entirely proper to award a general sum for the loss of amenity. I accept that there has been a loss of amenity brought about by the shortfall in depth and I award damages for loss of that amenity in the sum of £2,500.30

The House of Lords affirmed. Lord Mustill said: . . . It is a common feature of small building works performed on residential property that the cost of the work is not fully reflected by an increase in the market value of the house, and that

27.  Id. 28.  85 N.W.2d 273 (Minn. 1957). 29.  [1996] 1 A.C. 344 (HL) (appeal taken from Eng.). 30.  Id. at 363.

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comparatively minor deviations from specification or sound workmanship may have no direct financial effect at all. Yet the householder must surely be entitled to say that he chose to obtain from the builder a promise to produce a particular result because he wanted to make his house more comfortable, more convenient and more conformable to his own particular tastes; not because he had in mind that the work might increase the amount which he would receive if, contrary to expectation, he thought it expedient in the future to exchange his home for cash. To say that in order to escape unscathed the builder has only to show that to the mind of the average onlooker, or the average potential buyer, the results which he has produced seem just as good as those which he had promised would make a part of the promise illusory and unbalance the bargain. . . . In my opinion there would indeed be something wrong if . . . cost [of completion] and the depreciation in value were the only available measures of recovery . . . Having taken on the job the contractor is morally as well as legally obliged to give the employer what he stipulated to obtain, and this obligation ought not to be devalued. . . . There are not two alternative measures of damage, at opposite poles, but only one: namely the loss truly suffered by the promisee. In some cases the loss cannot be fairly measured except by reference to the full cost of repairing the deficiency in performance. In others, and in particular those where the contract is designed to fulfill a purely commercial purpose, the loss will very often consist only of the monetary detriment brought about by the breach of contract. But these remedies are not exhaustive, for the law must cater for those occasions where the value of the promise to the promisee exceeds the financial enhancement of his position which full performance will secure. This excess, often referred to in the literature as the “consumer surplus” . . . is usually incapable of precise valuation in terms of money, exactly because it represents a personal, subjective and non-​monetary gain. Nevertheless, where it exists the law should recognise it and compensate the promisee if the misperformance takes it away. . . . [T]‌he test of reasonableness plays a central part in determining the basis of recovery, and will indeed be decisive in a case such as the present when the cost of [completion] would be wholly disproportionate to the non-​monetary loss suffered by the employer. But it would be equally unreasonable to deny all recovery for such a loss. The amount may be small, and since it cannot be quantified directly there may be room for difference of opinion about what it should be. But in several fields the judges are well accustomed to putting figures to intangibles, and I see no reason why the imprecision of the exercise should be a barrier, if that is what fairness demands.31

Similarly, in Jacobs & Youngs v. Kent, if Kent attached an idiosyncratic but real subjective value to Reading pipe he should have been able to recover diminished-​satisfaction damages based on that value. The diminished-​satisfaction formula is preferable to the unreasonable-​economic-​waste and unreasonable-​disproportion formulas where personal values are involved. For example, under the diminished-​satisfaction formula the Peevyhouses and Toushin probably would have come away with a significant recovery. However, the formula probably will work only when the service-​purchaser is an individual, because normally enterprise utility is not measured in terms of satisfaction, and in any event the formula does not get to the real issue. The only justification for limiting a service-​purchaser to diminished-​value damages is that if the 31.  Id. at 360–​61. See also Donald Harris, Anthony Ogus & Jennifer Phillips, Contract Remedies and the Consumer Surplus, 95 Law Q. Rev. 581, 601–​10 (1979).

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service-​purchaser does not intend to complete, cost-​of-​completion damages would constitute a windfall. For example, if Eastern Steamship had been awarded $4 million cost-​of-​completion damages even though upon completion Acadia would only be worth $2 million, it is clear that Eastern Steamship would not have spent the $4 million to restore the Acadia, but instead would either have purchased two vessels comparable to the Acadia or would buy one vessel and put the remaining $2 million in the bank. Similarly, if the farm in Peevyhouse had been owned by Peevyhouse Agribusiness, a corporation with large farmholdings throughout the Midwest, it is clear if Agribusiness was awarded $29,000 cost-​of-​completion damages, completion would increase the value of the farm by only $300, and upon completion the farm would have been worth only $3,200, then Agribusiness would not restore the farm but instead would use the $29,000 to buy nine comparable farms. In such cases cost-​of-​completion damages would conflict with the expectation measure, because the service-​purchaser would be better off with breach than with performance. In contrast, if it is likely that if the service-​purchaser will use cost-​of-​completion damages to complete the service-​provider’s promised performance, then denying those damages would be improper because it would both frustrate the purchaser’s bargained-​for-​expectation and provide a windfall to the service-​provider. Accordingly, if the purchaser has already paid a substitute provider to complete the promised performance that should be the end of the matter, because the court will know beyond doubt that the purchaser really wanted completion. However, the absence of completion does not necessarily show that the purchaser does not want completion, because without a recovery he may have lacked the funds to complete. What if it is doubtful whether the service-​purchaser would use cost-​of-​completion damages to complete? In such cases, cost-​of-​completion damages should be awarded because the service-​provider is responsible for creating the situation in which the doubt arises. In short, if completion is attainable, cost-​of-​completion damages should be awarded unless they would be substantially greater than diminished-​value damages and it is clear that damages so measured would be a windfall because in all likelihood the service-​purchaser would not use those damages to complete the promised performance (the likelihood-​of-​completion rule). This rule was explicitly adopted in Advanced, Inc. v. Wilks:32 A [service-​purchaser’s] recovery is not necessarily limited to diminution in value whenever that figure is less than the cost of repair. It is true that in a case where the cost of repair exceeds the damages under the value formula, an award under the cost of repair measure may place the service-​purchaser in a better economic position than if the contract had been fully performed, since he could pocket the award and then sell the defective structure. On the other hand, it is possible that the service-​purchaser will use the damage award for its intended purpose and turn the structure into the one originally envisioned. He may do this for a number of reasons, including personal esthetics or a hope for increased value in the future. If he does this his economic position will equal the one he would have been in had the service-​provider fully performed. The fact finder is the one in the best position to determine whether the service-​purchaser will actually complete performance, or whether he is only interested in obtaining the best immediate economic position he can. In some cases, such as where the property is held solely for investment, the court may conclude as a matter of law that the damage award can not exceed the diminution in value. Where,

32.  711 P.2d 524 (Alaska 1985).

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however, the property has special significance to the service-​purchaser and repair seems likely, the cost of repair may be appropriate even if it exceeds the diminution in value.33

Other cases, although not quite so explicit, also support a likelihood-​of-​completion rule. For example, in Eastern Steamship the court concluded that “[c]‌ommon sense and reality tell us” that if the plaintiff recovered the $4 million cost of completion it would not spend that amount on restoration, “since after the expenditures it would have only a $2,000,000 ship. The result would be that the Government would pay out $2,000,000 more than the plaintiff had lost by the Government’s chartering and use of its ship.”34 English cases have also adopted a likelihood-​of-​completion rule. For example, in Radford v. de Froberville35 Radford owned a building in London that was divided into flats leased to residential tenants. The building had a large garden, part of which was a plot of land suitable for a basic building. In 1965 Radford sold the plot to de Froberville, who paid £6,500 and agreed that she would immediately erect a brick wall separating the plot from the remainder of the garden. Eight years later de Froberville had not built the wall, and Radford sued for the cost of building the wall on his side of the boundary. The lack of a wall did not significantly diminish the rental value of Radford’s building, and in fact, the extra open space might have enhanced the value of the building. The court nevertheless granted cost-​ of-​completion damages because it was persuaded that Radford actually did intend to build the wall: In applying [the principle that expectation damages should put the plaintiff where he would have been had the contract been performed], the court does not disregard the hopes and aspirations or the individual predilections of the particular plaintiff. . . . What the court does is to use its common sense in measuring, in the case of the individual plaintiff and by reference to his particular circumstances, what he has lost by the breach. . . . Assume, for instance, two identical houses on an estate which have been let subject to a covenant for use as a single residence, each lease expiring at the same time, each containing a covenant against alteration. Each has been altered by the tenant, in breach of covenant, to form a number of flats and in each case the effect is to make the property more valuable as a marketable commodity. On the expiry of each lease, the landlord sues for damages. The landlord of one wishes to occupy it himself as a single residence for his family. The landlord of the other wishes to demolish it immediately for redevelopment. The adoption of a single universal principle which looks only at market value regardless of the wishes of the individual plaintiff would dictate a nominal award in both cases, but the authorities . . . show that the courts do not approach the problem in this way.36

33.  Id. at 527. 34.  112 F. Supp. 167, 175 (Ct. Cl. 1953). 35.  [1977] 1 WLR 1262, 1273 (Ch) (U.K.). 36.  Id. at 1271–​73. See also [1996] Ruxley Elecs. & Constr. Ltd. v. Forsyth, 1 AC 344, 372–​73 (HL) (appeal taken from Eng.) (“[S]‌ome contracts for alterations to buildings, or for their demolition, might not, if carried out, enhance the market value of the land, and sometimes would reduce it. The tastes and desires of the owner may be wholly out of step with the ideas of those who constitute the market; yet I cannot see why eccentricity of taste should debar him from obtaining substantial damages”) (quoting Tito v. Waddell (No.2), [1977] 1 Ch. 106, 332 (Ch.) (U.K.)). It is sometimes said that cost-​of-​completion damages should not be awarded where completion would involve an unreasonable destruction of completed work. See, e.g., Brewer v. Custom Builders Corp., 356

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A special problem arises where diminished-​value damages are otherwise appropriate but the promisee has explicitly or implicitly paid for the services the promisor failed to perform. In such a case, the service-​provider should be required to disgorge the amount of the payment. This point can be illustrated by considering a hypothetical variation of Peevyhouse.37 Suppose the farm in that case had been owned by Peevyhouse Agribusiness Corporation, which owned a number of farms in the Midwest. In that event the diminished-​value measure, rather than the cost-​of-​completion measure, would have been appropriate. If the cost of restoring the farm was ten times the value of the farm as restored, it is clear that Peevyhouse Agribusiness would not have used cost-​of-​completion damages to restore the farm, but instead would have either put the money in the bank or used it to purchase nine comparable farms. However, if in this hypothetical, as in the actual Peevyhouse case, Garland Coal was not required to pay cost-​of-​completion damages, it should at least be required to disgorge the expected cost of restoration at the time the contract was made. Here is the reason: when Garland Coal made a strip-​mining contract with a land owner, it must have been willing to pay the land owner a royalty—​say $X per ton—​for every ton of coal it mined. If the land owner also wanted restoration and Garland Coal agreed, then presumably Garland Coal would factor this extra cost into the per-​ton royalty it bargained for, and would either (1) make a flat upfront payment that the land owner could use for restoration, and reduce the per-​ton royalty by the pro-​rated amount of the payments it expected to make—​say $Y per ton; or (2) promise to make restoration at the end, and pay the land owner $X–​$Y per ton, rather than $X per ton, for each ton mined.38 Accordingly, to give Garland Coal the correct incentives and to prevent unjust enrichment, if Garland Coal is not required to pay cost-​of-​completion damages it should be required to disgorge $Y per ton for each ton mined.

N.E.2d 565, 570 (Ill. App. 1976) (“If to repair the defects or omissions would require a substantial tearing down and rebuilding of the structure, the measure of damages is the difference in value between the work if it had been performed according to the contract and that which was actually performed”). The fact that expensive destruction of completed work would be required is some evidence that the owner might pocket a cost-​of-​completion recovery rather than have the work performed. However, if it seems probable that the owner values the contracted-​for performance so highly that he would in fact destroy and reconstruct, he should be entitled to do so, and several cases have allowed cost-​of-​completion damages in such circumstances. See, e.g., Gory Associated Indus. Inc. v. Jupiter Roofing & Sheet Metal, Inc., 358 So. 2d 93 (Fla. Dist. Ct. App. 1978) (awarding the cost of replacing roof made of a tile other than that specified in the contract); Edenfield v. Woodlawn Manor, Inc., 462 S.W.2d 237, 242 (Tenn. Ct. App. 1970) (awarding the cost of replacing defective air-​conditioning ducts, including the cost of removing and restoring walls and cabinets). In Gory the court said, “[W]‌e are sympathetic to a replacement of defective work. If a proud householder, who plans to live out his days in the home of his dreams, orders a new roof of red barrel tile and the roofer instead installs a purple one, money damages for the reduced value of his house may not be enough to offset the strident offense to aesthetic sensibilities, continuing over the life of the roof.” 358 So. 2d at 95. 37.  382 P.2d 109 (Okla. 1962). 38.  Judith Maute reports that under the standard strip-​mining lease in the area in which the Peevyhouse farm was located, mining companies typically made a per-​acre payment up front to compensate the land owners for the damage that would be done to their land. Usually, this payment would equal the total value of the land before mining began. The Peevyhouses were aware of this standard provision, but they instead obtained Garland Coal’s agreement to restore their land because they had seen the damage done to their neighbors’ land by strip-mining. Judith L. Maute, Peevyhouse v. Garland Coal & Mining Co. Revisited: The Ballad of Willie and Lucille, 89 Nw. U. L. Rev. 1341, 1363–​64 (1995).

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Disgorgement of the costs that a service-​provider saved as a result of breach should be an alternative, not a supplement, to diminished-​value damages. For example, in Jacob & Youngs v. Kent,39 Kent should have been able to recover either (1) the difference between the value of his home with the Cahoes pipe and the value of his home with Reading pipe, or (2) the difference in cost between the installed pipe and Reading pipe, but not both, because the two damage measures would overlap or even duplicate.40 Similarly, in Peevyhouse Agribusiness, Agribusiness should not be awarded both diminished-​value damages and disgorgement of Garland Coal’s saved costs, because if Garland had invested the amount of those costs in restoring the farm, the diminution in the value of the farm would have been significantly reduced.

39.  129 N.E. 889. 40.  Shawn Bayern has illustrated this point as follows: To explain this idea, imagine a variation on Jacob & Youngs in which the amount the promisor saves by breaching equals the diminished value to the promisor. For instance, suppose that Reading pipes cost $5,000, Cohoes pipes cost $4,000, and the house is worth $1,000 more with Reading pipes than Cohoes pipes. However, continue to suppose that it would cost substantially more—​say $50,000—​to replace the pipes. In this case, the promisor gains $1000 from breach and the promisee loses $1,000 from breach; the appropriate remedy seems to be a transfer of $1000, not separate damages for loss and disgorgement for gain.

Now, suppose that the owner’s diminished value in this variation of Jacob & Youngs were instead $500. Still, disgorgement seems appropriate, but the total payment should still be $1,000—​right? That is, just disgorgement—​not disgorgement plus diminished value. And if the owner’s diminished value were $2000, no separate disgorgement would be necessary. Communication from Shawn Bayern to Melvin A. Eisenberg, April 19, 2005.

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Damages for a Purchaser’s Breach of a Contract for the Provision of an Off-​the-​Shelf Commodity The e x pe ctation measu re is based i n si g n i fi ca n t pa rt on the

premise that parties who bargain under ideal conditions and address the issue of damages would probably select that measure, and the satellite formulas that implement it, to determine damages for ordinary cases. Accordingly, that measure and its satellite formulas should not necessarily govern damages in categories of cases in which it is likely that the parties would not have agreed to that measure and those formulas. So, for example, bargaining parties probably would not agree to lost-​ profit damages for breach by a purchaser of a contract for the provision of a commodity that has the following characteristics: (1) The commodity is standardized. (Recall that the term commodity is used in this book to mean anything that can be purchased and sold, including goods and services). (2) The purchaser is a consumer and the provider is a firm. (3) The provider’s variable costs of performance are close to zero. (4) The breach does not cause the provider to incur either out-​of-​pocket or opportunity costs. (5) The purchaser breaches at the outset and derives little or no benefit from the contract. Contracts with these characteristics will be referred to as contracts for the purchase of off-​the-​shelf commodities.

I .  O F F -​T H E -​S HEL F S ERVI CES Consider the following hypothetical: Yoga Lessons. Murray owns a yoga studio, which offers group yoga classes. Enrollment in each class is limited to 20 and a class will be canceled if fewer than 12 students sign up. The yoga teachers are on one-​year contracts and the building in which classes are conducted is held by Murray under a long-​term lease. Elizabeth, an electrical engineer, wants to learn to do yoga. On May 1 Elizabeth

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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Expectation Damages signs a contract with Murray to take Yoga 101, which begins on July 1. Yoga 101 meets two hours a week, runs 20 weeks, and has a fee of $800. Elizabeth reads all the provisions of the contract, but knows nothing about the legal rules of damages. As of June 15, 16 students had enrolled in Yoga 101. On June 16, Elizabeth changes her mind and repudiates the contract. No additional students enrolled or withdrew thereafter. Murray brings suit against Elizabeth.

Since there are no variable costs remaining to be incurred by Murray, under the standard formula for breach by a service-​purchaser (contract price minus remaining variable costs) Murray would be awarded the entire $800 contract price despite the fact that Murray has incurred no costs and Elizabeth has received only a very limited benefit.1 In analyzing whether that is the appropriate measure of damages in such a case an important question is why a consumer would enter into a contract for future off-​the-​shelf services instead of waiting to contract until just before the services would be rendered. So in Yoga Lessons, why would Elizabeth make a contract on May 1 rather than simply wait until July 1 and enroll on that day if she hasn’t changed her mind? The reason would seldom be to allocate the risk of price changes or to speculate on prices:  consumers normally do not make contracts to purchase off-​the-​shelf services for either purpose. Rather, the typical purpose of a consumer in making such a contract is to ensure supply—​in Yoga Lessons, to ensure a place in the class—​and, perhaps, to commit oneself to taking an action in the belief that absent such a commitment when the time comes the consumer will suffer akrasia—​weakness of will—​and not enroll. Given these purposes it is unlikely that a consumer would knowingly enter into an off-​the-​shelf-​services contract under which she would be required to pay the entire contract price if she cancelled, because damages measured that way would be highly disproportionate to both the benefit to the consumer from making the contract now rather than waiting (often very limited), and the cost to the provider resulting from a breach by the consumer (often, as in Yoga Lessons, zero). The provider, on its part, would be unlikely to insist on such a damages provision because if he did so he would diminish his profitability since too few consumers would sign contracts, and in any event it would be unnecessary to do so in light of the relatively low degree of harm he will suffer from breaches.2 Lost-​profit damages are also normally not required to provide the correct incentives to a consumer for performance and precaution. These incentives are premised on the assumption 1.  See J.J. & L. Inv. Co. v. Minaga, 487 P.2d 561, 562 (Colo. App. 1971) (a secretarial school was not required to refund tuition upon a student’s voluntary withdrawal); Leo Found., Inc. v. Kiernan, 240 A.2d 218, 221 (Conn. Cir. Ct. 1967) (when a student withdrew without fault on the part of school, the school was entitled to the entire tuition). But see Edu. Beneficial, Inc. v. Reynolds, 324 N.Y.S.2d 813, 816, 820 (Civ. Ct. 1971) (a commercial school’s contract that provided for a $600 nonrefundable enrollment fee and $7 per hour for all scheduled instructional hours in uncompleted course was unconscionable). 2.  If the seller had been operating at full capacity and reserved a place for a purchaser he may have turned away an alternative purchaser. If the purchaser’s place was not eventually filled the provider will have incurred an opportunity cost equal to the contract price. One way to handle this problem is to permit the provider to recover his lost profit in such a case, with the burden on the provider to prove both that he was operating at full capacity and that he turned away another customer because of his contract with the buyer. However, if the buyer probably would not have agreed to lost-​profit damages, recovery of those damages might be inappropriate unless the parties specifically contracted to that effect.

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that the promisor knows how damages will be measured:  measuring damages by any given formula cannot affect a promisor’s incentives if he does not know or reasonably expect that damages would be measured that way. It is very unlikely that in off-​the-​shelf-​services cases the consumer would either know or reasonably expect that damages for her breach would be measured by the seller’s lost profit, and it is equally unlikely that she would have agreed to a lost-​profit formula, unless she set a very high value on reserving a place. Lost-​profit damages normally would also not be justified in off-​the-​shelf-​services cases on the ground that they are necessary to enable the provider to plan effectively. Firms dealing in off-​ the-​shelf services normally make a large number of contracts and develop formal or informal statistical-​planning models that predict the rate of breach. If the seller’s statistical forecast is reasonably accurate his planning is not interrupted by any single breach or even by a number of breaches. Indeed, if expectation damages should put a seller at the profit level he would have attained if as many buyers performed as he expected to perform then it may be said that he has realized his expectation in spite of a purchaser’s breach. In short, in contracts between an off-​the-​shelf service-​provider and a consumer, lost-​ profit damages normally are not required by either efficiency or fairness, particularly where the provider uses a statistical-​planning model. Rather, damages in such cases should be based on the amount necessary to reimburse the provider for incidental costs, provide enough deterrence against breach to facilitate planning, and require the consumer to pay for the benefit she obtained by reserving a place. Indeed, casual investigation suggests that few mass retailers sue for breach of executory contracts. Rather, retailers commonly allow buyers to even return purchased goods, often for a full refund, sometimes minus a restocking fee. The measure of damages that should be used in such cases often will not be difficult to formulate. If the contract contains an enforceable liquidated-​damages provision, and the consumer is made aware of the provision, that should suffice. So too should an explicit statement to the consumer of the consequence of breach, such as loss of one-​night’s room rate at a hotel if a guaranteed reservation is canceled without sufficient notice. In addition, normally the law should treat a deposit as an implicit liquidated-​damages provision. Most consumers probably expect that if they cancel a contract for off-​the-​shelf commodities they will lose their deposit, but nothing more. Denying lost-​profit damages to off-​the-​shelf providers would also give such providers an incentive to use alternative and better techniques, such as deposits, if they want to collect damages for a consumer’s breach.

I I .  O F F -​T H E -​SHEL F   GOODS Consider now contracts for the sale of off-​the-​shelf goods, as in the following hypothetical: Camry Buyer. Martin Marin, a high-​school teacher, wants to buy a new Toyota Camry. After shopping around, Marin decides to buy the car from the Acme Toyota dealership because Acme’s price matches the lowest price available from competing dealers and Acme has a good reputation for service. On November 15 Marin signs a contract to buy from Acme a new Camry, with specified accessories, for $30,000, delivery on December 1. Marin puts down a deposit of $300. On

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Expectation Damages November 20, Marin repudiates the contract. Acme’s cost for a Camry is $25,000, and Acme can buy as many Camrys from the factory as it can sell.

Much the same analysis can be made here as in off-​the-​shelf-​services cases. If Acme is awarded lost-​profit damages it would recover $5,000. This result is not as draconian as the application of that formula to typical off-​the-​shelf-​services cases: In off-​the-​shelf-​goods cases the seller’s variable costs are significant, consisting of the amount required to manufacture the good or purchase it for resale. Therefore, the seller’s recovery normally would be only a percentage of the contract price rather than the entire contract price, as would often be the case in off-​the-​shelf services cases. Nevertheless, it is unlikely that a consumer of off-​ the-​shelf goods would have agreed ex ante to a provision measuring damages for cancellation in this manner, or that lost-​profit damages are necessary to provide such a consumer with incentives for efficient behavior. A rule that where a consumer breaches a contract for the provision of off-​the-​shelf services or goods the seller’s damages should not be measured by his lost profit also finds support in Restatement Second Section 351(3). This Section provides that a court “may limit damages for foreseeable loss by excluding recovery for loss of profits, by allowing recovery only for loss incurred in reliance, or otherwise if it concludes that in the circumstances justice so requires in order to avoid disproportionate compensation.” It is not easy to imagine damages that would involve more disproportionate compensation than an award of the entire contract price to a service-​provider who has provided no services and incurred little or no costs, or an award of a significant portion of the contract price to a seller of goods who has provided no goods and incurred little or no costs. The problem of disproportionality in off-​the-​shelf consumer contract cases is reinforced by the asymmetry that would result if the seller can recover lost-​profit damages. The market price of off-​the-​shelf consumer commodities will seldom fluctuate significantly. Accordingly, if a provider of off-​the-​shelf commodities to consumers was entitled to lost-​profit damages, normally the provider’s damages for breach by the consumer would be significant whereas the consumer’s damages for breach by the provider would be close to zero.

I I I .   F U L L C A PA CI T Y Suppose in a case such as Yoga Lessons the seller is operating at full capacity. If the seller reserves a place for the buyer, he may then turn away an alternative customer. If the defaulting buyer’s place is not filler, the seller will have incurred an opportunity cost equal to the contract price. One way to handle this problem is to permit the seller to recover damages under a net-​proceeds formula if he could shoulder the burden of proving these elements. However, if a buyer would probably not agree to this measure in advance, a net-​proceeds formula might be inappropriate even in the full-​capacity case, at least in the absence of a specific contractual provision to that effect. In any event, the likelihood that a given seller is both operating at full capacity and unable to replace the defaulting buyer may be too slim to justify a special rule for such cases.

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seventeen

The Cover Principle The c on c ep t of c over embraces t wo sepa r ate bu t i n ti m ately

related ideas. First, cover is an act—​a buyer’s act of purchasing a commodity in the market to replace a contracted-​for commodity that the seller failed to deliver. Under conventional usage the term cover normally refers to a purchase of replacement goods, but the purchase of any type of replacement commodity, including services, also constitutes cover. Second, cover is a remedy—​a judgment for the difference between the contract price and the cost of cover.1 As a remedy cover has the look and feel of damages, because the buyer ends up with a money judgment. As an act, however, cover constitutes virtual specific performance.2 By covering, the buyer finds a replacement performance that, together with cover damages, is close to what he would have received if the seller had been ordered to specifically perform. Where cover can be achieved, it presents four substantial advantages over both market-​price damages and actual specific performance:





1. Because the buyer chooses the replacement performance himself, the act of cover reflects the buyer’s preferences. Therefore, cover avoids the shortfalls that often result when the buyer’s damages depend on a constructed market price that does not take the buyer’s preferences into account. 2. In the case of differentiated commodities, cover damages are often easier to prove than market-​price damages. To prove market-​price damages the buyer needs to locate and then extrapolate from comparable transactions. In contrast, if the buyer covers, he may need to show only that the cover was reasonable. 3. The act of cover normally prevents or minimizes the social and private costs of consequential losses. If a seller breaches a contract to supply an input or a factor of production, timely cover will prevent or minimize the buyer’s loss of profits as a result of the

1.  Section 2-​712 of the Uniform Commercial Code reflects this bifurcated nature of cover. Section 2-​ 712(1) concerns the act of cover: “After a breach . . . the buyer may ‘cover’ by making in good faith and without unreasonable delay any reasonable purchase of or contract to purchase goods in substitution for those due from the seller.” Section 2-​712(2) concerns the remedy of cover: “The buyer may recover from the seller as damages the difference between the cost of cover and the contract price. . . .” 2.  See infra Chapter 24.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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breach. Correspondingly, timely cover will prevent or minimize the cost to the buyer that result from the principle of Hadley v. Baxendale.3 4. Actual specific performance often involves problems concerning enforcement, mitigation, and the right to a jury trial.4 Cover does not present these problems. In short, where the act of cover is unexceptionable the advantages of cover are substantial. Often, however, a seller argues that the buyer is not entitled to cover damages because the buyer paid an unduly high price for the replacement commodity or the replacement is so superior to the breached commodity that it does not qualify as cover. Two classic dichotomies bear on how such arguments should be addressed. The first dichotomy is between process and substance. If we apply this dichotomy to the act of cover, we see that the search a buyer conducts to find a replacement commodity is a process while the buyer’s ultimate choice of a replacement commodity is a substantive decision. The second dichotomy concerns the standards by which the courts should review the propriety of the buyer’s search and ultimate choice. Although the law has a number of standards of review in its armory, for present purposes the two most salient standards are reasonableness and good faith. A reasonableness standard of review is purely objective. In applying that standard, the question is whether an actor acted reasonably. A good-​faith standard of review is more complicated; see Chapter 52. These dichotomies serve as a background to an analysis of the standards of review of a buyer’s search for and choice of cover. The standard of review of a buyer’s search for cover should be measured objectively, that is, by the standard of reasonability. However, a search should not be deemed unreasonable solely because in retrospect it can be shown that a more comprehensive search would have turned up a lower-​priced commodity or a commodity that is more closely comparable to the breached commodity than the commodity the buyer selected. Search is costly, and the more extensive the search the more it will cost. If the costs of searching for information were zero, then an actor would always conduct a comprehensive search and arrive at the best possible result. However, because searching for information does involve costs, search will rarely if ever be comprehensive, and even a reasonable search may fail to reach the best possible result.5 Under a model of search developed by George Stigler, a rational actor invests in search until the expected marginal cost of further search equals the expected marginal benefit.6 For example, a buyer shopping for a branded raincoat may visit three sellers before deciding to buy a coat at the lowest price he has found. The buyer knows that he might find an even lower price if he visited more sellers, but he may reasonably conclude that the expected cost of continuing to search exceeds the expected value of finding an even lower price. In that case, the buyer’s bounded search was reasonable even if it turns out that a more extensive search would have turned up a less expensive coat.

3.  The principle of Hadley v. Baxendale is discussed in Chapter 19, infra.. 4.  See infra Chapter 24 Section B. 5.  See James G. March, Bounded Rationality, Ambiguity, and the Engineering of Choice, 9 Bell J. Econ. 587, 590 (1978); see also Herbert A. Simon, Administrative Behavior 79–​109 (3d ed. 1976); Herbert A. Simon, Rational Decisionmaking in Business Organizations, 69 Am. Econ. Rev. 493, 502–​03 (1979). 6.  George J. Stigler, The Economics of Information, 69 J. Pol. Econ. 213 (1961).

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In contrast to the standard of review of a buyer’s search for cover, the standard of review of a buyer’s choice of cover should be whether the choice was made in good faith. Accordingly, the law should give weight to the buyer’s preferences in considering whether his choice of cover was justified. The initial bargain was made on the basis of the buyer’s preferences, and under the Indifference Principle if the replacement purchase reflects those same preferences it should qualify as cover. Furthermore, because of the advantages of cover as compared to market-​price damages and specific performance, cover should be encouraged, albeit within appropriate limits. Buyers who want to choose replacements for breached commodities based on their good faith preferences may fear that their choices will be invalidated if the courts applied a reasonableness standard that does not take account of those preferences. This risk may have the undesirable effect of giving buyers an incentive to pursue market-​price damages or specific performance rather than covering.

I .   T H E C O V ER PR I NCI PL E A N D P O S I T I VE  L AW In light of the advantages of cover, the principle governing cover should be as follows: If a buyer has purported to cover, cover damages should be awarded if the buyer’s choice of a replacement commodity was made in good faith, given the buyer’s demonstrable preferences, after the buyer conducted a reasonable search. This principle will be referred to in this book as the Cover Principle. The cases uniformly require that search be reasonable, but are not uniform on the standard of review that applies to a buyer’s choice of a replacement. Some cases adopt a test that is very close to the Cover Principle. For example, in Cetkovic v. Boch, Inc.,7 the court stated that a helpful guide “is to pose the question how, when and where would the buyer have procured the goods had he not been covering and had no prospect of a court recovery from another. If a buyer can truthfully answer he would have spent his own money in that way even if he had no prospect of reimbursement, the court should not demand more.”8 Similarly, in R.K. Cooper Builders Inc. v. Free-​Lock Ceilings, Inc.,9 Free-​Lock breached a contract with Cooper under which Free-​Lock was to install lighting fixtures. Cooper then paid a third party $5,681 to perform the work remaining to be done under the contract. The trial court found that the reasonable amount of money required to complete the work was $2,500. Cooper argued that the reasonable value of the work and materials required to complete the job was not the issue, and the Court of Appeals agreed:10 Instead, controlling weight should be given to the actual expenditures, made in good faith, that are necessary to complete the job covered by the original contract. But we hasten to add that a mere showing of the actual expenses for completion is not determinative of the issue of damages, for the 7.  2003 Mass. App. Div. 1 (Mass. Dist. Ct. App. Div.). 8.  Id. at 2. 9.  219 So. 2d 87 (Fla. Dist. Ct. App. 1969). 10.  Id. at 88–​89.

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Expectation Damages general rule permits the defaulting subcontractor to go forth with evidence in order to set off the cost of completion. Such evidence should go toward proving waste, extravagance, or lack of good faith, but the courts will not hear a defaulting subcontractor’s claim that the party who was forced to complete the job spent too much absent evidence as to [those] factors.11

In some cases, the courts have rejected replacement purchases on the ground that they were unreasonable12 and in others the courts have simply sent the issue to the jury.13 The uncertain state of the law on this issue may reflect a concern that under a good-​faith standard of review a buyer may opportunistically choose a gold-​plated replacement for a copper-​plated commodity and then falsely claim that he acted in good faith. However, there are several reasons why a buyer is unlikely to act in this way. To begin with, self-​regard is likely to keep a buyer from opportunistically making an overly expensive purchase in the hope that ultimately the seller will pay, because litigation involves costs and risks and if the buyer loses his suit he will be left holding the bag for the excessive cost of the replacement. The requirement that the buyer conduct a reasonable search serves as a further control on opportunism. The buyer cannot expect to easily get away with ignoring replacements that either did or should have come to his attention and would have satisfied his demonstrable preferences. For one thing, the seller can learn the results of the buyer’s search through discovery. For another, the rise of virtual markets on the Internet makes it easy for sellers to determine what replacements were readily available. In any event, if the replacement purchase will generate higher profits for the buyer than he would have earned from the contracted-​for commodity, the excess profits can and should be deducted from the buyer’s recovery. As stated by White and Summers: Suppose, for example, that seller breaches a sales contract for four-​speed food blenders. . . . [B]‌uyer procures a substitute contract for more expensive eight-​speed food blenders. . . . If the eight-​speed blenders were the only available substitute,. . . . [o]‌ne can argue that the buyer should recover the full difference. . . . [H]ere the buyer has not elected to increase its damage recovery. If the added quality of the cover item will not benefit the buyer in any way, then it should be allowed to claim the full differential from the breaching seller. However, if because of the added quality the seller can prove that the buyer stands to make a greater profit on resale, then the buyer’s damage recovery under [U.C.C. §] 2-​712 should be reduced sufficiently to put it in the same position as performance would have. If the aggrieved buyer will itself consume the cover goods, as for example by the use of furniture or equipment in a business, the problem is more difficult. Should the damage recovery . . . be reduced because the cover machinery which the aggrieved buyer purchased is marginally more

11.  Id. See also In re Lifeguard Indus., Inc., 42 B.R. 734, 738 (Bankr. S.D. Ohio 1983)  (different siding constituted cover). 12.  See, e.g., Martella v. Woods, 715 F.2d 410, 413–​14 (8th Cir. 1983) (different-​weight cattle did not constitute cover); Kanzmeir v. McCoppin, 398 N.W.2d 826, 832–​33 (Iowa 1987) (same); Freitag v. Bill Swad Datsun, 443 N.E.2d 988, 991 (Ohio 1981) (buyer’s purchase of a 1980 Datsun was not a reasonable substitute for a differently equipped 1979 Datsun). 13.  See, e.g., Thorstenson v. Mobridge Iron Works Co., 208 N.W.2d 715, 716 (S.D. 1973) (different tractor); Dickson v.  Delhi Seed Co., 760 S.W.2d 382, 390 (Ark. Ct. App.  1988) (different kind of oats); Mueller v. McGill, 870 S.W.2d 673, 676 (Tex. App. 1994) (1986 Porsche Targa 911 purchased as cover for a 1985 Porsche Targa 911).

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efficient? Because the waiting room furniture is slightly more attractive than that contracted for? We think the damage recovery should not be reduced unless the seller comes forward with persuasive evidence that the buyer will reap added profits because of the superior quality of the cover merchandise.14

I I .   C O N C L US I ON The Cover Principle and the Specific-​Performance Principle—​that a court should award actual specific performance unless (1) a special moral, policy, or experiential reason suggests otherwise in a given class of cases; or (2) the promisee can achieve virtual specific performance through cover—​are intimately related. The greater the latitude the courts afford buyers to choose cover and thereby achieve virtual specific performance, the harder it should be for buyers to obtain an award of actual specific performance. Correspondingly, the less latitude the courts afford buyers to effect cover, the easier it should be for buyers to obtain actual specific performance. To put this differently, the Specific-​Performance Principle is a loose reciprocal of the Cover Principle. However, the two principles are not mirror images. The Cover Principle is applied retrospectively: the issue is whether a purchase that has already occurred satisfies that Principle. If it does, the promisee is entitled to cover damages; if it doesn’t, he isn’t. In contrast, the Specific-​ Performance Principle is applied prospectively: the issue is whether the promisor should be ordered to specifically perform in the future. Accordingly, if the promisee seeks cover damages, he must show that he made a reasonable search before covering. In contrast, if the promisee seeks specific performance it may suffice to show that a search was unnecessary because the buyer would have been unable to find a satisfactory replacement for the breached commodity. The seller can rebut such a showing by producing evidence that there is a commodity readily available in the market that the buyer could not in good faith reject as a replacement for the breached commodity, given the buyer’s demonstrable preferences. Where cover can be accomplished it is a form of virtual specific performance that is superior to actual specific performance because it avoids the major costs that the latter entails. Cover is also superior to market-​price damages, because it comes much closer to satisfying the Indifference Principle, since it reflects the buyer’s preferences. Given its great advantages, the remedy of cover should be liberally administered. Under the Cover Principle, therefore, cover damages should be awarded if a covering buyer shows that his choice of a replacement was made in good faith, given his demonstrable preferences, after he conducted a reasonable search.

14.  James J. White & Robert S. Summers, Uniform Commercial Code, § 7–​3, at 290–​91 (6th ed. 2010). See also Cetkovic v. Boch, Inc., 2003 Mass. App. Div. 1, 2 (Mass. Dist. Ct. App. Div.) (“The recovery for ‘cover’ goods ought not to be denied merely because there exists a possibility of a windfall unless the seller demonstrates persuasively the likelihood of a significant windfall due to the superior quality of the cover goods.”).

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The Certainty Principle It is a principle of c ontract l aw that da m ag es m u st b e proved

with reasonable certainty.1 In practice, this principle is usually applied to cut off profits a promisee claims it would have made if the promisor had performed. Because the certainty principle leaves open the degree of certainty that is required to establish damages, the meaning of the principle is to be found more in its application than in its formulation. Under classical contract law the degree of certainty required was typically set at a high level and the use of financial probability-​based analysis was explicitly or implicitly rejected. This approach, which has been carried over in some modern cases, is exemplified in two decisions by the New York Court of Appeals, Freund v. Washington Square Press, Inc.2 and Kenford Co. v. Erie County.3 In Freund, Philip Freund, an author, entered into a contract with Washington Square Press, a publisher, under which Washington Square obtained the exclusive right to publish and sell a book to be written by Freund. Washington Square, in turn, agreed to pay Freund an advance of $2,000 and royalties based on specified percentages of actual sales. Freund wrote the book and delivered it to Washington Square, which paid Freund the $2,000 advance. However, Washington Square never published the book because after the contract was signed Washington Square stopped publishing hardcover books.4 Freund brought suit and the trial court awarded him damages of $10,000, based on the cost of publication elsewhere.5 The Court of Appeals held that Freund was entitled only to nominal damages of six cents, because Freund’s “expectancy interest in the royalties—​the profit he stood to gain from sale of the published book—​while theoretically compensable, was speculative.”6 Freund, the court said, had “provided no stable foundation for a reasonable estimate of royalties he would have earned had defendant not breached its promise to publish.”7 In Kenford, Erie County entered into a contract with Kenford and its affiliate, Dome Stadium. Under the contract Kenford agreed to convey 178 acres of land to the County for construction 1.  Restatement (Second) of Contracts § 352 (Am. Law Inst. 1979). 2.  314 N.E.2d 419 (N.Y. 1975). 3.  493 N.E.2d 234 (N.Y. 1986). 4.  Freund, 314 N.E.2d at 419–​20. 5.  Id. at 420. 6.  Id. at 421. 7.  Id.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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of a domed stadium. On its part, the County agreed to construct the stadium and lease it to Dome for forty years or, if the parties were unable to agree on the terms of a lease, to enter into a fallback management agreement on terms stated in an appendix to the contract. Under those terms Dome would manage the stadium for twenty years in exchange for a stated percentage of the stadium’s gross revenues. The stadium was never constructed: The County passed a $50 million bond resolution to finance the stadium, but breached its contract with Dome when it became apparent that the cost of construction had been significantly underestimated and that going forward with the stadium would result in a loss to the County, rather than a profit. Dome sued the County for breach, and summary judgment was entered against the County on the issue of liability. In the ensuing damages trial, Dome presented statistical projections of the profits it would have made under the fallback management agreement, and was awarded $25.6 million by a jury. The New  York Appellate Division set aside the jury’s verdict. A  line of federal cases interpreting New York law had held that lost profits for a new venture could be awarded if there was a rational basis for calculating the profits.8 The Appellate Division accepted the rational-​ basis test but reversed on the ground that Dome’s statistical projections of its profits under the management agreement involved too many variables to provide a rational basis for calculating Dome’s lost profits. On appeal the Court of Appeals rejected the rational-​basis test but nevertheless affirmed the Appellate Division’s decision on the ground of uncertainty. It did so despite the fact that, in the Court’s words: [T]‌he procedure for computing damages selected by [Dome] was in accord with contemporary economic theory and was presented through the testimony of recognized experts. . . . [Dome’s] economic analysis employed historical data, obtained from the operation of other domed stadiums and related facilities throughout the country, which was then applied to the results of a comprehensive study of the marketing prospects for the proposed facility in the Buffalo area. The quantity of proof is massive and, unquestionably, represents business and industry’s most advanced and sophisticated method for predicting the probable results of contemplated projects.9

It might be thought that massive proof that “unquestionably . . . represents . . . [the] most advanced and sophisticated method for predicting the probable result”10 of a business project would have sufficed. The Court of Appeals, however, concluded otherwise: [D]‌espite the massive quantity of expert proof submitted by [Dome], the ultimate conclusions are still projections, and as employed in the present day commercial world, subject to adjustment and modification. We of course recognize that any projection cannot be absolute, nor is there any such requirement, but it is axiomatic that the degree of certainty is dependent upon known or unknown factors which form the basis of the ultimate conclusion. Here, the foundations upon which the economic model was created undermine the certainty of the projections. [Dome] assumed that the facility was completed, available for use and successfully operated by it for 20 years, providing professional sporting events and other forms of entertainment, as well as hosting meetings,

8.  This line of cases originated with Perma Research & Dev. Co. v. Singer, 542 F.2d 111 (2d Cir. 1976). 9.  Kenford Co. v. County of Erie, 493 N.E.2d 234, 235–​36 (N.Y. 1986). 10.  Id. at 236.

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conventions and related commercial gatherings. At the time of the breach, there was only one other facility in this country to use as a basis of comparison, the Astrodome in Houston. Quite simply, the multitude of assumptions required to establish projections of profitability over the life of this contract require speculation and conjecture, making it beyond the capability of even the most sophisticated procedures to satisfy the legal requirements of proof with reasonable certainty. The economic facts of life, the whim of the general public and the fickle nature of popular support for professional athletic endeavors must be given great weight in attempting to ascertain damages 20 years in the future.11

In its rejection of a probabilistic analysis the classical-​contract-​law approach to the certainty principle reflects the binary approach of that school. This approach is often referred to as the all-​or-​nothing rule.12 In the area of certainty, under this rule if the injured party proves its damages with a degree of certainty just above a designated level of likelihood, his damages are considered to be reasonably certain and it is awarded all of his damages. If, however, his proof is just below that level its damages are considered to be speculative and it is awarded nothing. The required level of likelihood under this approach, although not always made explicit, was that the promisee’s claimed damages are more likely than not. This approach is dramatically out of touch with the reality of probability, and there are much better ways to deal with the problem of uncertainty. The best approach would be to apply, rather than reject, concepts of probability that are generally accepted in the world of business and finance. Failing that, the simplest alternative would be to award specific performance, because in that case no measurement of damages is required, and indeed the difficulty of determining damages is a standard ground for awarding specific performance. In some cases, however, specific performance is not feasible. For example, in Freund it would have been difficult for a court to order a publisher who is no longer publishing hardcover books to publish Freund’s book any­ way. Similarly, in Kenford it would have been difficult for a court to order the county to build a stadium. Another approach to the certainty problem is to give the promisee the least amount of damages that satisfy the certainty test. For example, in Freund the court could have held that although it was too difficult to determine how many copies of Freund’s book would have been sold it was probable that at least some minimum number would have been sold, and damages could have been awarded on the basis of that minimum. By way of analogy, in Mears v. Nationwide Mutual Insurance Co.,13 Mears won a contest in which the prize was two Mercedes-​Benz automobiles. The promoter of the contest contended that the contract was too indefinite to enforce because there was a very wide range of used and new Mercedes-​Benz models and no model had been specified in the contest rules. The court rejected this argument: First, contract terms are interpreted with strong consideration for what is reasonable. . . . Under a reasonable interpretation of the contest contract, the jury could expect the automobiles to be new. 11.  Id. 12.  See Miller v.  Allstate Ins. Co., 573 So. 2d 24, 28 (Fla. Dist. Ct. App.  1990); see also, e.g., E. Allen Farnsworth, Legal Remedies for Breach of Contract, 70 Colum. L. Rev. 1145, 1214–​15 (1970); see Elmer J. Schaefer, Uncertainty and the Law of Damages, 19 Wm. & Mary L. Rev. 719, 763–​64 (1978); Note, Damages Contingent upon Chance, 18 Rutgers L. Rev. 875, 877–​78 (1964). 13.  91 F.3d 1118 (8th Cir. 1996).

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Second when a minor ambiguity exists in a contract, Arkansas law allows the complaining party to insist on a reasonable interpretation that is least favorable to him. . . . These two factors, taken together, are sufficient to support the jury’s conclusion that Nationwide owed Mears two of Mercedes-​Benz’s least expensive new automobiles as his contest prize.14

Still another approach to the problem of uncertainty is to allow the promisee to recover the costs he incurred in connection with the breached contract. The rationale of this approach is that the amount of costs the promisee incurred before the promisor’s breach serves as a surrogate for expectation damages because the promisee would not have incurred those costs unless he confidently expected to earn revenues at least equal to these costs. The burden is then on the promisor to prove that the promisee’s revenues would have been less than his costs. As stated in Beefy Trail, Inc. v. Beefy King International, Inc.:15 Essentially, the rationale [for granting reliance damages in a bargain context] is this: Normally, had the contract’s performance not been prevented by the defendant, and the contract had been a profitable one for the plaintiff, the plaintiff would have recovered over the life of the contract a gain, sufficient not only to fully reimburse him for his expenditures, but also to yield an excess which would be the profit. Since the amount of the gross receipts (i.e., the gain) cannot be determined with the requisite degree of certainty, the amount of the profit cannot be determined and therefore cannot be allowed in the recovery. But the amount of the gain which would have reimbursed plaintiff for the expenditures incurred in preparation and part performance can be determined by and to the extent of these expenditures, and therefore this amount can be allowed in the recovery.16

Consistent with this rationale, if the promisee uses the incurred-​costs measure the promisor should be and is allowed to show that the promisee would have incurred a loss on the contract. In such cases the promisee is not entitled to recover his incurred costs on the basis that he would have made back those costs if the promisor had performed.17 Damages measured this way are often referred to as reliance damages, but that is a misnomer because the promisee should be allowed to recover not only costs incurred in reliance on the contract but also costs incurred before the parties even made the contract. Accordingly, this measure would be better called incurred-​costs damages. The reason that even prior costs should be included is as follows: When costs are used as a measure of damages because normal expectation damages are too uncertain, the object is not to reimburse the promisee for his costs but to use the promisee’s costs as a surrogate for expectation damages. From that perspective it doesn’t matter whether the costs were incurred before or after contract formation. For example, in Security Stove & Manufacturing Co. v. American Railways Express Co.,18 Security Stove, which had manufactured a special type of furnace, wanted to exhibit the furnace at a booth it had already rented at a trade show. American Railways agreed to deliver the furnace to the show in time for 14.  Id. at 1122–​23. 15.  267 So. 2d 853 (Fla. Dist. Ct. App. 1972) (Owen, J., concurring in part and dissenting in part). 16.  Id. at 859. 17.  See also L. Albert & Son v. Armstrong Rubber Co., 178 F.2d 182, 189–​90 (2d Cir. 1949) (L. Hand, J.). 18.  51 S.W.2d 572 (Mo. Ct. App. 1932).

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the exhibition but failed to do so. The court held that Security Stove’s expectation damages were too speculative but that it could recover its costs, including the cost of the booth. Similarly, in Anglia Television Ltd. v. Reed,19 Anglia wanted to make a television film, The Man in the Wood, which would portray an American man married to an English woman. Before Anglia selected the leading man it arranged a location for the film; employed a director, a designer, and a stage manager; and involved itself in much other expense. For the leading man, Anglia required a strong actor capable of holding the film together. It eventually decided upon Robert Reed, “an American with a very high reputation as an actor,” and the parties agreed that Reed would come to England and star in the film for £1,050 and expenses.20 Reed later repudiated the contract because of a mix-​up in his bookings. Anglia tried to find a substitute but could not do so, and subsequently abandoned the film. It then sued Reed for its out-​of-​pocket expenses of £2,750, including almost £1,900 incurred before it made the contract with Reed.21 The English Court of Appeals held that Anglia was entitled to recover its expenses, including the £1,900 pre-​contract expenses. Lord Denning said: [I]‌t is plain that, when Mr. Reed entered into this contract, he must have known perfectly well that much expenditure had already been incurred on director’s fees and the like. He must have contemplated—​or, at any rate, it is reasonably to be imputed to him—​that if he broke his contract, all that expenditure would be wasted, whether or not it was incurred before or after the contract. He must pay damages for all the expenditure so wasted and thrown away. . . . . . . It is true that, if the defendant had never entered into the contract, he would not be liable, and the expenditure would have been incurred by the plaintiff without redress; but, the defendant having made his contract and broken it, it does not lie in his mouth to say he is not liable, when it was because of his breach that the expenditure has been wasted.22

Another alternative to the all-​or-​nothing approach is to use the promissor’s pre-​contract estimate of its revenues or the promisee’s revenues to construct a surrogate for expectation damages. This alternative will be referred to as expected-​revenue-​based damages. Many contracts create a structure that aligns the interests of the parties. The most common way to achieve such an alignment is by giving each party a share of revenues. For example, in Freund Washington Square Press and Freund were to share the revenues from sales of Freund’s book by allocating a certain share of the revenues to Freund, in the form of royalties, and the balance to Washington Square. In such cases, the courts can often derive the promisee’s minimum expected gains by extrapolation from the revenues the promisor expected to derive.23 For example, in Freund the trial court found that the cost of publishing Freund’s book was $10,000. Presumably, therefore, the publisher would not have entered into the contract unless it expected to generate revenues of at least that amount plus royalties and other expenses. Thus, Freund’s minimum expected royalties could be derived from the publisher’s minimum expected revenues. Similarly, in Kenford the County must have confidently expected that the contract 19.  [1972] 1 QB 60 (C.A.) (Eng.). 20.  Id. at 63. 21.  Id. 22.  Id. at 64. 23.  This approach was suggested by Ed Anderson.

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would generate sufficient revenues to pay off the $50 million in bonds that the County expected to issue to pay for construction. Dome’s share of those revenues under the management agreement should have been easy to calculate. Therefore, only Dome’s costs would need to be determined to compute Dome’s expected gains. (Just as under the incurred-​costs measure the promisor should be and is allowed to show that the promisee’s revenues would actually not have covered its costs, so too under the expected-​revenue measure the promisor should be allowed to show that the promisee’s share of contract revenues would actually have been less than the amount projected by the promisor.) Indeed, the New York Court of Appeals utilized the expected-​revenue-​based method in 1993, only seven years after its decision in Kenford. In Ashland Management Inc. v. Janien24 Ashland was a successful investment-​advisory company, which managed over one billion dollars in client funds. As part of its investment strategy Ashland relied on a computerized mathematical stock-​ selection model, known as Alpha, to analyze selected financial information and make an initial determination which stocks should be bought and sold.25 In 1985, Ashland entered into a contract with Janien under which Janien would develop a second investment model, Eta, to be used by Ashland. Paragraph C(12) of the contract projected the minimum sums expected to come under Eta management for each year between 1988 and 1992. Paragraph C(21) provided that if for any reason Janien left Ashland’s employment he was entitled to a royalty of 15 percent of the gross annual revenues of accounts using Eta or any derivative of Eta, or $50,000, whichever was greater. Thereafter, Ashland terminated Janien’s employment. Janien sued and the trial court held that he was entitled to damages for lost profits based on the projections set forth in paragraph C(12). The Court of Appeals affirmed: Ashland itself had enough confidence in its ability to perform to predict minimum amounts of funding which Eta would attract. It agreed to compensate Janien on that basis. Based on this evidence, the court properly relied on the projections of paragraph C(12) and the provisions of paragraph C(21) to hold that defendant had met his burden of proving his lost profits with reasonable certainty.26

The validity of using the expected-​revenue measure as a surrogate for expectation damages in interest-​aligning or comparable contracts is not negated by the fact that the promisor decided to breach. Often the promisor decides to breach not because of a shortfall in expected revenues but because it appears that its actual costs will exceed its expected costs, or for some other reason entirely. In Freund, for example, the publisher breached simply because it stopped publishing hardbound books. In Kenford the County breached because it decided that its actual costs would be higher than its projected costs and the higher costs would not be covered by its share of expected revenues. However, that did not mean that the County’s projection of expected revenues was incorrect. More generally, in interest-​aligning contracts that involve a division of revenue, typically the contract revenues are largely a function of the post-​contract costs incurred by only one of the parties. For example, in contracts between publishers and authors once the book is completed 24.  624 N.E.2d 1007 (N.Y. 1993). 25.  Id. at 1008. 26.  Id. at 1012.

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the author has no remaining costs, so that his share of revenues (royalties) are pure profit. In contrast, the publisher will only make a profit if its share of revenues exceeds the post-​contract costs of publication, distribution, royalties, and so forth. Call the party who will have no post-​ contract costs A, and the party who will have such costs B. It is easy to see that an unexpected increase in costs may lead B to breach even though expected contract revenues remain as B originally projected. Although the approaches based on the promisee’s incurred costs or the promisor’s expected revenues are preferable to denying any damages to a victim of breach, they usually fall short as an adequate measure of expectation damages, because they are based on minimum damages rather than probability-​adjusted damages. In this connection it is instructive to consider the certainty issue in contract damages from the perspective of financial economics. With limited exceptions the profitability of all income-​generating assets is risky and the profitability of some assets is extremely risky. Nevertheless, in the real world firms and individuals routinely purchase such assets. The question therefore arises, how should the value of a risky asset be determined where the asset is not of a type that is freely traded, so that the market establishes its value. An answer has been developed by financial economics, which utilizes a model known as the Capital Asset Pricing Model (CAPM, pronounced cap-​em). To apply CAPM a potential purchaser determines the various possible cash flows that the asset may yield, assigns a probability to each cash flow, and multiplies each cash flow by its probability. The results are then summed to obtain the expected cash flow. Next, the expected cash flow is discounted by a rate generated under a formula that essentially adds (1) the time value of money measured by the interest rate for risk-​free investments, such as treasury bonds; and (2) the rate for marketwide risk (known as market or systematic risk) multiplied by the risk for the kind of asset in question. The latter risk is known as the asset’s beta and is usually determined on the basis of the market’s evaluation of the risk of similar assets as evidenced by the stock market valuation of companies whose business is based on assets of that type.27 So, for example, in deciding whether to purchase a movie theater a buyer applying CAPM would first calculate the theater’s expected cash flow and then calculate the discount rate to apply to that cash flow by plugging into the CAPM formula the time value of money, the market risk, and the beta of stock of corporations engaged in the movie-​theater business. As the methodology of financial economics shows, riskiness of returns does not prevent the valuation of an income-​generating asset—​it could not; virtually all such assets are risky. Instead, the uncertainty is impounded into the value of the asset, first by assigning appropriate weights to the cash flows the asset is likely to produce and then by applying the appropriate discount rate to the probability-​adjusted projected cash flow.

27.  See, e.g., Richard A. Brealy, Stuart C. Myers & Richard A. Brealy, Principles of Corporate Finance 284–​90 (8th ed. 2006); Stephen A. Ross et al., Fundamentals of Corporate Finance 423–​ 24, 442–​46 (11th ed. 2016). The formula is: E (Ri ) = Rf +  E (RM ) − Rf  × βi where E(Ri) is the expected return on the investment or asset, Rf is the pure time value of money, RM is the rate for the market risk, E(RM)-​Rf is the market premium per unit of risk, and βi is the beta for the asset.

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The issue of uncertainty in contract-​law damages parallels the issue of riskiness in valuing assets. Indeed, the two issues converge: a contract is a special type of income-​producing asset, whose value may be determined in the same way as the value of other such assets.28 So, for example, suppose in Kenford there was a 40 percent probability of a $10 million cash flow over the twenty-​year term of the management agreement, a 30 percent probability of a $20 million cash flow, a 20 percent probability of a $30 million cash flow, and a 10 percent probability of a $40 million cash flow. The expected cash flow would then be $20 million (40% x $10 million + 30% x $20 million + 20% x $30 million + 10% x $40 million). Damages would be determined by applying a discount rate calculated under CAPM to that expected cash flow. Many modern courts have properly broken away from the binary, economically uninformed, all-​or-​nothing approach to uncertainty taken by classical contract law. Some courts have simply adopted a more liberal test of uncertainty. For example, in the past a major application of the uncertainty principle was the new-​business rule. This rule prohibited recovery of lost profits that a plaintiff claims would have been generated by a proposed new business, on the ground that in such cases profits are too speculative. In one typical fact pattern, the plaintiff leased premises for a new business from the defendant, who broke the lease before the plaintiff moved in. The plaintiff sued for the profits he would have made from the business and the defendant pleaded the new-​business rule. The rule still surfaces in some cases, but there is a strong trend toward abrogating the rule and reconstruing the older cases as resting only on the particular facts involved rather than on a special rule for new businesses. For example, in Fera v. Village Plaza, Inc.,29 the plaintiffs executed a ten-​year lease for a shop in the defendants’ proposed shopping center. Later the plaintiffs were refused their space because the defendants had misplaced the lease and rented the space to others. The plaintiffs brought suit, claiming lost profits. The jury returned a verdict against the defendants for $200,000. The Court of Appeals, an intermediate appellate court reversed, partly on the basis of the new-​business rule. The Michigan Supreme Court reinstated the jury verdict: [Earlier Michigan cases] should not be read as stating a rule of law which prevents every new business from recovering anticipated lost profits for breach of contract. The rule is merely an application of the doctrine “[i]‌n order to be entitled to a verdict, or a judgment, for damages for breach of contract, the plaintiff must lay a basis for a reasonable estimate of the extent of his harm, measured in money.” The issue becomes one of sufficiency of proof. . . . The Court of Appeals based its opinion reversing the jury’s award on two grounds: First, that a new business cannot recover damages for lost profits for breach of a lease. We have expressed our disapproval of that rule. Secondly, the Court of Appeals held plaintiffs barred from recovery because the proof of lost profits was entirely speculative. We disagree. . . . While we might have found plaintiffs’ proofs lacking had we been members of the jury, that is not the standard of review we employ. As a reviewing court we will not invade the fact finding

28.  See John Leubsdorf, Remedies for Uncertainty, 61 B.U. L. Rev. 132, 150–​53 (1981); Miller v. Allstate Ins. Co., 573 So. 2d 24, 28 (Fla. Dist. Ct. App. 1990); Elmer J. Schaefer, Uncertainty and the Law of Damages, 19 Wm. & Mary L. Rev. 719 (1978); Note, Damages Contingent upon Chance, 18 Rutgers L. Rev. 875, 877–​78 (1964). 29.  242 N.W.2d 372 (Mich. 1976).

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of the jury or remand for entry of judgment unless the factual record is so clear that reasonable minds may not disagree. This is not the situation here. . . .30

Various courts have also accepted the kinds of probabilistic evidence that Kenford rejected. For example, in Independent Mechanical Contractors, Inc. v.  Gordon T.  Burke & Sons31 the plaintiff ’s evidence on lost profits consisted of the expert testimony of an economics professor experienced in evaluating future profits who used a standard methodology to project the plaintiff ’s lost profits from 1980 through 1985. The court approved a verdict based on this evidence: [W]‌e are not persuaded that the projection of lost profits in this case constituted speculative proof of lost profits. . . . . . . Proof of lost profits is not speculative as a matter of law simply because all conceivable factors have not been assessed. A  degree of uncertainty is inherent in any projection of future profits . . . the essential issue is whether the evidence on lost profits provides enough information under the circumstances to permit the fact finder to reach a reasonably certain determination of the amount of gains prevented.32

In Locke v. United States,33 Locke, who owned a typewriter-​repair company in San Diego, was awarded a one-​year contract for the repair, maintenance, and reconditioning of federally owned typewriters in the San Diego area. Similar contracts were awarded to three other repair companies. Locke and the three other companies were listed in a Federal Supply Schedule. The government had its own repair facilities, but agencies that used an outside contractor to make typewriter repairs were required to choose a contractor listed in the Schedule, although they were free to choose any contractor in the Schedule. In the middle of the contract year the Government improperly terminated Locke’s contract, and his name was struck from the Schedule. Locke sued. The court held that although the Government was free to enlarge its own repair facilities to satisfy its needs, which would have left nothing to be awarded under Locke’s contract, Locke was entitled to compensation for the value of his chance: [T]‌he facts as alleged show that the Government did have some service requirements beyond its own capacity. . . . Plaintiff ’s chance of obtaining some of these awards, by being in the schedule and competing with the other contractors, had value in a business sense. The Government by its breach deprived plaintiff of this value. . . . . . . We are here concerned with the value of a chance for obtaining business and profits. . . . Here it appears that the plaintiff [had] a chance of obtaining at least one-​fourth of the total typewriter-​ repair business let by the government. . . . We believe that where the value of a chance for profit is not outweighed by a countervailing risk of loss, and where it is fairly measurable by calculable odds and by evidence bearing specifically on the probabilities that the court should [attempt] to value that lost opportunity.34

30.  Id. at 373–​76. 31.  635 A.2d 487 (N.H. 1993). 32.  Id. at 491 (N.H. 1993). 33.  283 F.2d 521 (Cl. Ct. 1960). 34.  Id. at 524–​25.

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In Rombola v.  Cosindas35 Rombola agreed to train, maintain, and race Cosindas’s horse Margy Sampson from November 8, 1962, through December 1, 1963. Rombola was to pay all expenses and receive 75 percent of all gross purses and Cosindas was to receive the remaining 25 percent. In winter 1962 Rombola maintained and trained Margy Sampson at his stable, and in spring and summer 1963 he raced her twenty-​five times. In fall 1963, Rombola entered Margy Sampson in six stake races (races in which horses run against others in their own class according to the amount of money they have won) to be held at a Suffolk Downs racing meet ending on December 1. Before the meet began Cosindas took possession of Margy Sampson and thereby deprived Rombola of the right to race her. The horse was not raced again until after December 1. Rombola sued Cosindas for lost profits, and the trial judge directed a verdict for Cosindas. The Massachusetts Supreme Judicial Court reversed, holding that Margy Sampson’s racing history established Rombola’s damages with sufficient certainty: In the year of the contract, of the twenty-​five races in which the horse was entered by Rombola, she had won ten and shared in the purse money in a total of twenty races, earning, in all, purses approximating $12,000. In the year following the expiration of Rombola’s contract with Cosindas, the horse raced twenty-​nine times and won money in an amount almost completely consistent percentage-​wise with the money won during the period of the contract. . . . . . . We think . . . that Rombola would be entitled to show substantial damages on the theory of loss of prospective profits. . . . [Margy Sampson] had already proved her ability both prior to and while under Rombola’s management and training, over an extended period of time, against many competitors and under varying track conditions. Her consistent performance in the year subsequent to the breach negates any basis for an inference of a diminution in ability or in earning capacity at the time of the Suffolk Downs meet. While it is possible that no profits would have been realized if Margy Sampson had participated in the scheduled stake races, that possibility is inherent in any business venture.36

In Contemporary Mission, Inc. v. Famous Music Corp.,37 Famous Music had agreed to pay royalties to Contemporary Mission in exchange for the master tape recording of a religious rock opera called Virgin together with the exclusive right to manufacture and sell records made from the master. The contract required Famous Music to release at least four single records from Virgin.38 Under the doctrine of Wood v. Lucy39 Famous Music was obliged to use reasonable efforts to promote Virgin. Famous Music breached the contract by failing to promote the singles. Prior to the breach a single from Virgin had reached number 80 on the Hot Soul record charts. After the breach the single reached number 61. At the trial Contemporary offered a statistical analysis of every song that had reached number 61 during 1974. This analysis showed that of the 324 songs that had reached number 61, 76 percent reached the top 40, 65 percent reached the top 30, 51 percent reached the top 20, 34 percent reached the top 10, 21 percent reached the top 5, and 10 percent reached number 1. Contemporary Mission was also prepared 35.  220 N.E.2d 919 (Mass. 1966). 36.  Id. at 921–​22. 37.  557 F.2d 918 (2d Cir. 1977). 38.  Id. at 921 (2d Cir. 1977). 39.  118 N.E. 214 (N.Y. 1917).

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to offer the testimony of an expert witness who could have converted these measures of success into projected sales figures and lost royalties. The trial judge excluded all this evidence under Freund on the ground that it was speculative. The Second Circuit held that the evidence should have been admitted: This is not a case in which the plaintiff sought to prove hypothetical profits from the sale of a hypothetical record at a hypothetical price in a hypothetical market. . . . [T]‌he record was real, the price was fixed, the market was buying and the record’s success, while modest, was increasing. Even after the promotional efforts ended, [and] the record was withdrawn from the marketplace, it was carried, as a result of its own momentum, to an additional 10,000 sales and to a rise from approximately number 80 on the “Hot Soul Singles” chart of Billboard magazine to number 61. It cannot be gainsaid that if someone had continued to promote it, and if it had not been withdrawn from the market, it would have sold more records than it actually did. Thus, it is certain that Contemporary suffered some damage in the form of lost royalties.40

In some cases there is too much uncertainty to determine expectation damages directly. For example, in Security Stove (the oil-​burner case) the product was innovative and was being shipped for display at a convention, rather than for immediate sale. It would have been almost impossible to quantify the profits that would have been generated by the display over and above the profits that Security Stove earned even without the display. In most cases, however, if other means fail the profit that a contract would have generated if it had not been breached can be calculated probalistically. Essentially, the classical contract law approach to uncertainty, reflected in Freund and Kenford, lags a generation behind financial economics. However, there has been an important evolution in this area. Many or most modern courts set a much lower threshold for jumping over the uncertainty barrier. Many modern courts straightforwardly apply a probalistic approach. Other courts simply finesse the certainty principle by invoking one of two counterprinciples: that the certainty principle applies only to the fact of damage, not to the amount of damages;41 or that the wrongdoer should bear the risk of uncertainty that his own conduct has created.42 Both of these counterprinciples are inconsistent with the certainty principle as applied under classical contract law. Because the counterprinciples can be invoked in almost any case, they serve to illustrate the radical instability of the classical approach. As Calamari observed, “what is clear is that there is no universal application of the rule of certainty, and that, within a given jurisdiction, case authority which applied a stringent 40.  Famous Music Corp., 557 F.2d at 927. See also Lexington Prods. Ltd. v.  B.D. Commc’ns, Inc., 677 F.2d 251 (2d Cir. 1982). Lexington licensed B.D.  to market its toothbrush and associated dental liquid. B.D. agreed to purchase 200,000 brushes a year for the life of the contract, to pay royalties on each brush sold, and to spend at least $500,000 on promotion each year for the life of the contract. After two years B.D. had invested only $104,038 in marketing and sold only 60,843 brushes. Lexington sued. At the trial Lexington offered to prove damages by (1) dividing the number of toothbrushes sold into the amount of marketing dollars expended, and (2) using that ratio to show how many toothbrushes would have been sold if $1 million had been spent on marketing as promised. The trial court rejected this theory and awarded only nominal damages. The Second Circuit reversed on the ground that Lexington’s theory provided an acceptable degree of certainty. Id. at 252–​54. 41.  See, e.g., Oral-​X Corp. v. Farnam Cos., 931 F.2d 667, 670–​71 (10th Cir. 1991); Lewis River Golf, Inc. v. O.M. Scott & Sons, 845 P.2d 987, 990 (Wash. 1993). 42.  See, e.g., Migerobe, Inc. v. Certina USA, Inc., 924 F.2d 1330, 1338–​39 (5th Cir. 1991).

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test often exists along with other cases which, in express terms or, in effect, hold that certainty is not a requirement.”43 Such instability is the hallmark of an unjustified rule.44 The high-​threshold, all-​or-​nothing uncertainty test, although still applied by some courts, is gradually fading away, to be replaced by a much more realistic test based on probability.

43.  Joseph M. Perillo, Calamari on Contracts (6th ed. 2009). 44.  See Melvin Aron Eisenberg, The Nature of the Common Law 105–​20 (1988).

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The Principle of Hadley v. Baxendale I .   I N T R O DUCT I ON In 1854 the English Court of Exchequer Chamber decided the famous case of Hadley v. Baxendale.1 Hadley owned a flour mill that had gone down due to a break in the crankshaft that powered the mill. To get the mill back up, Hadley wanted to transport the broken shaft to its manufacturer, Joyce & Co. of Greenwich, to serve as a model for a new shaft. Hadley therefore sent an employee to the local office of Pickford & Co., a public carrier.2 The employee told Pickford’s clerk that Hadley’s mill was stopped and the shaft must be sent to Greenwich immediately. The clerk answered that if the shaft was delivered to Pickford by twelve o’clock any day it would be delivered at Greenwich on the following day. The shaft was delivered to Pickford at twelve o’clock the next day and Hadley paid £2 4d. for its shipment. However, delivery to Joyce was delayed for five days, apparently because Pickford had originally planned to ship the shaft through London by rail, but instead of immediately forwarding the shaft to Greenwich from London by rail it held the shaft in London for several days and then sent it to Greenwich by canal together with an unrelated shipment of iron goods that Pickford was transporting to Joyce.3 Joyce’s completion of the new shaft was correspondingly delayed and as a result Hadley’s mill was down an extra five days. Hadley brought suit against Pickford claiming damages of £300, based on five days of lost profits. Pickford argued that the claimed damages were “too remote.”4 Hadley responded that the damages were “not too remote, for they are . . . the natural and necessary consequence of the defendants’ default.”5 The trial court “left the case generally to the

1.  (1854) 156 Eng. Rep. 145; 9 Ex. 341. 2.  For ease of exposition, the names of the parties used in the title of the case are also used in this chapter. Actually, it appears that Hadley was a co-​owner of the mill and only one of the plaintiffs, and Baxendale was a co-​owner of Pickford and only one of the defendants. 3.  Richard Danzig, Hadley v. Baxendale: A Study in the Industrialization of the Law, 4 J. Legal Stud. 249, 251 & n.5 (1975). 4.  Hadley, 156 Eng. Rep. at 147; 9 Ex. at 344. 5.  Id.; 9 Ex. at 345.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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jury,”6 which awarded Hadley damages of £25 above and beyond the amount of £25 that Pickford had already paid into court. Exchequer Chamber reversed, but not on the theory of remoteness. Instead, it held that a party injured by a breach of contract can recover only those damages that either (1) should “reasonably be considered . . . as arising naturally, i.e., according to the usual course of things” from the breach; or (2) might “reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.”7 The court concluded that Hadley had failed to satisfy either test. The two branches of the court’s holding have come to be known as the first and second rules of Hadley v. Baxendale. The two rules are normally applied only to cases involving a breach by a seller, because usually a buyer’s only obligation is to pay money, and the nonpayment of money only occasionally implicates the Hadley rules. Accordingly, for ease of exposition in the balance of this chapter the party in breach will be referred to as the seller and the party injured by the breach will be referred to as the buyer. On the basis of the two rules of Hadley v. Baxendale contract law has conventionally distinguished between general or direct damages, on the one hand, and special or consequential damages, on the other. General or direct damages are the damagesthat flow from a given type of breach without regard to the buyer’s particular circumstances. General damages fall within the first rule of Hadley v. Baxendale, because by definition they should “reasonably be considered [as] . . . arising naturally, i.e., according to the usual course of things” from the breach. For example, if a seller breaches a contract for the sale of goods it follows naturally that the buyer will suffer damages equal to the difference between the contract price of the goods and the market or cover price. Special or consequential damages are the damages above and beyond gen­eral damages that flow from a breach as a result of the buyer’s particular circumstances. Such damages are awarded under the second rule if but only if they might “reasonably be supposed to have been in the contemplation of both parties, at the time they made their contract, as the probable result of the breach of it.” Typically, consequential damages consist of lost profits. For example, suppose a seller breaches a contract for the sale of a factor of production, such as a die press, that the buyer plans to use rather than resell. The buyer’s consequential damages are the difference between the profits he earned on his actual post-​breach output and the profits that he would have earned if the die press had been furnished as promised. The second rule of Hadley v. Baxendale is presently conceptualized to mean that consequential damages can be recovered only if at the time the contract was made the seller had reason to foresee that the consequential damages would probably result from the breach.8 Under this conceptualization of the second rule the first rule is simply a special case of the second: if a given type of damage arises “naturally, i.e., according to the usual course of things” from a breach of contract (the first rule), then the seller will always have reason to foresee that the type of damage will result from the breach (the second rule). Therefore, for ease of exposition in the balance of this chapter the foreseeability concept underlying both rules will be referred to as the principle of Hadley v. Baxendale or the Hadley principle. 6.  Id. 7.  Id. at 151; 9 Ex. at 356. 8.  See, e.g., Restatement (Second) of Contracts § 351 (Am. Law Inst. 1981)  [hereinafter Restatement Second]. The conceptualization of the second rule has varied over time; some of the alternative conceptualizations are discussed in the text at notes 9–​10, infra.

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I I .   T H E H A D L E Y PR I NCI PL E A ND G E N E R A L P R I N CI PL ES   OF   L AW Under the indifference principle, expectation damages should make a victim of breach indifferent between performance, on the one hand, and breach and damages, on the other. Hadley v. Baxendale departs from this principle. If a promisor performs, the promisee will get all the benefits of his contract, including the profits that he expected. Under the Hadley principle, however, if the promisor breaches those profits may be cut off, so that the promisee is not as well off with breach and damages as he would have been with performance. The Hadley principle also departs from the general principles of law concerning the required relation between injury and loss. Outside contract law that relation is usually determined by application of the principle of proximate cause. The Hadley principle differs from that principle in two critical respects. The first difference concerns time. Application of the Hadley principle is normally based on the information that the breaching party had at the time of contract formation. In contrast, application of the principle of proximate cause is normally based on the circumstances that existed at the time of the wrong. Accordingly, the Hadley principle is static whereas the principle of proximate cause is dynamic. The second difference between the Hadley principle and the principle of proximate cause concerns the degree of foreseeability required to make a wrongdoer liable for the harm that results from her wrong. Under the principle of proximate cause, five levels of foreseeability can be distinguished. At one level an event is foreseeable if it could have been foreseen. In that sense of the term almost any event that actually occurs was foreseeable.9 At a second level an event is foreseeable if the possibility that the event will occur is not insignificant or more than negligible. At a third level an event is foreseeable if the possibility that the event will occur is likely. The term reasonably foreseeable can be used to refer to events that are foreseeable at this level. At a fourth level an event is foreseeable if its occurrence is probable.10 At a fifth level an event is foreseeable only if its occurrence is highly likely. At the height of classical contract law the courts interpreted the Hadley principle to require the plaintiff to satisfy the exceptionally demanding fifth level of foreseeability, thereby cutting off even those damages that resulted from events whose occurrence was probable. (In some cases this result was achieved by the application of a highly artificial and extremely strict “tacit agreement” test under which consequential damages could be recovered only if the parties had tacitly agreed to the recovery of such damages at the time the contract was made.11 An example

9.  See Paul L. Joskow, Commercial Impossibility, the Uranium Market and the Westinghouse Case, 6 J. Legal Stud. 119, 157 (1977) (“In an objective sense, virtually nothing is truly unforeseeable to the extent that theoretically every possible state of the world could be enumerated and some probability assigned to its occurrence.”). 10.  See Restatement Second § 351(1) (“Damages are not recoverable for loss that the party in breach did not have reason to foresee as a probable result of the breach when the contract was made.”) (emphasis added). 11.  See, e.g., Globe Ref. Co. v. Landa Cotton Oil Co., 190 U.S. 540, 544 (1903) (recovery “depends on what liability the defendant fairly may be supposed to have assumed consciously, or to have warranted the plaintiff reasonably to suppose that it assumed, when the contract was made”); British Columbia & Vancouver’s Island Spar, Lumber & Saw-​Mill Co. v. Nettleship, [1868] 3 LR-​CP.499, 509 (Eng.) (“[T]‌he mere fact of knowledge cannot increase the liability.”) (emphasis added).

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of the highly likely test is Hadley v. Baxendale itself. When the contract in that case was made, Hadley’s employee told Pickford’s clerk that the mill was down and the shaft must be sent immediately. 12 No reasonable person in the clerk’s position would have failed to understand that the mill was down because of a problem with the shaft. Indeed, Hadley’s counsel futilely argued that if the court was to adopt a foreseeability rule, rather than a rule based on remoteness of the injury, “[t]‌here was ample evidence that the defendants knew the purpose for which this shaft was sent, and that the result of its nondelivery in due time would be the stoppage of the mill; for the defendants’ agent, at their place of business, was told that the mill was then stopped, that the shaft must be delivered immediately, and that if a special entry was necessary to hasten its delivery, such an entry should be made.”13 The court nevertheless artificially cut off Hadley’s damages by holding, in the face of the facts, that Pickford was not on notice of Hadley’s special circumstances.14 This approach was well-​characterized in the discussion of the Hadley principle by Lord Reid in Koufos v. C. Czarnikow Ltd.—​“For a considerable time there was a tendency to set narrow limits to awards of damages.”15 Over time, however, there has been a steady reformulation and relaxation of the standard of foreseeability required under the Hadley principle. Koufos is a leading case on this issue. A carrier contracted with a shipper to transport 3,000 tons of sugar from Constanza to Basrah. The shipper planned to sell the sugar on the market promptly after the vessel’s arrival in Basrah. The vessel should have arrived on November 22, but in breach of contract the carrier made deviations in the journey and the vessel did not arrive until December 2. Between the expected and actual dates of delivery the market price of sugar in Basrah fell, partly due to the intervening arrival of another cargo of sugar, and the shipper sued the carrier for the difference between the November 22 market price and the December 2 market price. The carrier had reason to know that sugar prices in Basrah would fluctuate, but it “had no reason to suppose it more probable that during the relevant period such fluctuation would be downward rather than upwards—​it was an even chance that the fluctuation would be downwards.”16 The House of Lords nevertheless held the carrier liable for the difference between the market prices on November 22 and December 2. Although the Lords’ opinions in Koufos differed somewhat as to the precise reformulation of the foreseeability test, most of the opinions approved the terms “liable to result,”

12.  Hadley, 156 Eng. Rep. at 148; 9 Ex. at 341. 13.  Id. at 149; 9 Ex. at 349. 14.  In Victoria Laundry (Windsor) Ltd. v. Newman Indus. Ltd., [1949] 2 K.B. 528 (C.A.) (Eng..), Lord Justice Asquith stated that “the headnote [in Hadley v. Baxendale] is definitely misleading in so far as it says that the defendant’s clerk, who attended at the office, was told that the mill was stopped and that the shaft must be delivered immediately. . . . If the Court of Exchequer had accepted these facts as established, the court must . . . have held the damage claimed was recoverable under the second rule.” Id. at 537. Asquith here must have had his tongue glued to his cheek. For other examples of an artificially strict application of the principle of Hadley v. Baxendale to cut off reasonably foreseeable damages, see, e.g., McMillain Lumber Co. v.  First Nat’l Bank, 110 So. 602 (Ala. 1926); Marcus & Co. v. K.L.G. Baking Co., 3 A.2d 627, 632–​33 (N.J. 1939); Czarnikow-​Rionda Co. v. Fed. Sugar Ref. Co., 173 N.E. 913, 918 (N.Y. 1930); Keystone Diesel Engine Co. v. Irwin, 191 A.2d 376, 378 (Pa. 1963), overruled by R.I. Lampus Co. v. Neville Cement Prods. Corp., 378 A.2d 288 (Pa. 1977). 15.  Koufos v. C. Czarnikow Ltd., [1969] 1 AC 350 (HL)387 (appeal taken from Eng.) (opinion of Lord Reid). 16.  Id. at 382.

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“real danger,” or “serious possibility.” A passage in Lord Reid’s opinion suggests, by implication, the parameters of the serious-​possibility test. “Suppose one takes a well-​shuffled pack of cards, it is quite likely or not unlikely that the top card will prove to be a diamond: the odds are only three to one against. But most people would not say that it is quite likely to be the nine of diamonds for the odds are then fifty-​one to one against.” If this metaphor is to be taken seriously it suggests that if at the time of contract formation there is a 25 percent chance that a given type of damage will occur in the event of breach the damage will be compensable under Hadley v. Baxendale, but if there is only a 2 percent chance that a given type of damage will occur the damage will not be compensable. These reformulated tests allow the recovery of consequential damages when the type of harm that occurred was reasonably foreseeable even if a reasonable person would not have foreseen the harm as more probable than not. In other cases, the test of foreseeability has been even further diluted. For example, in Hector Martinez & Co. v. Southern Pacific Transportation Co. the court said that the plaintiff “need only demonstrate that his harm was not so remote as to make it unforeseeable to a reasonable man at the time of contracting.”17 The principle of proximate cause, like the Hadley principle, turns on foreseeability or a like test, scope of risk. However, the foreseeability test under the principle of proximate cause typically is set at a lower, easier-​to-​satisfy level than the foreseeability test under the Hadley principle. In Koufos,18 for example, Lord Reid stated: The modern rule of tort is quite different [from that of contracts] and it imposes a much wider liability. The defendant will be liable for any type of damage which is reasonably foreseeable as liable to happen even in the most unusual case, unless the risk is so small that a reasonable man would in the whole circumstances feel justified in neglecting it. . . . I have no doubt that today a tort feasor would be held liable for a type of damage as unlikely as was the stoppage of Hadley’s Mill for lack of a crankshaft: to anyone with the knowledge the carrier had that may have seemed unlikely [and therefore not within the principle of Hadley v. Baxendale] but the chance of it happening would have been seen to be far from negligible [and therefore within the principle of proximate cause]. But it does not at all follow that Hadley v. Baxendale would today be differently decided.19

17.  606 F.2d 106, 110 (5th Cir. 1979). See also, e.g., Wullschleger & Co. v. Jenny Fashions, Inc., 618 F. Supp. 373, 377 (S.D.N.Y. 1985); Prutch v. Ford Motor Co., 618 P.2d 657, 659 (Colo. 1980); Miles v. Kavanaugh, 350 So. 2d 1090, 1093 (Fla. Dist. Ct. App. 1977); Midland Hotel Corp. v. Reuben H. Donnelley Corp., 515 N.E.2d 61, 67–​68 (Ill. 1987); R.I. Lampus Co. v. Neville Cement Prods. Corp., 378 A.2d 288, 292–​93 (Pa. 1977). 18.  Koufos, 1 AC at 350. 19.  Id. at 385–​86 (citation omitted). In H. Parsons (Livestock) Ltd. v. Uttley Ingham & Co., [1978] QB 791 (Eng.), Lord Denning summarized Koufos as follows: In the case of a breach of contract, the court has to consider whether the consequences were of such a kind that a reasonable man, at the time of making the contract, would contemplate them as being of a very substantial degree of probability. . . . In the case of a tort, the court has to consider whether the consequences were of such a kind that a reasonable man, at the time of the tort committed, would foresee them as being of a much lower degree of probability.

Id. at 801–​02 (opinion of Lord Denning, M.R.).

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The contrast between the causation requirements in contracts and tort is also illustrated by Petition of Kinsman Transit Co.20 As a result of the defendants’ negligence the vessel MacGilvray Shiras broke loose from her moorings, careened stern first down a river channel, and struck another vessel. That vessel also broke loose from her moorings and drifted downstream, with the MacGilvray Shiras following, until both vessels crashed into a bridge. The bridge collapsed, and the wreckage formed a dam that caused extensive flooding. The Second Circuit, in a notable opinion by Judge Friendly, held that the damages resulting directly from the flooding were allowable as proximately caused by the defendant’s wrongdoing, citing with approval a Minnesota ruling “that the rule of Hadley v. Baxendale has no place in negligence law.”21

I II .   T H E MO D E R N A R GUM ENT S F O R   T H E H A D L E Y PR I NCI PL E Given that the principle of Hadley v. Baxendale departs from both the Indifference Principle, and the principle of proximate cause that prevails in most other areas of law, what accounts for the survival of the Hadley principle? Over the years, a number of arguments have been made in support of the principle. As one argument is shot down, another pops up. The current argument is rooted in the concept of information-​forcing. More specifically, the argument is that at the time a contract is made, a seller has a choice whether to enter into the contract, what terms she will accept, and what precautions she will take to ensure that she will be able to perform the contract. If a seller knows that a particular buyer will probably incur consequential damages the seller might either refuse to enter into the contract, ask for a higher price, limit her liability, or take greater-​than-​normal precautions to ensure her own performance. It is then argued that efficiency requires a buyer to communicate to the seller information concerning his special circumstances, if any, so that the seller can make an informed and appropriate decision concerning whether to adopt one of these alternatives.22 The principle of Hadley v. Baxendale is said to provide an incentive to the buyer to communicate that information. Indeed, a form of this argument was adopted in Hadley itself: “[H]‌ad the special circumstances been known,” the 20.  338 F.2d 708 (2d Cir. 1964), cert. denied, 380 U.S. 944 (1965). See also Dan Dobbs, Handbook on the Law of Remedies § 12.3, at 804 (1973) (“[I]‌t is clear that what is ‘foreseeable’ in a tort case may not be foreseeable in a contracts case[.]”) 21.  Kinsman, 338 F.2d at 724 (citing Christianson v.  Chicago, St. P., M.  & O.  Ry., 69 N.W. 640, 641 (Minn. 1896)). Similarly, the Restatement (Second) of Torts permits the recovery of all damages when the defendant’s conduct is a substantial factor in bringing about the harm, as long as the result was not “highly extraordinary.” See Restatement (Second) of Torts § 435 (Am. Law Inst. 1964). In contrast, the Restatement (Second) of Contracts provides that “damages are not recoverable for loss that the party in breach did not have reason to foresee as a probable result of the breach when the contract was made.” Restatement Second § 351(1). The cases under Hadley v. Baxendale traditionally applied this or even stricter standards. See, e.g., Dobbs, supra note 20, at 804–​05; Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. Chi. L. Rev. 89, 113 n.45 (1985). 22.  See, e.g., Easterbrook & Fischel, supra note 21 at note 45 (“The foreseeability doctrine of Hadley v. Baxendale denies recovery for nonforeseeable losses, which gives plaintiffs an incentive to disclose any unusual conditions and risks at the time of the transaction. Disclosure, in turn, allows the other party to take extra precautions or to charge appropriate compensation for bearing increased risk.”).

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court said, “the parties might have specially provided for the breach of contract by special terms as to the damages in that case; and of this advantage it would be very unjust to deprive them.”23 In assessing the information-​forcing argument it is useful to distinguish between contracts for the sale of relatively differentiated and relatively homogeneous commodities. Relatively differentiated commodities are often or usually tailored to a buyer’s special needs. As a result, the principle of Hadley v. Baxendale typically will not come into play, because the pre-​contract parley between the parties—​specifications, quotations, preliminary discussions, negotiations—​ will normally put the seller on notice of the buyer’s special circumstances. For example, in Victoria Laundry (Windsor) Ltd. v.  Newman Industries Ltd., Victoria was in the laundry and dyeing business. It owned a boiler, but it wanted one of much greater capacity in order to expand its business. In April 1946, Victoria contracted to buy from Newman a used boiler with five times the capacity of its old one. The boiler was to be loaded by Newman onboard a carrier at Newman’s premises, with delivery to take place on June 5. Newman employed a third person, T, to dismantle the boiler for shipping. On June 1, T damaged the boiler in the process of dismantling it. As a result, the boiler was not delivered to Victoria until November 8, and Victoria sued Newman for lost laundry and dyeing profits during the period June 5–​November 8. Newman argued that under the Hadley principle the lost laundry profits were not recoverable. The court rejected this argument on the basis of Newman’s business knowledge, in general, and its knowledge of Victoria’s business, in particular: The defendants were an engineering company supplying a boiler to a laundry. We reject the submission for the defendants that an engineering company knows no more than the plain man about boilers or the purposes to which they are commonly put by different classes of purchasers, including laundries. . . . The obvious use of a boiler, in such a business, is surely to boil water for the purpose of washing or dyeing . . . for purposes of business advantage, in which term we, for the purposes of the rest of this judgment, include maintenance or increase of profit, or reduction of loss. . . . No commercial concern commonly purchases for the purposes of its business a very large and expensive structure like this—​a boiler 19 feet high and costing over £2,000—​with any other motive, and no supplier, let alone an engineering company, which has promised delivery of such an article by a particular date, with knowledge that it was to be put into use immediately on delivery, can reasonably contend that it could not foresee that loss of business (in the sense indicated above) would be liable to result to the purchaser from a long delay in the delivery thereof.24

A related issue is whether the amount of consequential damages must be reasonably foreseeable. One of the buyer’s claims in Victoria Laundry was that if the boiler had been delivered in a timely fashion the buyer would have accepted highly lucrative dyeing contracts from the Ministry of Supply, which would have yielded a profit of £262 per week during the period of delay. The court held that Victoria could recover some lost dyeing profits, because the loss of dyeing profits, like the loss of laundry profits, was reasonably foreseeable. However, the court continued, Victoria could not recover its actual lost dyeing profits unless Newman was on notice of the prospect and terms of the lost Ministry of Supply contracts at the time the contract was

23.  Hadley v. Baxendale, (1854) 156 Eng. Rep. 145, 151; 9 Ex. 341, 355. For similar expressions, see Koufous, 1 A Cas. at 386 (opinion of Lord Reid), 413 (opinion of Lord Pearce), 422 (opinion of Lord Upjohn). 24.  Victoria Laundry (Windsor) LD. v. Newman Industries LD., [1949] 2 KB 528, 540–​41 (Eng.).

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made. Instead, Victoria could only recover “some general . . . sum for loss of business in respect of dyeing contracts to be reasonably expected.”25 This position is difficult to justify under the efficiency argument for the Hadley principle. If Newman had reason to know that Victoria would lose dyeing profits if the boiler was not delivered on time, it also had reason to know that Victoria’s actual lost dyeing profits might be supranormal. As a matter of efficiency, that is all Newman needed to know, unless the lost dyeing profits were so high that the probability of their occurrence was not significant. Even in that case the buyer should be entitled to damages up to the level where the probability of their occurrence lacked significance, rather than simply standardized damages as were awarded in Victoria Laundry. For example, in H. Parsons (Livestock) Ltd. v. Uttley Ingham & Co., 26 Lord Justice Orr properly adopted the position that the seller’s “ ‘assumed contemplation should be limited to the type of damage that occurs but . . . he is liable if the quantum is greater than he may be presumed to anticipate.’ ” Similarly, in Wroth v. Tyler27 in 1971 a husband had contracted to sell a house but in 1973 his wife legally prevented him from consummating the sale. The husband agreed to pay some damages to the buyer, but argued that he could not have foreseen a dramatic increase in property values that occurred between 1971 and 1973. Justice Megarry held that a defendant cannot escape liability because the amount of damages was unforeseeable. Once a contracting party is held liable for a type of damage based on foreseeability, he said, the party will be liable for the full extent of those damages: It was beyond question that a rise in the price of houses was in the contemplation of the parties when the contract was made in this case. But Mr. Lyndon-​Stanford [the defendant’s barrister] took it further. He contended that what a plaintiff must establish is not merely a contemplation of a particular head of damage, but also of the quantum under that head. Here, the parties contemplated a rise in house prices, but not a rise of an amount approaching that which in fact took place. A rise which nearly doubled the market price of the property was, as the evidence showed, outside the contemplation of the parties, and so it could not be recovered. Thus ran the argument. I do not think that this can be right. On principle, it seems to me to be quite wrong to limit damages flowing from a contemplated state of affairs to the amount that the parties can be shown to have had in contemplation, for to do this would require evidence of the calculation in advance of what is often incalculable until after the event. The function of the so-​called “second rule” in Hadley v. Baxendale, 9 Exch. 341, seems to me to be not so much to add to the damages recoverable as to exclude from them any liability for any type or kind of loss which could not have been foreseen when the contract was made. No authority was put before me which appeared to me to provide any support for the alleged requirement that the quantum should have been in contemplation. So far as it went, the language used in the authorities that were cited seems to me to have been directed to the heads of damage rather than to quantum. Thus one finds phrases such as “special circumstances” and the “type” or “kind” of damage. I would therefore on principle reject the defendant’s contention, and hold that a plaintiff invoking the so-​called “second rule” in Hadley v. Baxendale, 9 Exch. 341, need show only a contemplation of circumstances which embrace the

25.  Id. at 543. 26.  H. Parsons (Livestock) Ltd. v. Uttley Ingham & Co., [1978] QB 791, 805 (Eng.) (opinion of Orr, L.J.) (quoting lower court opinion of Swanwick, J.) (Italics added.) 27.  [1974] Ch 30 (Eng.).

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head or type of damage in question, and need not demonstrate a contemplation of the quantum of damages under that head or type.28

Judge Posner, who is generally friendly to the principle of Hadley v. Baxendale, takes the same view, and offers an important efficiency reason in its support: Suppose I offer you $140,000 for a house that has a market value of $150,000; you accept the offer but later break the contract, and I sue you for $10,000, my lost profit. You would not be permitted to defend on the ground that you had no reason to think the transaction was such a profitable one for me. Otherwise it would be difficult for a good bargainer to collect damages unless before the contract was signed he had made disclosures that would reduce the advantage of being a good bargainer—​disclosures that would prevent the buyer from appropriating the gains from his efforts to identify a resource that was undervalued in its present use.29

Now suppose a commodity is relatively homogeneous. Such commodities are characteristically sold without the kind of pre-​contract parley that in the case of relatively differentiated commodities puts the seller on notice of the buyer’s special circumstances. Therefore, unless the buyer communicates information concerning his special circumstances the seller normally will not have reason to foresee that her breach is likely to cause consequential damages. However, the real interest of a seller is not whether a buyer will have consequential damages, but whether the buyer will have supranormal damages. Sellers of relatively homogeneous commodities typically sell in significant volumes and develop an extensive claims experience. This experience allows these sellers to construct a probability distribution of potential claims. Therefore, although these sellers might not know whether any individual buyer will likely incur supranormal damages, either general or consequential, they will usually know that a given percentage of their buyers will almost certainly incur supranormal damages. Accordingly, these sellers can predict damages outcomes taken in the aggregate and can set an equilibrium price that reflects aggregate damages.30 Therefore, a high-​volume seller of homogeneous commodities can reliably price and plan for supranormal damages, even in the absence of information transmitted at the time of contract formation, by setting an equilibrium price and level of precaution that takes into account, on a weighted basis, all likely potential damages from breach. Another argument for the Hadley principle remains—​that even if sellers can protect themselves by equilibrium pricing, under such pricing buyers who will incur only normal damages are forced to unfairly and inefficiently cross-​subsidize supranormal-​damages buyers, because the higher costs of selling to the latter will be reflected in higher prices charged to the former. The Hadley principle, the argument goes, allows a seller to prevent this cross-​subsidization by forcing supranormal-​ damages buyers to reveal themselves or lose out on consequential damages. However, the Hadley principle is a clumsy and ineffective tool to deal with this problem. At best, the principle forces only those buyers who would incur consequential damages to reveal themselves, leaving unrevealed those buyers who will incur supranormal general damages. Moreover, even buyers who may incur consequential damages normally are not required to reveal the likely extent of those damages.

28.  Id. at 60–​61. See also Brown v. KMR Services Ltd. [1995] 4 All ER 598. 29.  Richard A. Posner, Economic Analysis of Law 139–​40 (9th ed. 2014). 30.  See Danzig, supra note 3, at 281.

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Furthermore, the arguments in favor of the Hadley principle count only the potential gains from that principle, not the costs. Under Hadley buyers must incur the costs of determining what kind of information is relevant to determining their damages for breach, gathering the information, and transmitting it. These costs may easily exceed the expected value of the transmission. For example, assume that Ajax, a seller, makes 1,000 contracts a year. Historically, Ajax significantly breaches 5 percent of its contracts in random fashion, and 20 percent of those contracts, or 1 percent of all of Ajax’s contracts, entail consequential damages. Buyers’ general damages for breach by Ajax average $50 per contract. Buyers’ consequential damages, for those who incur them, average $500 per contract. The expected value to a consequential-​damages buyer of transmitting information concerning his potential consequential damages will be $5 ($500 in consequential damages if Ajax commits a significant breach multiplied by a 1 percent chance that Ajax will do so). If the buyer’s cost of determining, gathering, and transmitting the information is $6, it will be inefficient to do so. Furthermore, often the costs that a buyer must incur to comply with the Hadley principle will result in no benefit to the seller, because the seller’s front-​line employees, to whom the information would be transmitted, have neither the authority, the capability, nor the incentive to deal with the information, and it will simply go to waste. Another cost of complying with Hadley is that information that is valuable to a buyer might lose much of that value if it is transmitted to a seller. For example, suppose the buyer is a middleman dealing in relatively differentiated commodities, who expects to consummate a resale at a very advantageous price. If the buyer communicates that information to the seller, the seller is likely to raise her price to capture some of the buyer’s extra surplus of which she is now aware. (Indeed, in some cases the seller might try to locate the buyer’s customer and sell to him directly, acing out the buyer.31) Similarly, if the buyer is an end user, such as a manufacturer, he might be unable to transmit information to the seller about his planned use of the seller’s commodity unless he also discloses proprietary information concerning his manufacturing process, which he likely would not want to do. Sellers also must incur costs under Hadley, to make use of information communicated by buyers. First, a seller must incur the costs of processing such information. For example, the seller must train its employees to recognize relevant information, must create and maintain protocols for utilizing such information, and must expend employee time to apply the protocols to individual transactions. Often, these costs will exceed the benefits of utilizing the information. For example, in the Ajax hypothetical if the annual cost to Ajax for creating and maintaining the required protocols, training employees, and processing consequential-​damages information is $6,000, Ajax will not take those actions, because the cost will exceed the $5,000 consequential damages that Ajax faces (10 breached consequential-​damages contracts at $500 per contract). Furthermore, just as a seller’s cost of processing information for the purpose of stratifying prices can exceed the benefits, so too can the buyer’s cost of stratifying precautions. Indeed, although the concept of stratifying precautions has become a major justification of the Hadley principle,32 in practice such stratification is extremely unlikely to occur. The critical issue here is the promisor’s probable rate of significant breach—​that is, either complete nonperformance

31.  See Janet T. Landa, Hadley v. Baxendale and the Expansion of the Middleman Economy, 16 J. Legal Stud. 455, 463–​65, 467 (1987). 32.  See, e.g., Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts:  An Economic Theory of Default Rules, 99 Yale L.J. 87, 101–​04 (1989).

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or substantially defective performance. Contracts scholars often implicitly assume that the rate of significant breach is notable. In fact, however, both theory and observation suggests that the rate of significant breach tends to be very low. Contracting parties, particularly buyers, place an enormous premium on reliable planning, and sellers who develop a reputation for a notable rate of significant breach will not stay in business long. Correspondingly, a seller who significantly breaches only a small number of contracts, only a fraction of which result in consequential damages, is unlikely to incur the expense of setting up special administrative processes just to deal with the occasional consequential-​damages buyer. Sellers of relatively homogeneous commodities typically sell those commodities in high volume. For a high-​volume seller with a low rate of significant breach the costs of stratifying precautions would typically exceed the benefits of the stratification even where the seller knows which contracts carry a risk of higher-​ than-​average liability. For example, high-​volume carriers, such as express-​mail companies and household movers, routinely set low contractual limits on their liability for buyers’ losses unless the buyer pays a special premium for higher liability limits. Therefore, these carriers know precisely which shipments will involve supranormal damages. However, both common sense and casual empirical research indicates that such carriers will normally take no greater precautions in transporting shipments that the carriers know have a high value, and whose loss or injury therefore will result in supranormal damages for breach, than in transporting shipments as to which the carriers’ liability is severely limited, because of the expense of segregating those shipments and giving them special treatment.33 Similarly, information about a buyer’s special circumstances that the buyer transmits to a seller’s front-​line sales or clerical personnel will rarely travel further, and therefore will rarely have an impact on the seller’s conduct. In short, a buyer must incur costs both to determine what information must be transmitted to satisfy the Hadley principle and then to transmit the information, and a seller must incur costs to adopt procedures to correctly process and make use of the information. It is doubtful that the benefits of the Hadley principle outweigh these costs, particularly because in all likelihood most contracts are not significantly breached, and in those cases transmission of the relevant information will likely involve economic costs but no economic benefits. Where there are no such benefits, it seems unlikely that sellers will stratify either prices or precautions on the basis of information communicated by buyers under the whip of Hadley. This explains Cardozo’s observation, in the context of telegraph companies, that: The truth seems to be that neither the clerk who receives the message over the counter nor the operator who transmits it nor any other employee gives or is expected to give any thought to the sense of what he is receiving or transmitting. This imparts to the whole doctrine as to the need for notice [under Hadley v. Baxendale] an air of unreality.34

33.  Telephone interviews by Daniel A. Saunders with Jim Hanon, Director of Underwriting for United Van Lines (1992​); Trudy Atkinson, Customer Service Agent for Federal Express Lines (1992); Tina McGuire of Emery Air Freight (1992​); Alice Rogers of American Airlines (1992​) ; and representatives of Airborne, Pan Am, United, and TWA (1992). 34.  Kerr S.S. Co. v. Radio Corp. of Am., 157 N.E. 140, 142 (N.Y. 1927).

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The Hadley principle also provides inefficient incentives for making perform-​or-​breach decisions. Efficiency requires that in making such decisions sellers should take into account the gains and losses to both parties if breach occurs. In contrast, the Hadley principle allows a seller, in determining whether to breach, to disregard costs that she knows the buyer will suffer from breach if she learned of those costs after the contract was formed. Finally, the principle of Hadley has a fairness cost. Many—​probably most—​buyers, particularly, but not exclusively, consumers, do not know the principle. Such buyers will often fail to communicate information about their special circumstances because they reasonably see no need to do so, especially if they realize that the information will in all probability be disregarded by the seller’s bureaucracy. To summarize: the relative costs and benefits of the principle of Hadley v. Baxendale are impossible to quantify with much accuracy. It cannot be shown that the benefits exceed the costs, and it seems likely that the costs exceed the benefits. More important, there is an alternative regime under which the objectives thought to be accomplished by the Hadley principle can be achieved in a much less costly and more efficient way. This regime is discussed in the next section.

I V.   A N A LT E R N AT I VE R EGI M E T O   T H E H A D L E Y PR I NCI PL E The alternative regime to the Hadley principle has three elements:  contractual allocation of losses resulting from breach, the principle of proximate cause, and limits on disproportionate damages.

A.  CONTRACTUAL ALLOCATIONS OF LOSSES Despite the rivers of ink spilled in defending the Hadley principle, sellers typically do not rely on that principle either to limit their liability or to stratify prices and precautions. Instead, sellers generally limit their liability through contractual provisions. Such provisions may, for example, place a dollar or formula limit on liability, preclude consequential damages, or substitute some nonmonetary obligation, such as replacement or repair, for dollar liability. Often a seller offers buyers a menu of prices and limits on liability, consisting of a basic price with relatively limited liability and stepped-​ up prices with increased liability. (These stepped-​up prices are often denominated as insurance, but that nomenclature is inapt because third-​party insurers are usually not involved.) In contracts for the sale of goods such provisions are virtually invited by UCC Section 2-​719. Under that Section an agreement for the sale of goods “may provide for remedies in addition to or in substitution for those provided in [the UCC] and may limit or alter the measure of damages recoverable under [the UCC], as by limiting the buyer’s remedies to return of the goods and repayment of the price or to repair and replacement of non-​conforming goods or parts.”35 Under Section

35.  U.C.C. § 2-​719(1)(a) (Am. Law Inst. & Unif. Law Comm’n 1990).

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2-​719(3), “consequential damages may be [contractually] limited or excluded unless the limitation or exclusion is unconscionable.”36 It is easy to see why sellers would usually prefer to limit their liability through contractual provisions rather than through reliance on the Hadley principle. From a seller’s perspective, at best the Hadley principle will provide an incentive to buyers to communicate information about consequential damages and will protect the seller against liability for such damages if the information is not communicated. Typically, however, a seller’s interest is not whether a buyer will have consequential damages, but whether a buyer will have supranormal damages. Moreover, information that would put a reasonable person on notice might not put the actual seller on notice, so that the Hadley principle does not protect a seller against consequential damages that the seller should have known but did not actually know would be likely to occur. Accordingly, the Hadley principle serves the interests of sellers only in an indirect, helter-​skelter, and often irrelevant manner. In contrast, contractual allocations of loss serve the ends of sellers directly, and perhaps more important, serve the varying ends of various sellers. By contract a seller can limit liability not merely for consequential damages but also for supranormal or even normal damages. Furthermore, under contract-​based limits on liability there is no need for the buyer to incur the cost of determining, gathering, and transmitting information or for the seller to incur the cost of processing such information. Instead, the seller only needs to make a one-​time or at worst periodic investment to determine whether and how to limit damages or what price-​and-​liability menu it should adopt, and the buyer only needs to decide whether to accept the seller’s limitation on damages or which price-​and-​ liability combination best serves his interests. Also important, under a contractual regime buyers do not need to know the law, because the limitations on the seller’s liability will derive not from law but from the contract.

B. PROXIMATE CAUSE Suppose a seller does not put express contractual limits on the buyer’s damages. Would the seller’s liability then be unlimited in the absence of the principle of Hadley v. Baxendale? It is sometimes assumed that the answer is yes, but this assumption is incorrect. Even in the absence of Hadley a seller’s liability should and would be limited by the principle of proximate cause which is morphing into scope of the risk under Restatement Third, and perhaps by a principle of proportionality. Although there are competing conceptions of the principle of proximate cause37 the ascendant conception is that except for personal injuries that result from a tortious impact, as in eggshell-​ skull cases,38 whether an injury is proximately caused by a wrong depends on the scope of the risk that was foreseeable to the wrongdoer at the time of the wrong.39 Accordingly, if the principle of proximate cause was applied in contract law instead of the Hadley principle, a promisor 36.  Id. § 2-​719(3). 37.  See, e.g., 4 Fowler V. Harper et al., The Law of Torts §§ 20.5–​.6, at 133–​85 (2d ed. 1986); W. Page Keeton et al., Prosser and Keeton on the Law of Torts § 43, at 281–​82 (5th ed. 1984). 38.  When injuries follow from a tortious impact upon the person the wrongdoer is liable for all resultant harm, whether or not reasonably foreseeable, 4 Harper et al., supra note 37, § 20.5, at 162–​69; Keeton et al., supra note 37, § 43, at 291–​93, and liability is likely to be even further extended in the case of intentional torts. 39. 4 Harper et al., supra note 37, § 20.5, at 136–​37; Keeton et al., supra note 37, § 43, at 297–​300.

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in making a perform-​or-​breach decision would efficiently be required to sweep into its calculus the losses to the buyer that were reasonably foreseeable at the time of the decision, rather than only those losses that were reasonably foreseeable at the time the contract was made. Moreover, the standard of foreseeability required under the principle of proximate cause or scope of the risk normally depends on the nature of the interest invaded and the nature of the wrong. In tort law, for example, the standard of foreseeability varies according to whether a case involves personal injuries resulting from negligence, economic loss resulting from negligence, or an injury that was intentionally caused. The standard of foreseeability required in contract law under the principle of proximate cause or scope of the risk should depend on comparable elements—​for example, on whether the interest of the promisee consisted of lost profits, forgone opportunities, or out-​of-​ pocket costs, and whether the breach was inadvertent, justified, or opportunistic.

C.  NATURE OF THE BREAK The principle of Hadley v. Baxendale was explicitly borrowed from the French Civil Code, but the court seems not to have fully understood that case. During the course of the argument in Hadley, Baron Parke said: The sensible rule appears to be that which has been laid down in France, and which is declared in their . . . Code Civil . . . and which is thus translated in Sedgwick: “The damages due to the creditor consist in general of the loss that he has sustained, and the profit which he has been prevented from acquiring, subject to the modifications hereinafter contained. The debtor is only liable for the damages foreseen, or which might have been foreseen, at the time of the execution of the contract, when it is not owing to his fraud that the agreement has been violated. Even in the case of non-​ performance of the contract, resulting from the fraud of the debtor, the damages only comprise so much of the loss sustained by the creditor, and so much of the profit which he has been prevented from acquiring, as directly and immediately results from the non-​performance of the contract.40

Fraud, in the italicized phrase, is a translation of the word dol in Article 1150 of the French Civil Code, but it is not a very good translation. The term dol is actually much wider than fraud. One modern translation renders dol as willfulness. Similarly, the predecessor of Article 1997 of the Louisiana Civil Code, which was based on Article 1150 of the French Civil Code, used the term fraud or bad faith in place of dol, and today Article 1997 uses only the term bad faith. The breach in Hadley v.  Baxendale almost certainly involved willfulness and bad faith. Pickford’s clerk had promised Hadley’s agent that the shaft would be delivered to Joyce & Co. at Greenwich in one day. This promise must have been predicated on shipping the shaft to Joyce by rail from London. However, when the shaft arrived in London Pickford realized that it was making a shipment of scrap metal to Joyce by barge. Almost certainly the reason for Pickford’s breach was that shipping the shaft by a slow barge cost much less than shipping by rail, particularly when the shaft could be added to a load of scrap metal going to the same destination, ​so that by opportunistically breaching Pickford would save money at Hadley’s expense. Accordingly, Pickford should have been liable for the resulting loss to Hadley, which was proximately caused or within the scope of the risk of loss to Hadley that Pickford had reason to 40.  Hadley v. Baxendale, 156 Eng. Rep. 145, 147–​48 (Ex. D. 1854) (emphasis added).

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foresee at the time of its breach. On the other hand, if Pickford had promised to send the shaft by barge, and the shipment arrived late because of the barge company’s fault, so that Baxendale’s breach was inadvertent, Hadley’s damages could properly be limited to the rental value of the shaft for the period of the delay.

D.  LIMITATIONS ON DISPROPORTIONATE DAMAGES Damages may sometimes be appropriately limited not only by the principle of proximate cause but also by a principle of disproportionality. This idea may have influenced the decision in Hadley v. Baxendale itself. The fee for transporting the shaft was £2, 4s. Presumably, Pickford’s profit from transporting the shaft would be only a fraction of the amount—​probably £1 at most. In contrast, Hadley claimed damages of £300. Baron Morton remarked, “Take the case of the non-​delivery by a carrier of a delicate piece of machinery, whereby the whole of an extensive mill is thrown out of work for a considerable time; if the carrier is to be liable for the loss in that case, he might incur damages to the extent of 10,000l . . .”41 The principle of disproportionality is adopted in Restatement Second Section 351(3), which provides that “a court may limit damages [even] for foreseeable loss by excluding recovery for loss of profits, by allowing recovery only for loss incurred in reliance, or otherwise, if the court concludes that in the circumstances justice so requires in order to avoid disproportionate compensation.”42 But what should be the test for disproportionality, and what should be the measure of damages when the principle of disproportionality is applied? The concept of disproportionality is typically conceived in the form of an explicit or implicit ratio. In applying that concept to contract damages it is necessary to determine the elements of the ratio that should be used for this purpose. The ratio suggested by the Comment to Restatement Second Section 351(3) is “an extreme disproportion between the [victim’s] loss and the price charged by the party whose liability for that loss is in question.” This approach has intuitive appeal but is not completely satisfactory because a seller’s price for commodities that are sold in large volumes will normally impound the risk that some buyers will have very large losses and damages if the product is defective. In such cases, the buyer has paid a premium to compensate the seller for very large losses, and the seller’s liability therefore should not be considered disproportionate simply on the ground that the ratio between the seller’s price and the buyer’s loss is very large. A better approach is to focus on the parties’ reasonable expectations or tacit assumptions. The underlying methodology is that used when a contract does not address a relevant issue: the objective is to construct the term the parties probably would have agreed upon if they had addressed the issue. To begin with, a distinction should be drawn between a breach that diminishes the promisee’s pre-​contract wealth and a breach that prevents the promisee from realizing all of his potential gains under the contract. A promisor’s liability should not be limited on the ground of disproportionality where the breach has caused a diminution in the promisee’s pre-​contract wealth, because as a matter of corrective justice such a loss should be shouldered by the promisor, who wrongfully caused the diminution, not by the innocent promisee. In contrast, both parties may tacitly assume that the promisor will not be liable for the promisee’s failure to realize a gain that would be highly disproportionate to the promisor’s expected gain. 41.  Hadley, 156 Eng. Rep at 148; 9 Ex at 347. 42.  Restatement Second § 351(3) (emphasis added).

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To put all this differently, each party to a contract will expressly or impliedly take some risk. The issue is, how much risk? Of course, a promisor should expect that if she breaches she will have to pay damages, and that the damages may be significant. In some cases, such as where one or both parties are speculators, it can be inferred from the circumstances that the promisor took the risk of paying extremely large damages if she breaches. In many or most cases, however, neither party expects the promisor to take the risk of a loss that is highly disproportionate to the promisor’s expected gain where the breach would not diminish the promisee’s pre-​contract wealth. Assuming both parties have approximately the same wealth, utility for money, and attitude to risk, normally a promisor either would not accept such a risk or would charge a steep premium to do so. The promisee, on his part, would normally be unwilling to pay such a premium where damages did not involve a recompense for loss in wealth. As Pietro Trimarchi has observed: [I]‌t is unreasonable to assume that the parties would normally be willing to gamble on uncertainties about disastrous events. . . . It seems likely that the parties would normally be more inclined to avoid [such a] gamble and to change their overall plans in the event of exceptional unforeseen changes in market conditions; accordingly, a legal rule allowing discharge or amendment of the contract would presumably more often correspond to their preferences.43

This brings up the question, assuming the disproportionality test is satisfied: What should be the remedy? The answer is that if full expectation damages would be disproportionate, the promisee’s damages should be reduced to the highest amount that is not disproportionate.

V.   C O N C L US I ON When a promisor breaches a contract, the principle of Hadley v. Baxendale limits the promisee’s recovery to his general damages and those consequential damages that were reasonably foreseeable at the time the contract was made. This principle entails significant costs: It is inconsistent with both the general-​law doctrine of proximate cause and the Indifference Principle in contract law, it forces buyers to either disadvantageously disclose private information or risk losing out on recovering full damages for the promisor’s breach; it unfairly cuts off damages to unsophisticated buyers who are unlikely to be aware that they need to warn their counterparties of their potential losses from the counterparty’s breach. The benefits of the principle are unlikely to exceed these costs and the seller’s costs of processing the buyer’s information. The argument that the principle is information-​forcing and allows sellers to stratify prices and precaution is unrealistic because sellers normally will not use the relevant information in that way due to the costs of doing so. Because of the Hadley principle’s undesirable costs and limited benefits, it should be retired. In its place there should be substituted a regime under which a promisee’s damages would be limited by contract and by the principles of proximate cause and proportionality. 43.  Pietro Trimarchi, Commercial Impracticability in Contract Law: An Economic Analysis, 11 Int’l Rev. L. & Econ. 63, 71 (1991). Cf. Daniel A. Farber, Contract Law and Modern Economic Theory, 78 Nw. U. L. Rev. 303, 335–​36 (1983) (impracticability doctrine protects promisors against catastrophic losses); Subha Narasimhan, Of Expectations, Incomplete Contracting, and the Bargain Principle, 74 Cal. L. Rev. 1123, 1147 (1986) (neither party to a contract accepts unlimited risks).

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Other Limitations on Expectation Damages litigation costs , the time value of forgone gains , and the risk of the promisor’s insolvency

The re are th ree f u rt h er reason s w hy the ex pectati on m easu re will rarely if ever make a promisee indifferent between performance and damages.



1. Generally speaking, under American law each party to a dispute pays its own litigation costs—​attorney’s fees, expert fees, and so forth—​win or lose. Accordingly, even if a promisee prevails in litigation, expectation damages will not include the costs of litigation. For this reason alone, a promisee will never be indifferent between performance and damages. 2. If a contract is performed the promisee has the use of his gains under the contract from and after the time of performance. Accordingly, to make a promisee indifferent between performance and damages he would have to be paid the time value of his forgone gains during the period between the date of breach and the date on which judgment is rendered, measured by compound interest at the rate he pays for borrowed funds. The general rule, however, is that prejudgment interest will be awarded only if the amount of the plaintiff ’s loss is liquidated—​that is, certain or at least reasonably ascertainable in amount.1 The specific rule in contract law, embodied in Restatement Second, is that prejudgment interest is recoverable as a matter of right only if the breach consists of a failure to pay a definite sum of money or to render a performance that has a fixed or ascertainable monetary value. Otherwise, the award of prejudgment interest is discretionary.2 Furthermore, even when prejudgment interest is allowed it is often

1.  See 1 Dan B. Dobbs, Law of Remedies § 3.6(1), at 336 (2d ed. 1993). 2.  See Restatement (Second) of Contracts § 354 (Am. Law Inst. 1981). However, it has been said that the trend is to award prejudgment interest in contracts cases even where damages are unliquidated. See Report in Support of Pre-​verdict Interest in Personal Injury Cases, 55 The Record (N.Y.C. B. Ass’n) 496, 502 n.18 (2000) (citing Funkhouser v. J.B. Preston Co., 290 U.S. 163, 168 (1933)) (prejudgment interest is proper in contract actions, even if damages are unliquidated, “for the purpose of securing a more adequate compensation”). But, not all cases take that position. See, e.g., Buono Sales, Inc. v. Chrysler Motors Corp.,

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not compounded and is often computed on the basis of an artificially low statutory rate,3 such as the interest rate on U.S. Treasury Bills,4 which is typically well below the market rate of interest for most borrowers.5 Therefore, as Judge Posner recognized in Patton v. Mid-​Continent Systems, Inc.6 if the promisor performs the promisee will have the time value of his gains from the point of performance forward, while if the promisor breaches the promisee will seldom recover the full time value of his lost gains. 3. Finally, once a promisor performs, the promisee no longer bears the risk that the promisor will become insolvent. In contrast, if a promisor breaches the promisee bears the risk of insolvency between the time of the breach and the time that damages are paid. The presence of this risk is still another reason why the expectation measure will not make a promisee indifferent between performance and damages.

449 F.2d 715, 723 (3d Cir. 1971) (holding that a successful plaintiff in an action for breach of contract is not entitled to prejudgment interest as a matter of right if his damages are unliquidated); Black Gold Coal Corp. v. Shawville Coal Co., 730 F.2d 941, 943–​44 (3d Cir. 1984) (same). 3.  See, e.g., 815 Ill. Comp. Stat. 205/​2 (1993). 4.  See, e.g., McCrann v. U.S. Lines, Inc., 803 F.2d 771, 774 (2d Cir. 1986) (approving award of prejudgment interest in admiralty case based on six-​month Treasury Bill rates); ECDC Envtl., L.C. v. N.Y. Marine & Gen. Ins. Co., 96 Civ. 6033, 1999 U.S. Dist. LEXIS 9836, at *37–​39 (S.D.N.Y. June 29, 1999) (applying interest rate paid on six-​month Treasury Bills); Barwil ASCA v. M/​V SAVA, 44 F. Supp. 2d 484, 489 (E.D.N.Y. 1999) (same); Zim Isr. Navigation Co. v. 3-​D Imps. Inc., 29 F. Supp. 2d 186, 193–​94 (S.D.N.Y 1998) (same); Weeks Marine, Inc. v. John P. Picone, Inc., 97 Civ. 9560, 1998 U.S. Dist. LEXIS 15053, at *24–​25 (S.D.N.Y. Sept. 23, 1998)  (applying twelve-​month average Treasury Bill rate); Mich. Comp. Laws § 600.6013(8) (2016) (except for judgments on written instruments, “interest on a money judgment recovered in a civil action is calculated at 6-​month intervals from the date of filing the complaint at a rate of interest equal to 1% plus the average interest rate paid at auctions of 5-​year United States treasury notes during the 6 months immediately preceding July 1 and January 1”). 5.  See Michael S. Knoll, A Primer on Prejudgment Interest, 75 Tex. L. Rev. 293, 315 (1996). 6.  841 F.2d 742, 751 (7th Cir. 1988).

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The Theory of Overreliance As discussed in Chap ter 20, there are strong reasons of efficiency

and fairness for utilizing the expectation measure of damages in a bargain context. Many of these reasons were developed by law-​and-​economics scholars, but since around 1980 some law-​and-​economists have formulated revisionist critiques of the expectation measure. One critique, known as the theory of overreliance, which would only modestly modify the expectation measure, has gained a fair amount of traction in the scholarly literature although little if any in the law. Other critiques, which propose either more radical revisions of or complete alternatives to the expectation measure have gained little traction even in the scholarly literature. Because the theory of overreliance is accepted in a significant portion of the law-​and-​economics literature the theory will be considered in detail in this chapter. Several of the more radical critiques of the expectation measure will be considered in Chapter 22.

I .   I N T R O DUCT I ON The theory of overreliance was originally developed by Steven Shavell.1 The theory is as follows: (1) Often a promisee can increase the value of a contract by making investments that will increase the surplus he will derive from the contract (hereafter, surplus-​enhancing reliance or reliance). Recall, for example, the hypothetical in which The Blue Angels, a rock group, contracts with Promoter to give a concert in three months. Promoter can greatly increase his box-​office receipts, and therefore the value of the contract, by investing in advance advertising of the concert. (2) There is always some probability that a promisor will breach. (3) The expectation measure fully insures a promisee against the promisor’s breach. (4) This full insurance allows a promisee to ignore the probability that a promisor will breach and therefore gives the promisee an incentive to invest in reliance at a level that is inefficient because it does not take that probability into account. To put this differently, the expectation measure may lead a promisee to inefficiently overinvest in reliance, or overrely. (5) In contrast, an efficient remedial regime would require a promisee to calibrate his investment in reliance according to the probability that the promisor will breach. 1.  See Steven Shavell, Damage Remedies for Breach of Contract, 11 Bell. J. Econ. 466, 472 (1980); Steven Shavell, The Design of Contracts and Remedies for Breach, 99 Q.J. Econ. 121, 124 (1984).

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Shavell developed the theory of overreliance as a refinement of the expectation measure, not as a counter to that measure. He argued that the expectation measure should be utilized for breach of bargain contracts, but should be modified by basing the promisee’s damages on the gains he would have made if he had optimally relied rather than on the gains he would have made as a result of his actual reliance. As time went on, however, many scholars overinvested in the theory by treating it as a criticism, rather than a refinement, of the expectation measure. More important, many scholars failed to recognize that when litigation costs and risks and the economics of business practice are taken into account, in most cases overreliance cannot occur and even in those cases in which it can occur the likelihood that it will occur is extremely low.2

II.   P R E L I MI N A RY C ONS I DER AT I ONS To properly consider the theory of overreliance it is important to bear in mind that expectation damages usually do not include any amounts for reliance as such. Instead, reliance normally enters into expectation damages through the back door:  if a promisee invests in surplus-​ enhancing reliance the investment normally will increase the profit that the promisee will make if the promisor performs, and therefore will increase the promisee’s expectation damages if the promisor breaches. It is also important to bear in mind that even if overreliance was a significant problem, and the expectation measure fully insured the promisee against the promisor’s breach, that measure would not provide a promisee with an incentive to make an unlimited investment in reliance. Even if a rational and prudent promisee is fully insured against breach he will invest in reliance only to the point where the last dollar of investment is likely to generate an extra dollar of revenue. For example, advance advertising constitutes surplus-​enhancing reliance only up to up to the point at which the cost of additional advertising is justified by the returns the additional advertising will likely generate. Thus in The Blue Angels Promoter might spend too much on advertising in the sense that even if performance by The Blue Angels was perfectly insured the last increment of spending may not be covered by an equal increment of additional revenue. Maybe Promoter miscalculates, or has an overly optimistic disposition, or simply exercises poor judgment. In such cases, the promisee’s investment in reliance is surplus-​ diminishing—​will decrease the promisee’s expectation damages—​because it will decrease the profit that the promisee would have earned if the promisor had performed. Accordingly, even if the promisee’s reliance was fully insured by the expectation measure, the amount of his investment in reliance will be constrained by natural economic limits based on marginal costs and revenues.

2.  The discussion of the theory of overreliance in this chapter is adapted from Melvin A. Eisenberg & Brett H. McDonnell’s, Expectation Damages and the Theory of Overreliance, 54 Hastings L.J. 1335 (2003). See also Aaron S. Edlin & Stefan J. Reichelstein, Holdups, Standard Breach Remedies, and Optimal Investment, 86 Am. Econ. Rev. 478 (1996); Aaron S. Edlin, Cadillac Contracts and Up-​Front Payments:  Efficient Investments under Expectation Damages, 12 J.L. Econ. & Org. 98 (1996).

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II I .   C A S E S W H E RE OVER R EL I A NCE I S N O R MA L LY I M POS S I BL E Reliance is not a monolithic concept; rather, it falls into various categories. In some of these categories overreliance is normally impossible. Among these categories are cases in which reliance consists of necessary performance or preparation costs and cases in which expectation damages are invariant to reliance.

A.  CASES IN WHICH RELIANCE CONSISTS OF NECESSARY PERFORMANCE OR PREPARATION COSTS One category of reliance that normally does not implicate the likelihood of overreliance consists of investments in costs that are necessary to perform a contract or receive any benefit from the other party’s performance. In The Blue Angels, for example, if Promoter is to get any benefit from the contract he must incur the cost of leasing a venue before the concert occurs. Similarly, if Seller, a distributor, agrees to deliver 40,000 Fuji apples to Buyer on February 1 he must incur the cost of acquiring 40,000 Fuji apples before that date. If Buyer, a manufacturer, contracts to purchase a die press that will rest on a concrete foundation he must incur the cost of installing a foundation before the die press is delivered. Performance and preparation costs are normally not susceptible to overreliance because normally these costs are not discretionary. In The Blue Angels, for example, if Promoter does not rent a venue prior to the concert he will have to pay The Blue Angels’ $75,000 fee but will be unable to stage the concert. In the die-​press case if Buyer does not construct a foundation on time he will be unable to take delivery of the die press when scheduled and will be in breach. In the Fuji apples case if Seller does not acquire 40,000 apples prior to February 1 he will be unable to make delivery on time and therefore will be in breach. The amount of minimum performance costs may sometimes be variable or discretionary at the margin. In The Blue Angels, for example, Promoter might be able to rent a better or worse venue, and in the die-​press case Buyer might be able to build a better or worse foundation. This qualification is largely immaterial because often and perhaps typically the amount of performance and preparation costs will not be variable as a practical matter. In many cases, there is only one realistic choice (for example, in the die-​press case there may be just one accepted way to lay a concrete foundation for a die press of a given weight and size). In other cases, the quality of the commodity in which the buyer must invest cannot be easily reduced below the otherwise-​optimal quality without reducing the value of the contract.3

3.  There is a set of costs that falls into a zone between necessary reliance, on the one hand, and discretionary reliance, on the other. These are principally costs that involve the timing of performance. This issue requires a complex analysis, which is set out in Eisenberg & McDonnell, supra note 2, at 1344–​46. As shown there the resolution of this issue does not give a noticeable boost to the theory of overreliance.

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B.  CASES IN WHICH EXPECTATION DAMAGES ARE INVARIANT TO RELIANCE Overreliance is also normally impossible where the promisee’s expectation damages are invariant to his reliance, that is, where an increase in the promisee’s investment in reliance will not increase his expectation damages.

1.  Liquidated Damages As discussed in Chapter 23, many contracts include provisions that liquidate, or fix, the amount of damages if breach occurs. Liquidated-​ damages provisions are not always enforceable. However, where such a provision is enforceable the promisee’s damages will be invariant to his reliance; that is, no matter how much the promisee invests in surplus-​enhancing reliance his damages will be the same. Consequently, in such cases the expectation measure will not give the promisee an incentive to overrely. Liquidated-​damages cases are the most salient example of a case in which a promisee’s damages are invariant to his reliance, but they are far from the only such examples. The general principle of expectation damages—​that the promisee should be put in the position he would have been in if the contract had been performed—​is both instantiated and limited by various damages principles and formulas that are based on the nature of the injury, the nature of the damages, and the question whether the promisee is a buyer or a seller. Under many of these principles and formulas the promisee’s damages are invariant to the amount of his reliance.

2.  Sellers’ Damages for Breach by a Buyer In most contracts one party is required to provide a commodity—​using that term to include anything that can be purchased and sold—​and the other party is required to pay for the commodity before, upon, or after delivery. A party who is required to provide a commodity will be referred to as a seller, and a party who is required to pay for a commodity will be referred to as a buyer. The expectation measure normally cannot provide a seller with an incentive to overrely because a seller’s expectation damages normally are invariant to his reliance, for the following reasons. Contract law categorizes damages in various ways. One categorization is a division between general and consequential damages. General damages are the damages that a promisee normally incurs as a result of a given kind of breach regardless of the promisee’s particular circumstances. For example, if a seller fails to deliver goods pursuant to a contract of sale the buyer, regardless of his circumstances, will always incur general damages consisting of the excess of the market or cover price of the goods over the contract price. Consequential damages are the damages that a promisee incurs as a result of his particular circumstance. In a sale-​of-​goods case, for example, the buyer may incur consequential damages if he planned to make a profit through the use or resale of the goods and cannot replace the goods on the market. Under the principle of Hadley v. Baxendale,4 discussed in Chapter 19, a breaching promisor is liable for all of the promisee’s general damages, but is not liable for the promisee’s consequential

4.  (1854) 156 Eng. Rep. 145; 9 Ex. 341.

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damages unless those damages were reasonably foreseeable at the time the contract was made.5 Buyers often suffer consequential damages. Sellers, however, rarely suffer compensable consequential damages. A buyer’s usual default is failure to pay. In normal circumstances, the disappointed seller will be able to sell to another, borrow to replace the breaching buyer’s promised payment, or otherwise adjust its affairs to avoid consequential loss.6 As a result, normally a seller can collect only general damages for breach by the buyer. Several alternative formulas can be employed to calculate a seller’s general damages for a buyer’s breach of a contract for the sale of goods. One formula is based on the difference between the contract price and the replacement price, that is, either the market price of the contracted-​ for commodity at the time of the breach or the actual price that the seller realizes on a resale to a third party. An alternative formula is based on the seller’s lost profit—​a better term would be lost surplus—​defined as the difference between the contract price and seller’s total variable costs together with due allowance for the seller’s reasonable out-​of-​pocket costs prior to the breach.7 Several alternative formulas can also be employed to calculate a seller’s general damages for a buyer’s breach of a contract for the provision of services, such as a construction contract. One formula is based on the seller’s lost profit plus the out-​of-​pocket costs the seller incurred prior to the breach. An alternative formula is based on the difference between the contract price and the variable costs remaining to be incurred by the seller at the time of breach. These two formulas are algebraically and economically equivalent.8 Under all these formulas for breach by the buyer, a seller’s general damages are normally invariant to his reliance. Where a seller’s damages are based on the difference between the contract price and the market or resale price an increase in the seller’s reliance normally will not increase his damages, because the contract price, the market price, and the resale price are all normally invariant to the seller’s reliance. Where the seller’s damages are based on lost profits plus variable costs incurred prior to breach, an increase in the seller’s variable costs will drive up the incurred-​ costs element of his damages but will drive down his lost profits by an equal amount, so that under this formula too the seller’s damages will normally be invariant to the seller’s reliance. In short, under the damages formulas that are applicable to breach by a buyer, the expectation measure normally cannot give a seller an incentive to overinvest in reliance. Accordingly, overreliance normally cannot be a problem for half of all contracting parties, that is, for sellers.

3.  Buyer’s Damages for Breach by a Seller Overreliance is also unlikely to be a problem in many or most cases involving a breach by a seller. A buyer’s general damages, like a seller’s general damages, can be measured by several alternative formulas. One formula, replacement-​price damages, is based on the difference between the contract price and either the market price of the contracted-​for commodity at the time of breach or the actual price paid by the buyer in a covering purchase. A second formula, 5.  Id. at 151; 9 Ex. 354. 6.  Thus the U.C.C. provides for a buyer’s consequential damages (section 2-715) but not for a seller’s consequential damages. 7.  U.C.C. § 2-​708 (Am. Law Inst. & Unif. Law Comm’n 2002). 8.  There are wrinkles that concern payments by the buyer made prior to breach but these wrinkles do not affect the present discussion.

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diminished-​value damages, is based on the difference between the market value of the performance that the seller promised and the market value of the performance that the seller rendered.9 A third formula, cost-​of-​completion damages, is based on the amount required to put the seller’s imperfect performance into the state he promised to achieve. Under any of these formulas an increase in the buyer’s investment in surplus-​enhancing reliance normally will not increase the buyer’s general damages because normally contract price, market price, cover price, diminished value, and cost of completion are all invariant to the buyer’s reliance. Accordingly, where a buyer can recover only general damages, as is often the case, his expectation damages will be invariant to his investment in surplus-​enhancing reliance. (Of course, consequential damages, if any, will often or even normally be increased by a buyer’s reliance.)

IV.   C A S E S I N   W H I C H OVER R EL I A NCE, ALTH O U G H T H E O R E TI CA L LY POS S I BL E, IS V E RY U N L I K E LY T O  OCCUR Even where overreliance by a buyer is theoretically possible, in large categories of cases it is highly unlikely to occur.

A.  RELIANCE THAT HOLDS ITS VALUE AFTER BREACH To begin with, overreliance is highly unlikely where the buyer’s investment in reliance will hold all or almost all of its value even if the seller breaches. In such cases the buyer should invest in reliance as if the seller’s performance was certain because the investment will have the same value whether the seller breaches or performs.10 A leading example is a contract for the purchase of a fungible commodity. A baker who contracts to buy flour in order to make 100 fancy wedding cakes normally cannot overrely because if the seller breaches the baker can buy replacement flour on the market and make the same 100 cakes, thereby putting to use any reliance costs that he has incurred.

B.  CASES WHERE IT WOULD BE INEFFICIENT FOR A BUYER TO TAKE THE SELLER’S PROBABILITY OF BREACH INTO ACCOUNT Even where a buyer may have consequential damages that will vary with his investment in reliance it would often be inefficient for the buyer to take the seller’s probability of breach into

9.  As in the case of the seller’s damages, there are wrinkles in the formulas, but they can be ignored for present purposes. 10.  See George M. Cohen, The Fault Lines in Contract Damages, 80 Va. L. Rev. 1225, 1319 (1994).

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account in determining the amount of that investment, and in such cases too overreliance is also very unlikely to occur. This will be true, for example, in cases involving lumpy reliance, coordinated contracts, and reliance on a seller who has a very low probability of committing an economicially significant breach.

1.  Lumpy Reliance If a buyer’s investment in reliance occurs in lumps that cannot feasibly be scaled down at the margin, it will usually be inefficient for the buyer to take the seller’s probability of breach into account in determining the amount of his reliance. For example, suppose that in The Seafarer hypothetical discussed in Chapter 13 Charterer cannot charter out the vessel unless it is equipped with a semi-​customized radar, which Charterer, rather than Boatmaker, is to purchase and install. Assume the following facts:  Charterer will earn a profit of $30,000 per month from chartering out the Seafarer. The radar for the Seafarer would cost $20,000, and must be ordered two months in advance. The probability that Boatmaker will breach is 10 percent. If Boatmaker breaches and Charterer must resell the radar on the market, Charterer will take a loss of $6,000 on the radar. On these facts, if Charterer does not order a radar until the Seafarer is delivered he will lose two months of profits, or $60,000. Since Charterer cannot purchase 90 percent of a radar, he should order the radar in advance despite a 10 percent chance of breach.11 Similarly, suppose the vessel cannot be chartered out unless it is equipped with ten life preservers, and life preservers must be ordered four weeks in advance. It is then efficient for Charterer to order ten rather than nine life preservers in advance despite a 10  percent chance of breach, because nine life preservers will not do Charterer any good. The lumpiness constraint can apply even to a collection of disparate items. For example, suppose that Charterer cannot charter out Seafarer unless it is equipped with ten different items in the galley—​a range, a sink, a refrigerator, and so forth—​and all these items must be ordered in advance, at a total cost of $20,000. Here too it would be inefficient for Charterer to take into account the 10 percent probability of Boatmaker’s breach and purchase only nine items, because no item will be useful without all the others.

2.  Coordinated Contracts Where a buyer must enter into a number of coordinated contracts it is normally inefficient to enter into less than all the contracts even though there is a positive probability of breach for

11.  It is possible that a promisee could scale down the level of his investment in lumpy reliance below the otherwise-​optimal level to take into account the probability of breach. For example, if an otherwise-​ optimal radar would cost $15,000, Boatmaker might buy a suboptimal $13,500 radar instead. However, if the rate of material breach is very low, as will usually be the case, then the expected cost of purchasing a suboptimal radar would be much higher than the expected cost of purchasing an optimal radar, even considering the probability of breach by Boatmaker. See Eisenberg & McDonnell, supra note 2, at 1358 n.25, for further elaboration of this issue.

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each contract. For example, suppose a film producer needs to make contracts with a writer, a director, five actors, a cinema photographer, a composer, and a film editor to produce a movie, and each artist has a 10 percent probability of breach. If production could not begin until all ten artists had been signed to contracts, it would be inefficient for the producer to make contracts with only nine artists.

3.  Reliance on a Seller Who Has a Very Low Probability of Committing an Economically Significant Breach A buyer will normally have consequential damages only if the seller’s breach is economically significant. If the seller’s breach is economically minor the buyer can usually remedy the breach on the market, collect damages, and proceed as if the seller had performed. For example, suppose Contractor agrees with Owner to build a commercial building by July 1. Contractor substantially completes the building by July 1, but fails to meet contract specifications in certain insignificant respects—​some of the carpeting is not the specified color and a few office doors do not close properly. Assume the defects do not prevent Owner from taking immediate occupancy and can be remedied on the market by contracting with third parties to make repairs. Then Owner’s damages will be measured by the cost of repairs and Owner’s reliance will not be wasted as a result of the breach. Accordingly, if the probability of a seller’s breach concerns only insignificant matters, normally a buyer can efficiently rely without regard to that probability. Correspondingly, it is inefficient for a buyer to take the probability of a seller’s breach into account unless the probability of the breach would be significant: if a seller’s probability of committing an economically significant breach is very low the cost of determining that probability, and then determining how to make appropriate adjustments in the buyer’s reliance, will likely exceed the benefit of the adjustments. Accordingly, overreliance is unlikely in such cases. Observation suggests that in general the rate of economically significant breach by sellers is very low. This is to be expected, because sellers who are known to have a high rate of economically significant breach will likely be driven out of the market. For example, many contracts are based in large part on the buyer’s need to reliably plan his production or distribution by ensuring control over his inputs. If in such a case a contracted-​for input is not timely delivered, the buyer’s entire production or distribution may be seriously disrupted. Few buyers who contract on this basis would be willing to consciously take a significant risk of late delivery even if they can get damages if delivery is late. Even buyers who contract for other reasons are unlikely to deal with sellers who have a high rate of economically significant breach. As stated in a Comment to the Uniform Commercial Code, “the fact [is that the essential purpose of a contract between commercial actors] is actual performance, that commercial [actors] do not bargain merely for . . . a promise plus the right to win a lawsuit and that a continuing sense of reliance and security that the promised performance will be forthcoming when due, is an important feature of the bargain.”12

12.  U.C.C. § 2-​609 cmt. 1 (Am. Law Inst. & Unif. Law Comm’n 2002).

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V.   A   F L AW E D T ENET OF   T HE T H E O RY O F   O VER R EL I A NCE The discussion above shows that overreliance can occur only in a very limited range of circumstances. That point leaves the theory of overreliance unaffected in principle although highly circumscribed in practice. But there is also a flaw in a central tenet of the theory: that the expectation measure fully insures a promisee’s investment in reliance. It is this supposed feature of the expectation measure that is said to lead to overreliance. For example, Richard Craswell states that “Because the expectation measure guarantees [the promisee] B full compensation whether [the promisor] S performs or not . . . it means that B can ignore the risk that S’s nonperformance might leave B’s reliance expenditures wasted,”13 and that “expectation damages allow B to capture all of the upside potential of his reliance without making him bear any of the downside potential. . . .”14 When institutional factors are taken into account, however, the full-​insurance tenet is incorrect. At the time a promisee determines the level of his investment in surplus-​enhancing reliance he cannot rationally expect that investment to be fully insured by expectation damages. On the contrary, as shown below, he knows that upon breach by the promisor he will bear much or even all of the costs of that investment. What matters to a promisee is not the expectation damages that he would receive in a world with perfect information and no transaction costs. Instead, what matters to the promisee is the expected present value of the damages that he will receive in the actual world. Call this the expected value of actual-​ world damages. In determining that expected value, the promisee must discount his prospective damages to reflect litigation risks and litigation costs.

A. LITIGATION RISKS Litigation risks are the risks of error by a judge or jury and the risk that the promisor may establish an unforeseen meritorious defense. Damages based on surplus-​enhancing reliance present particularly high litigation risks because they consist in whole or in part of lost profits, which are both difficult to measure and subject to special defenses, such as the principle of Hadley v.  Baxendale.15 Moreover, because lost profits are unliquidated in amount there is a risk that even if the promisee prevails the court might not award him prejudgment interest, so that the present value of a future recovery may also need to be discounted by the time value of money. Still another litigation risk is that the promisor may turn out to be judgment-​proof. Given these litigation risks, it seems safe to assume that at the time a promisee invests in surplus-​enhancing

13.  Richard Craswell, Performance, Reliance, and One-​Sided Information, 18 J. Legal Stud. 365, 376–​77 (1989). 14.  Richard Craswell, Offer, Acceptance, and Efficient Reliance, 48 Stan. L. Rev. 481, 494 (1996). 15.  It is theoretically possible that the promisee’s actual damages would be more than perfect expectation damages, rather than less. If the chances of overly high damages were as great as the chances of overly low damages, the promisee would not discount for litigation risk. That possibility, however, is not realistic, because courts have historically tended to be very conservative in awarding damages based on lost profits. For example, the requirement of certainty and the principle of Hadley v. Baxendale are always used to cut back on a promisee’s damages, not to increase a promisee’s damages.

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reliance the expected value of actual-​world damages is unlikely to exceed 70–​80  percent of perfect-​world expectation damages even before litigation costs are factored in.

B. LITIGATION COSTS Just as a promisee knows that he must apply a significant discount to perfect-​world expectation damages to determine the expected value of actual-​world damages, so too he knows that the expected value of actual-​world damages will be heavily reduced by litigation costs, such as attorney’s fees.16 Based on casual empiricism, the minimum legal fee for even a relatively straightforward commercial breach-​of-​contract case would likely be around $10,000–​$20,000, and the minimum fee for a complex case would likely be around $50,000–​$100,000. Indeed, a partner in a boutique litigation firm reported in conversation that his firm’s minimum fee for complex high-​stakes commercial-​contract litigation would seldom be less than $1 million, based strictly on billable hours. Under American law each party must shoulder his own litigation costs. The higher the litigation costs, the lower will be the promisee’s net recovery. If the promisee’s prospective litigation costs exceed his prospective damages he has no incentive to overrely. Indeed, if at the time a promisee decides how much to invest in surplus-​enhancing reliance his expected costs to litigate a breach by the promisor exceed the expected value of the promisee’s actual-​world damages, a rational promisee would invest in reliance as if the contract is governed by a no-​damages rule.

V I .   T H E C O S T S O F   M ODI F YI NG TH E   E X P E C TAT I O N M EA S UR E BY   TA KI NG INT O   A C C O U N T T HE  PR OBA BI L I T Y O F   T H E P R O M I S O R ’ S   BR EA CH Because overreliance is impossible in most cases and unlikely even where possible, the benefits of modifying expectation damages to take into account the promisor’s probability of breach would be slight. In contrast, the costs entailed by such a modification would be heavy, because of the difficulties in obtaining the relevant information and making the relevant determinations. These difficulties affect both promisees and courts. Promisees, in investing in surplus-​enhancing reliance, would have to take into account the probability that the promisor will breach. However,

16.  This may not be true where the contract includes a provision that if suit is brought under the contract, the losing party pays the fees of the winning party. However, most contracts do not contain such a provision. Moreover, even when such a provision is included it is risky to rely on the provision, because a party who brings suit and loses must absorb not only his own losses under the contract but also his own attorney’s fees and those of the other party. Therefore, such a provision is likely to have little impact unless the promisee has a very high level of confidence that if he sues without settling he is likely to prevail in court.

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promisees would almost never have reliable information about that probability, and therefore could almost never reliably take that probability into account. 17 Courts would face even greater informational problems. First, a court would have to determine the ex ante probability that the promisor would breach. Next, the court would have to determine the optimal amount of the promisee’s reliance in light of that probability. Then the court would have to determine whether, given that optimal amount, the promisee had or had not optimally relied. Finally, if the court determined that the promisee had not optimally relied, it would have to determine how much profit the promisee would have earned if he had optimally relied. All in all, a herculean enterprise. _​_​_​_­___________​_​_​_​ To summarize, the theory of overreliance posits that, unless modified, the expectation measure of damages provides inefficient incentives to a promisee because the measure fully and therefore inefficiently insures the promisee’s investment in surplus-​enhancing reliance. In the absence of institutional considerations, this theory could have significant consequences in formulating the legal rules that govern damages. When institutional considerations are taken into account, however, the theory, although illuminating, has few real-​world consequences. In most cases overreliance cannot possibly occur because of the actual economics of contracting and the way in which the expectation measure is instantiated in, and limited by, specific damages principles and formulas. Even in those cases where overreliance can possibly occur it remains highly unlikely, partly because in many such cases it would be impracticable for a promisee to limit his investment in surplus-​enhancing reliance in the way the theory requires, and partly because the central tenet of the theory, that the expectation measure insures the promisee’s reliance, is incorrect. Finally, even in those cases where overreliance would not be highly unlikely the theory of overreliance is virtually unadministrable, because normally it is all but impossible to determine the optimal rate of reliance and the profit that the promisee would have earned if he had optimally relied.

17.  Richard Craswell has made an ingenuous attempt to solve this problem. He suggests that at the time a contract is made the promisor should be required to state the probability that she will breach. The promisee then would be entitled to base the amount of his reliance on that statement, whether or not the statement was accurate. Under this rule the promisor’s actual probability of breach would be irrelevant; only the probability stated by the promisor would count. See Craswell, supra note 13, at 367–​68. It’s not easy, however, to imagine that a negotiating promisor would say to her counterparty, “By the way, before we sign this contract I should tell you that there is a 15% probability that I will breach it.” Nor is it likely that the promisor herself will know the probability that she will breach any given contract. Craswell attempts to deal with that problem by developing a model in which a promisor will breach if her cost of performance will exceed the contract price plus the damages she would be required to pay if she breaches. At the time the contract is made. However, a promisor often isn’t sure what her cost of performance will be, and almost never knows how much damages she will owe if she breaches. Furthermore, the social costs of overreliance, if there are any, depend on the actual probability of breach, not on the promisor’s stated probability of breach. Therefore, if the theory of overreliance otherwise had a bite, Craswell’s approach would not resolve the informational problem presented by the theory. Accordingly, far from solving the informational problem, Craswell’s approach underlines the difficulty and perhaps insuperability of that problem.

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Critiques of the Expectation Measure, and Alternative Damage Regimes I .   I N T R O DUCT I ON The theory of overreliance, properly understood, is an argument for a limited modification of the expectation measure. In contrast, some scholars have proposed damages regimes that would either drastically modify that measure or abandon it altogether.1 Some of the more prominent critiques and alternatives are considered in this chapter.

II.  E N F O R C E M E NT-​E R R OR R EGI M ES A. BACKGROUND Law-​and-​economists have long recognized that without adjustments to conventional remedies the law will not cause wrongdoers to fully internalize the costs of their actions because not all victims successfully enforce their rights. Some victims do not know they have been wronged;2 1.  Most or all of the arguments for the alternative regimes are sympathetically developed in an article by Richard Craswell, Instrumental Theories of Compensation: A Survey, 40 San Diego L. Rev. 1135 (2003), and critiqued in Shawn J. Bayern & Melvin A. Eisenberg, The Expectation Measure and its Discontents, 2013 Mich. St. L. Rev. 1. Shawn Bayern’s role in writing this article was more important than mine, and this chapter draws very heavily upon this article, so that Shawn Bayern is in effect a co-​author of this chapter. It would be tedious to here consider each proposed alternative regime in detail. Instead, the focus in this chapter will be on three critical issues that the proponents of the various regimes seldom address: whether a given regime is actually likely to significantly further a worthwhile goal, the strength of the goal to be served by the regime, and whether the regime is administrable. 2.  See William L.F. Felstiner et  al., The Emergency and Transformation of Disputes:  Naming, Blaming, Claiming, 15 Law & Soc. Rev. 631, 636 (1980).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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others know they have been wronged but do not sue;3 others sue but fail to establish their meritorious claims in court or settle for less than the full value of their claims. Cooter and Ulen call this the problem of enforcement errors.4 Economists have suggested that for remedial regimes to be efficient they must account for the possibility that wrongdoers know they might escape some or all liability due to such errors.5 An analysis based on enforcement errors is commonly applied by law-​and-​economists to tort and criminal law.6 Their traditional solution in tort law is that damages should be increased by a percentage that will offset the wrongdoer’s chance of escaping full liability. Under that approach if tortfeasors are caught only 50 percent of the time, damages should be doubled;7 if they are caught only 25 percent of the time, damages should be quadrupled.8 Some law-​and-​economists have argued in favor of applying an enforcement-​error analysis to contract law as well. For example, suppose a promisor can perform at a cost of $500 and knows that her breach will cost the promisee $1,000. Under the expectation measure if there were no prospect of enforcement errors the promisor would perform rather than breach, because she would rather pay $500 to perform than $1,000 to remedy a breach. However, if the promisor expects that the probability she will be held liable is less than 50 percent she would rather breach than perform, at least if she is selfish and does not expect other costs from breach, such as litigation expenses or reputational damage. The prospect of enforcement errors therefore appears to undermine the efficient incentives provided by the expectation measure unless the probability of such errors is factored into damages.

B.  THE SUBJECTIVE BELIEFS OF PROMISORS As the last example suggests, although arguments based on enforcement errors commonly rest on the probability of enforcement,9 what fundamentally matters in this regard is not the actual probability of enforcement but the promisor’s subjective belief about the probability of enforcement. Under an enforcement-​error regime it is this belief that will motivate the promisor’s precaution and perform-​or-​breach decisions. Subjective beliefs about probability are individual estimates based in whole or in part on personal beliefs. If I say that the chance that the Large Hadron Collider at CERN will destroy Switzerland is 1 percent, I say little more than that I would pay $1 for a chance to win $100 if that happens. I may believe that my estimate is informed by data or a carefully honed intuition, but for a subjective interpretation of probability it need not be—​at bottom my estimate is a personal guess, although possibly an informed one. Ideally, therefore, a remedial regime in contract law that attempted to correct for enforcement errors

3.  See id.; Shawn J. Bayern, Comment, Explaining the American Norm against Litigation, 93 Cal. L. Rev 1697, 1701–​05 (2005). 4.  Robert Cooter & Thomas Ulen, Law & Economics 260–61 (6th ed. 2012). 5.  See id. 6.  See, e.g., id. at 257–​61 (tort law), 462–​67 (criminal law). 7.  See, e.g., id. at 260. 8.  See Richard Craswell, Deterrence and Damages: The Multiplier Principle and Its Alternatives, 97 Mich. L. Rev. 2185, 2186 (1999). 9.  E.g., id. (referring to the “probability that any given violation will be punished”).

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would premise damages in part on the promisor’s state of mind. This raises the central problem of taking enforcement errors into account in contract damages: there is normally no reliable way to infer the promisor’s state of mind concerning the probability of enforcement.

C.  OBJECTIVE PROBABILITIES AND EVIDENCE ABOUT SUBJECTIVE PROBABILITIES It might seem that a solution to the problem of a court’s inability, in the normal case, to determine a promisor’s subjective belief concerning the probability of enforcement is to infer that belief on the basis of objective probability.10 This solution, however, would be highly problematic. One problem is that the odds are very low that a promisor can accurately predict the objective probability of enforcement. A related but even more significant problem is that objective determinations of probability are extremely elusive for one-​off (that is, single, nonrepeatable) events.11 To see why this is so, it will be helpful to briefly review and analyze several different theoretical interpretations of probability.12 In some settings, probability statements can be understood objectively rather than subjectively, that is, they may be taken to be statements about the world rather than statements about an actor’s belief about the world. 13 These kinds of probability statements are commonly presented, for example, in the context of theoretical games of chance,14 in which statements of probability represent almost definitional truths. For example, if we define a fair coin toss as one in which heads and tails are equally likely when the coin is flipped, then the objective likelihood the coin will show heads after one flip is 50 percent. This is a statement about the objective world. Similarly, if we know that 5 of 100 students in a Columbia Law School Contracts class graduated from Columbia College, we can say the probability of drawing the name of a Columbia College graduate at random from the Columbia Contracts class roster is 5 percent. These statements about probability are just derivations from axioms; they are, for the most part, just alternative ways of stating what we already know. Under what is now called classical probability theory probabilities are little or nothing more than these kind of axiomatic statements.15

10.  The law customarily infers states of mind from objective evidence. Cf. Model Penal Code § 2.02 (Am. Law Inst. 1962) (describing various mental states by which criminal guilt is in part determined). 11.  See, e.g., Matthew D. Adler, Risk, Death and Harm: The Normative Foundations of Risk Regulation, 87 Minn. L. Rev. 1293, 1314 (“Because it is structured around general reference classes, general attributes, and relative frequencies, the frequentist account [of probability] is unable to attach a probability number to so-​ called ‘singular’ propositions absent some restructuring of such propositions in general terms.”). 12.  For an introduction to the notion of “interpreting” probability—​that is, of trying to make sense out of the concept—​see Alan Hájek, Interpretations of Probability, The Stanford Encyclopedia of Philosophy (Fall 2007 Edition), http://​plato.stanford.edu/​archives/​fall2007/​entries/​probability-​interpret. 13.  As Colin Howson puts it in a helpful summary: “[T]‌he mathematical theory of probability seems to be a syntax with not one but two interpretations, one epistemic and the other objective, one relating to our knowledge of the world and the other to the world independently of our knowledge.” Colin Howson, Theories of Probability, 46 Brit. J. Phil. Sci. 1, 1 (1995). 14.  See Hájek, supra note 12. 15.  Cf. id.

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Objective views of probability are not limited to games of chance and other well-​defined idealized situations, but they run into difficulty as they move further away from those settings. Under the leading objective view of probability, known as frequentism, before estimating the probability of an event we need to construct a suitable reference class. This prevents us from speaking of objective probabilities for one-​off scenarios, such as whether the Large Hadron Collider will destroy Switzerland. Richard von Mises, a leading expounder of frequentism, has given the following example: [Frequentist probability] has nothing to do with questions such as:  “Is there a probability of Germany being at some time in the future involved in a war with Liberia?” . . . The implication of Germany in a war with the Republic of Liberia is not a situation which frequently repeats itself.16

The construction of appropriate reference classes—​and the decision whether any reference class is appropriate—​is a matter of judgment. For example, in discussing whether a suitable class of repeating events is available in a given type of case, von Mises includes dice games and molecular systems, excludes a war between Germany and Liberia, and concludes that “the reliability and trustworthiness of witnesses and judges [is] a borderline case since we may feel reasonable doubt whether similar situations occur sufficiently frequently and uniformly for them to be considered as repetitive phenomena.”17 It is important to recognize that in some cases as a matter of judgment decision-​makers may need to admit that relying on specific probability figures simply isn’t useful. Without an observed pattern or a theoretical justification for a pattern it becomes difficult either to reach agreement on particular probability estimates or to put probability estimates into practice.

D.  THE ELUSIVENESS OF OBJECTIVE PROBABILITIES, AND OF OBJECTIVE EVIDENCE ABOUT SUBJECTIVE PROBABILITIES, IN CONTRACTS CASES In some areas of law, such as accident cases, it may well be productive to apply objective probabilities, or to use objective evidence to infer subjective beliefs about probabilities. For example, if twice as many automobile accidents occur when automobiles are driven at speed X than at speed Y it makes sense to say that the probability of an accident is twice as high at speed X than at speed Y—​and perhaps it also makes sense to infer that certain actors are likely to have beliefs that accord with that understanding. However, although a few kinds of breach of contract—​such as a manufacturer’s breach of a consumer warranty as a result of a product defect—​might sensibly be analyzed by reference to large classes of events, in typical contracts cases the construction of a suitable reference class will be difficult or impossible. For one thing, by the time a promisor enters into an agreement she ordinarily knows the identity of the promisee, the history of the parties’ negotiation, and other situation-​ specific facts. Therefore, in most cases there simply is no reasonable reference class to use, because 16.  Richard von Mises, Probability, Statistics, and Truth 9–​10 (Hilda Geiringer trans., 2d rev. Eng. ed. 1961). 17.  Id.

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the individual characteristics of the transaction—​the nature of the contract, the amount, timing, negotiating history, personal relationships, locale, and so on—​will swamp any general features of the case and frustrate attempts to generalize. Compare von Mises’s example: even though wars recur through history, a war between two particular countries without a history of war against each other is not the sort of repeating event about which we can say, “This event happens in X out of every Y cases.”18 Accordingly, even if remedies can rest on objective probabilities (or on objective evidence about subjective probabilities) of enforcement in some areas of law, that means little for contract law, where singular and individualized injuries and enforcement are the norm. Moreover, unlike crimes and many torts, breach of contract is typically a private affair, and as a result relevant data would be difficult to gather in the first place. It may be relatively easy for a governmental agency, or even a private organization, to compile statistics about reported but unsolved crimes and then to compute an enforcement error. Similarly, many torts are publicly observed. By contrast, breach of contract tends to fly under the public radar. If a promisor expects to avoid liability for breach, that is probably because she believes that the promisee either will not detect the breach, will not be able to prove there was a breach, or will not have the resources to bring suit. Even if the promisee detects and establishes breach, except in small cohesive business communities it is unlikely that the breach will be reported to any agency or private group interested in and capable of compiling accurate statistics. In any event, the details of private contracts and the characteristics of contracting partners vary so widely that even if reliable data could be gathered concerning the likelihood of underenforcement of either contracts as a whole or of particular classes of contracts, that data would be virtually unusable as applied to any given contract. If there are no sensible ways to reach social or theoretical agreement about probabilities of enforcement in individual contracts cases, it is even less plausible to imagine that we can reliably infer an individual promisor’s subjective beliefs about enforcement. Such an inference would not just be a guess; it would be a guess at a guess. To put this differently, even if there was a sensible objective probability to which the promisor could have personally subscribed, the existence of that probability does not imply that the promisor was able to discern it. Nor would it imply that a court in setting damages would be able to determine that the promisor would predict the level of damages a court would impose.

E.  OTHER ADMINISTRATIVE CONCERNS RAISED BY ENFORCEMENT-​ERROR REGIMES As a result of these factors, estimates of the probability of enforcement errors in contract law are likely to be both highly speculative and highly inaccurate.19 Richard Craswell, who is 18.  There are other objective interpretations of probability, see Hájek, supra note 12, but they do not change the analysis importantly. For instance, there is a view known as logical probability, but it does not attempt to address one-​off events more than do frequentism or classical probability theory. Id. There is also a view known as the propensity interpretation, which does aim to make theoretical objective sense of one-​off events, but not in a way that makes objective probabilities more available. (Propensity theory was developed to explain the probabilities of one-​off events on the quantum-​mechanical level. See id.) 19.  Cf. Omri Ben-​Shahar & Lisa Bernstein, The Secrecy Interest in Contract Law, 109 Yale L.J. 1885, 1896 (2000) (“Unlike in the tort context . . . where actuarial tables make the award of a meaningful average

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generally supportive of the recent work in alternative remedial theory in contract law nevertheless develops a penetrating litany of further, related administrative problems that would be raised by enforcement-​error regimes: As a result [of the administrative costs of an enforcement-​error regime based on subjective estimates of probability,] recent economic analyses have . . . considered the use of multipliers that are the same for all defendants, rather than being figured separately on a case-​by-​case basis. Interestingly, if a constant multiplier is used, the most efficient multiplier will generally be less than the traditional multiplier would suggest, meaning that it will be less than one over the probability of punishment faced by the average wrongdoer. In some cases, the optimal multiplier could even be less than one, meaning that damages should be reduced (rather than augmented) in order to create efficient incentives in the presence of imperfect enforcement. . . . Unfortunately (but perhaps realistically), these analyses also suggest that the exact size of the efficient multiplier will depend on a number of factors that are likely to be hard to measure. . . . In short, the analysis of efficient remedies is complicated enough even if we consider only two sets of consequences: (a) the deterrent effect on wrongdoers, together with (b) the effect on total enforcement costs. That is, even if we limit our attention to these two effects alone, the most efficient measure of damages could be either higher or lower than an exactly compensatory measure. . . .20

In short, even if an economic understanding of enforcement errors was applicable in tort law or criminal law, achieving a coherent enforcement-​error remedial regime in contract law is probably impossible, and such a regime would certainly be unadministrable.21

I II.   REG I M E S T H AT TA KE I NT O  A CCOUNT T H E   S E C R E C Y I NT ER ES T Another critique of the expectation measure, put forward by Omri Ben-​Shahar and Lisa Bernstein, concerns the “secrecy interest” in contract law—​that is, the interest of a promisee in not being required to reveal secret information as a condition to recovering damages in a suit for breach of contract.22 For example, a promisee who wishes to establish a claim for lost profits may not want to reveal secret information about his suppliers or his costs. Ben-​Shahar and Bernstein

measure of damages feasible, using an ‘average expectation’ measure in the contracts context would require courts to make factual determinations . . . that in most cases they are ill-​equipped to make.”). 20.  See Craswell, supra note 1, at 1170–​71. 21.  Moreover, contracting parties—​unlike the parties in a typical tort case—​have some opportunity to minimize in advance the importance of potential enforcement errors. If, for example, the danger is that breach will be unnoticed, the contract can call for an ongoing exchange of information among the parties. If the danger is that breach will not be verifiable to a court, the contract can include a definition of breach that courts can easily apply in a way that the parties can reliably predict. As a result there may be reasons to believe that enforcement errors in contract law will be systematically less significant than in other areas of law. 22.  Ben-​Shahar & Bernstein, supra note 19.

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argue that the rules of contract law, coupled with those of civil procedure, fail to take this secrecy interest into account. As a result, contract damages tend to be undercompensatory because the law’s failure to protect the secrecy interest may cause a promisee to forgo all or part of his claim. Undercompensatory damages, in turn, will fail to provide proper incentives for the goals of achieving efficient performance, precaution, and surplus-​enhancing reliance. Ben-​Shahar and Bernstein do not call into question those goals, the expectation measure, or the Indifference Principle. Rather, their aim is to bolster those goals, and bring the expectation measure into closer conformity with the Indifference Principle, by better assuring that contracting parties are indifferent between performance on the one hand and breach and damages on the other. Accordingly, they write “[w]‌ith a view toward refining, rather than challenging, the well-​ established literature on the economics of contract damages”23 Ben-​Shahar and Bernstein point to a real-​life problem. However, they fail to balance the costs of addressing that problem against the costs of the solutions they propose. To begin with, Ben-​Shahar and Bernstein overweigh the secrecy interest. Observation suggests that promisees regularly bring suit for expectation damages, including lost profits, without a substantial concern about the information they must disclose by doing so. There are a number of reasons this is so. Many types of damages depend on formulas whose elements are not secret, such as the difference between contract price and market price or the difference between the market value of a promised performance and the market value of the performance actually rendered. Next, under the principle of Hadley v. Baxendale24 promisees must often disclose at the time a contract is made that if breach occurs they will incur lost profits of a certain type, thereby diminishing up front the amount of information they would otherwise prefer to keep secret. Furthermore, some kinds of secret information can be shielded in litigation by a protective order. For example, in In re Gabapentin Patent Litigation,25 a patent-​law suit, the court upheld a protective order that allowed a party to redact a supplier’s identity, among other secrets. Similarly, in CSU Holdings v. Xerox Corp.26 the court held that the defendant had not demonstrated that it needed to know the identities of twelve confidential suppliers. Finally, and perhaps most important, most secrets have a very short shelf life whereas litigation is long-​lived. Accordingly, even if there is secret information bearing on a contract that has some value when the contract is made, the information is likely to have lost most or all of that value before litigation proceeds very far. Just as Ben-​Shahar and Bernstein overweigh the costs of the secrecy interest, they underweigh the costs of abolishing or drastically changing the doctrines they believe undermine that interest. Ben-​Shahar and Bernstein critique a variety of remedial doctrines through the lens of the secrecy interest. Their critiques of the cover and mitigation principles are representative. As to cover, they say: In cases in which an aggrieved buyer has in fact covered, proving that she did so in an appropriate manner requires her to reveal a great deal of private information. Establishing whether cover has taken place necessitates an inquiry into many of the transactions that the aggrieved party entered

23.  Id. at 1924. 24.  (1854) 156 Eng. Rep. 145; 9 Exch. 341. 25.  312 F. Supp. 2d 653, 667–​68 (D.N.J. 2004). 26.  162 F.R.D. 355, 358 (D. Kan. 1995).

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into immediately following breach. It may also require her to reveal sensitive business or market information, the identity of the next lowest cost supplier and the price at which he is willing to sell, as well as the identity and price charged by a large number of other market participants.27

As to mitigation they say: A defendant attempting to establish that a plaintiff failed to mitigate her damages is permitted to take broad discovery of numerous documents and information that plaintiffs often have a substantial interest in keeping private.28

Apparently, therefore, Ben-​Shahar and Berstein would abolish the principles of cover and mitigation so as to protect the secrecy interest. However, the costs of abolishing or drastically cutting back the doctrines of cover and mitigation would be very high. The duty to mitigate reduces social losses and thereby increases social welfare. Moreover, that duty is based not only on sound policy but on morality: If a promisee can reduce damages at little or no cost to himself he is morally obliged to do so. Similarly, cover is a central remedy in contract law because it serves as a kind of virtual specific performance. As a remedy, cover has the look and feel of damages, because the buyer ends up with a money judgment. As an act, however, cover yields many of the benefits of specific performance.29 By covering, the buyer finds a replacement performance that, when put together with cover damages, is comparable to what the buyer would have received if the seller had been ordered to specifically perform. Where cover can be achieved it presents four substantial advantages over both market-​price damages and actual specific performance. First, because the buyer chooses the replacement performance himself, cover reflects the buyer’s preferences. Therefore, cover avoids the shortfalls that often result when the buyer’s damages depend on a constructed market price that does not take the buyer’s subjective preferences into account. Second, in the case of a differentiated commodity, cover damages are often much easier to prove than market-​price damages. In such cases, to prove market-​price damages the buyer needs to extrapolate from comparable transactions. In contrast, if the buyer covers, extrapolation may be unnecessary, and it is up to the seller to show that the covering commodity was not reasonably comparable to the contracted-​for-​commodity. Third, the act of cover normally prevents or minimizes the private and social costs of consequential losses. If a seller breaches a contract to supply an input or a factor of production, timely cover will prevent or minimize the buyer’s loss of profits as a result of the breach. Correspondingly, timely cover will prevent or minimize the private cost to the buyer that results from the operation of the principle of Hadley v. Baxendale.30 Finally, actual specific performance often involves problems concerning the enforcement process, mitigation, and the right to a jury trial. Cover does not present these problems. 27.  Ben-​Shahar & Bernstein, supra note 19, at 1912. 28.  Id. at 1913. 29.  Cf. Timothy J. Muris, The Costs of Freely Granting Specific Performance, 1982 Duke L.J. 1053, 1055–​56 (referring to “specific performance of [a]‌contract through the market”); Subha Narasimhan, Modification: The Self-​Help Specific Performance Remedy, 97 Yale L.J. 61 (1987) (using the phrase “self-​help specific performance,” although in a different context). 30.  (1854) 156 Eng. Rep. 145; 9 Exch. 341.

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In contrast to the strong benefits of cover and mitigation, the benefits of implementing the secrecy interest would be extremely low. For example, it is not clear why, as Ben-​Shahar and Bernstein claim, “[e]‌stablishing whether cover has taken place. . . . may . . . require [an aggrieved buyer] to reveal sensitive business or market information, the identity of the next lowest cost supplier and the price at which he is willing to sell, as well as the identity and price charged by a large number of market participants.”31 As a practical matter, normally a buyer will put into evidence a purchase that he claims is cover, and the seller will then have the burden of coming forward with evidence showing either that the purchase was not really a replacement for the breached commodity or that the buyer overpaid. Furthermore, in any event most of the information described by Ben-​Shahar and Bernstein in connection with cover is not secret. For example, it is highly unlikely that “the identity and price charged by a large number of market participants” will be known only to the buyer. Similarly, it is doubtful that a seller who wants to show that a plaintiff who failed to mitigate damages will have a broad right to discover secret documents and information. For example, the issue of mitigation arises most commonly in employment cases, and it is highly unlikely that a wrongfully discharged employee will have a trove of valuable relevant secret documents and information relating to his attempts to mitigate. Much the same will be true in other types of mitigation cases. Of course, there may be instances where a plaintiff will be required to reveal secret information in mitigation or cover cases—​although even that is made unlikely by the short shelf life of secret information—​but these instances will not be thick on the ground. In short, the problem with the remedial regime proposed in The Secrecy Interest is not lack of administrability, but lack of soundness: the proposed regime would throw out the baby with the bathwater. Like the baby, the remedial doctrines that Ben-​Shahar and Bernstein would eliminate or cut back are extremely valuable. Like the bathwater, in the typical case the secrecy interest has little or no value.

I V.   R E G I M E S T H AT HAVE T HE  GOA L OF   P R O M O T I N G E F F I CI ENT   S EA R CH Another possible alternative goal for remedial regimes in contract law is to promote efficient search for contracting counterparties. Search entails costs, but if successful can be rewarding. In particular, the joint surplus produced by one pair of contracting parties may be larger than the joint surplus produced by another, and a party who wants to contract may need to search to locate the counterparty who will generate the highest joint surplus. Peter Diamond and Eric Maskin have modeled the effects of remedial regimes on incentives to conduct efficient searches for contracting partners.32 Diamond and Maskin emphasize that an actor’s decision to search for a contracting counterparty affects other searchers, because 31.  Ben-​Shahar & Bernstein, supra note 19, at 1912 (emphasis added). 32.  See Peter A. Diamond & Eric Maskin, An Equilibrium Analysis of Search and Breach of Contract, I: Steady States, 10 Bell J. Econ. 282 (1979) [hereinafter Diamond & Maskin I]; Peter A. Diamond & Eric Maskin, An Equilibrium Analysis of Search and Breach of Contract, II: A Non-​steady Example, 25 Econ. Theory 165 (1981).

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that decision can influence the matches that other searchers can make. For example, if an actor decides to search for a condominium in Boca Raton he gives prospective sellers in Boca a new opportunity to be matched with a buyer. More generally, a decision to search can either help or hurt other searchers. New high-​quality searchers typically benefit potential counterparties. However, new low-​quality searchers can have either positive or negative effects.33 To simplify somewhat, new low-​quality searchers can help existing searchers by making it easier for them to find someone, but can harm existing searchers by reducing the average quality of potential matches. Given a preset fixed expenditure on search, a searcher’s best result is likely to be lower if the average quality of potential matches is reduced by the entrance of new low-​quality searchers. Accordingly, one of Diamond and Maskin’s central concerns is the positive or negative externalities that result from an actor’s decision to search for contracting counterparties. They argue that a remedial regime can give actors incentives either to search or not, because the regime can affect both the value of contracts that may result from search (thereby making search potentially more or less valuable) and the cost of breaching an existing contract to make a new one. That cost matters to Diamond and Maskin because in their model even after an actor has entered into a contract she can and often will continue to search for a better counterparty. This theory, however, does not easily translate into practice. As Diamond and Maskin point out: [H]‌igher damages induce opposite effects on the incentives for . . . search, sometimes making comparisons with compensatory [that is, expectation] damages difficult. On the one hand, search is encouraged (relative to compensatory damages) by the greater return higher damages yield when breach [of the new contract] occurs. On the other hand, search is discouraged by the higher damages set [for breach under the old contract], which diminish opportunities for breach.34

In other words, while it is conceivable that a remedial regime that is based on search, rather than on the Indifference Principle and the expectation measure, might provide a level of damages that gives better incentives for efficient search activity, Diamond and Maskin do not articulate such a regime. Indeed, as Craswell has pointed out “it is difficult to say whether the optimal measure of damages [for this purpose] would be either higher or lower than the expectation measure, for this may depend on the exact structure of the costs and potential returns to search.”35 Furthermore, even if an alternative remedial regime were successful at optimizing search activity the regime would be likely to promote inefficient perform-​or-​breach decisions. As Diamond and Maskin state, “Damage rules affect both search and breach decisions. Only by happy coincidence could a single instrument induce the right decisions in both categories.”36 It is therefore not surprising that Diamond and Maskin conclude that no single formula for damages promotes efficient incentives for both breach and search. If anything, they suggest,

33.  Diamond & Maskin I, supra note 32, at 283–​84. 34.  Id. at 284. 35. Craswell, supra note 1, at 1165. For Craswell’s discussion of search externalities, which differs somewhat from that of Diamond and Maskin, see id. at 1164–​65. 36.  Diamond and Maskin I, supra note 32, at 299.

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under some conditions “compensatory” (expectation) damages are probably more efficient than higher measures.37 Diamond and Maskin’s argument suffers from another problem. The argument implicitly builds on the theory of efficient breach, because one of Diamond and Maskin’s major concerns is to allow parties who have already contracted to fluidly continue to search for better counterparties. For example, in describing a case of two original pairs of contracting parties in which one party in each pair breaches and the two breaching parties make a new contract with each other, Diamond and Maskin state that with compensatory (that, is expectation) damages, “the incentives for two breaching coincides with efficiency for all four original parties. That is, the two [breaching] individuals find it in their interest to breach precisely when by so doing they increase the sum of the expected payoffs of these four partners.”38 In practice, however, a breach by a promisor—​ as opposed to a mutually agreed-​ upon termination—​almost never increases the payoff to the promisee as compared to the payoff from the performance, and on the contrary almost always decreases that payoff. To begin with, a promisor considering breach typically won’t know whether her gain from breach will exceed her promisee’s loss, and therefore is not in a position to determine the relative joint surplus from breach and performance. More important, expectation damages never make promisees indifferent between breach and performance, because, among other things, such damages generally rest on objective rather than subjective criteria; are unavailable unless reasonably foreseeable at the time the contract is made and fairly certain at the time the contract is breached; often entail the loss of the time value of money; and usually can be recovered only by incurring high legal fees that normally will not be included in the damage award. Indeed, the theory of efficient breach is actually inefficient, as shown in Chapter 6.

V.   C O N C L US I ON The validity of the arguments that particular alternative regimes would significantly further a worthwhile goal is questionable. In the case of some goals a given alternative regime would add only a miniscule incentive to the incentive that actors already have to achieve the goals. In other cases, the goal is already incentivized by law. Furthermore, alternative regimes are for the most part unadministrable in the sense that they cannot be made determinate when applied to real-​world breaches. Indeed, this point is recognized even by Craswell, who is sympathetic to, if not a proponent of, these regimes. For example, Craswell concludes that under a regime whose goal is to provide efficient incen­ tives for investigating potential risks, damages “could be either above or below expectation

37.  For purposes of discussion Diamond and Maskin do at times provide formulas for these measures, but in the end these formulas don’t amount to specific alternative proposals.   Craswell has also proposed that the possibility of more general pre-​contractual incentives ought to influence the damages awarded for breach of contract. Richard Craswell, Precontractual Investigation as an Optimal Precaution Problem, 17 J. Legal Stud. 401 (1988). However, this proposal would be almost impossible to apply, as Craswell recognizes. See Craswell, supra, at 426. 38.  Diamond and Maskin I, supra note 32, at 284.

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damages, with the exact measure depending on the exact costs and benefits of further investigation.”39 Of a regime whose goal is to promote efficiency in the search for contracting partners, Craswell concludes that “it is difficult to say whether the optimal measure of damages would be either higher or lower than the expectation measure, for this may depend on the exact structure of the costs and potential returns to search.”40 Of a regime whose goal is to promote efficiency by applying a multiplier to expectation damages, Craswell concludes that “Unfortunately [economic analysis] suggest that the exact size of the efficient multiplier will depend on a number of factors that are likely to be hard to measure.”41 Of a regime whose goal is to promote efficiency in the pre-​contractual investigation of risks, Craswell concludes that the problems “are likely to vary from case to case and may be impossible to observe precisely.”42 Another problem with alternative damages regimes concerns the relative weight of the goal to be advanced by any given regime as compared to the weight of goals advanced by competing regimes. Of course, if a damages regime could be formulated that advanced all relevant goals, that regime would be best. As Eric Posner has pointed out, however, each of the proposed alternative regimes focuses on one or at most two goals and brackets out all the rest.43 As a result the damages measure that any given alternative regime would promote will often or even usually conflict with the damage measures that all other regimes promote. When a choice must be made among remedial regimes that promote competing goals, the determination which goals should be treated as most weighty is a matter of prudential judgment. The goals served by the expectation measure include attaining efficient levels of precaution and performance, facilitating investment in surplus-​enhancing reliance, and facilitating reliable planning. These goals are widely and correctly believed to be significantly more weighty than any of the goals served by alternative remedial regimes. Finally, the expectation measure is based not only on efficiency considerations but also on elements of fairness, such as the fairness of requiring a buyer to pay the agreed-​upon price of what she has received, the fairness of requiring the losing party to a speculation to pay up, and the fairness of requiring a promisor to live up to a bargain promise that has induced the promisee to take an action that he might not have taken if the promise was not enforceable in full. In contrast, the proposed alternative damages regimes are inferior to the expectation measure not only on efficiency grounds but on fairness grounds as well.

39. Craswell, supra note 1, at 1164. 40.  Id. at 1165. 41.  Id. at 1169. 42. Craswell, supra note 37, at 422. 43.  Eric A. Posner, Economic Analysis of Contract Law after Three Decades: Success or Failure?, 112 Yale L.J. 829, 834–​39 (2003).

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Liquidated Damages In the absence of u nc onsciona b i l i t y, fr au d, or other free-​ standing defenses the courts normally enforce bargains according to their terms. In contrast, contract provisions that liquidate—​fix—​damages for breach are reviewed with special scrutiny (the special-​scrutiny rule). The formulations of this rule vary,1 but stated in its traditional and most general formulation the rule is as follows: Liquidated damages provisions are enforceable only if two requirements are satisfied: actual damages must be difficult to estimate (the difficult-​ to-​estimate requirement), and the liquidated amount must be a reasonable estimate of the actual loss (the reasonability requirement).2 Liquidated-​damages provisions that do not satisfy these requirements are referred to as penalties, and are unenforceable. It is not difficult to find scholars and judges who make arguments against the special-​ scrutiny rule.3 These arguments typically have an explicit or implicit three-​part structure: (1) The special-​scrutiny rule rests on the premise that liquidated-​damages provisions lend themselves to blameworthy exploitation and consequent one-​sidedness in a way that other types of contract provisions do not. (2) That premise is incorrect. (3) Therefore, the special-​scrutiny rule is unjustified. The fallacy in this argument is in its starting point. The justification for the special-​ scrutiny rule is not that liquidated-​damages provisions are especially amenable to blameworthy exploitation and one-​sidedness. Rather, it is that such provisions are systematically likely to reflect the limits of cognition. 1.  See, e.g., Restatement (First) of Contracts § 339 (Am. Law Inst. 1932); Restatement (Second) of Contracts § 356 & cmt. b (Am. Law Inst. 1979) [hereinafter Restatement Second]; 3 Dan B. Dobbs, Law of Remedies: Damages-Equity-​Restitution § 12.9 (2d ed. 1993). 2.  See, e.g., Chaffin v.  Ramsey, 555  P.2d 459, 461 (Or. 1976); Samuel A. Rea, Jr., Efficiency Implications of Penalties and Liquidated Damages, 13 J. Legal Stud. 147, 150 (1984)(“In many states, courts express the penalty rule in words that are identical to the First Restatement of Contracts, § 339(1): the damage agreement is not enforceable unless it was a reasonable forecast of the harm and the harm is difficult to estimate.”). 3.  See, e.g., Lake River Corp. v. Carborundum Co., 769 F.2d 1284, 1289 (7th Cir. 1985) (Posner, J.) (“[T]‌he parties (always assuming they are fully competent) will, in deciding whether to include a penalty clause in their contract, weigh the gains against the costs . . . and will include the clause only if the benefits exceed those costs  .  .  .”); Charles J. Goetz & Robert E. Scott, Liquidated-​Damages, Penalties and the Just Compensation Principle: Some Notes on an Enforcement Model and a Theory of Efficient Breach, 77 Colum. L. Rev. 554, 592 (1977) (“There is no reason to presume that liquidated damages provisions are more susceptible to duress or other bargaining aberrations than other contractual allocations of risk”).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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In most areas of contract law the limits of cognition are not sufficiently salient to figure in the formulation of the governing rules. In some areas, however, these limits are highly salient and have both normative and positive implications. The normative implications concern how the limits of cognition should figure in determining what rules should govern the relevant areas. The positive implications concern how the existing rules in those areas are best explained. One area in which the limits of cognition have a special bearing is the treatment of liquidated-​ damages provisions. To begin with, bounded rationality and rational ignorance are especially salient in this area. Contracting parties normally find it relatively easy to evaluate proposed performance terms—​terms that specify what performance the party is required to render, such as subject matter, quantity, and price—​because these terms are present, vivid, and salient. In contrast, at the time a contract is made it is often impracticable if not impossible to imagine all the scenarios of breach. Correspondingly, the inherent complexity of determining the application of a liquidated-​damages provision to every possible breach scenario will often exceed actors’ processing capabilities. Even on the doubtful assumption that a party could imagine all the scenarios of breach and calculate the application of a liquidated-​damages provision to every possible scenario, the costs of engaging in such a project will often heavily outweigh the benefits. A party who contracts to buy or sell a commodity normally expects to perform. Accordingly, the benefits of carefully deliberating on performance terms are compelling, and the costs of such deliberation usually do not outweigh the benefits. In contrast, a party will often not expect that a liquidated-​damages provision will ever come into play against him, partly because he intends to perform and partly because experience will tell him that in general there is a high rate of performance of contracts. For example, if contracts are significantly breached only 5 percent of the time (which observation suggests is likely), then 100 percent of the costs of processing the applications of a liquidated-​ damages provision would have to be taken into account but the benefits of such processing would have to be discounted by 95 percent. The resulting cost-​benefit ratio will often provide a substantial disincentive for processing every possible application of a liquidated-​damages provision even if it were possible to imagine every such scenario. As a result, contracting parties are often unlikely to think through liquidated-​damages provisions, and therefore are often unlikely to fully understand the implications of such provisions. The problem of irrational disposition also bears on liquidated-​damages provisions. Because actors tend to be unrealistically optimistic, a contracting party probably will believe that his performance is more likely, and his breach less likely, than is actually the case. Accordingly, unrealistic optimism will reduce even further the deliberation that actors spend on liquidated-​ damages provisions. Finally, defective capabilities have particular relevance to liquidated-​damages provisions: (1) The availability heuristic may lead a contracting party to give undue weight to his present intention to perform, which is vivid and concrete, compared to the abstract possibility that future circumstances may lead him to breach, which is pallid and abstract. (2) Because a contracting party is likely to take the sample of present evidence as unduly representative of the future he is apt to overestimate the extent to which his present intention to perform is a reliable predictor of his future intentions. (3) Because actors have faulty telescopic faculties, a contracting party is likely to overvalue the benefit of the prospect of performance, which will normally begin to occur in the short term, as against the cost of a breach, which will typically occur, if at all, only down the road. (4) Because actors tend to underestimate risks, a contracting party is likely to underestimate the risk that a liquidated-​damages provision will take effect.

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The cases provide dramatic evidence of how liquidated-​damages provisions are peculiarly subject to the limits of cognition. For example, in the landmark English case Kemble v. Farren4 an actor had agreed to be the principal comedian at the Covent Garden Theatre during the ensuing four seasons and to fully conform to the theater’s usual regulations. The theater agreed to pay the actor three pounds, six shillings, and eight pennies every night the theater was open during the four seasons. The contract also provided that if either party failed to fulfill the agreement or any part thereof, that party would pay the other a thousand pounds. The actor breached the contract and the theater sued for liquidated damages. The court began by noting that liquidated-​damages provisions can serve valid purposes: “In many cases, such an agreement fixes that which is almost impossible to be accurately ascertained; and in all cases, it saves the expense and difficulty of bringing witnesses to that point.”5 Nevertheless, the court held that the provision in question was unenforceable. In reaching this conclusion, the court pointed out the bizarre ways the provision could operate: [The clause] extends to the breach of any stipulation by either party. If, therefore, on the one hand, the Plaintiff had neglected to make a single payment of 3l. 6s. 8d. per day, or on the other hand, the Defendant had refused to conform to any usual regulation of the theatre, however minute or unimportant, it must have been contended that the clause in question, in either case, would have given the stipulated damages of 1,000 [pounds].6

It is scarcely likely that the parties in Kemble intended their liquidated-​damages provision to apply to every conceivable failure to perform. Rather, it is almost certain that as a result of the limits of cognition the parties failed to think through the multiple, if often minor, scenarios under which the provision could apply. Lake River Corp. v. Carborundum Co.,7 decided by Judge Posner, provides another example of how liquidated-​damages provisions reflect the limits of cognition. Carborundum made a contract with Lake River under which Lake River was to distribute a Carborundum product called Ferro Carbo, an abrasive powder used in making steel. Under the contract, Lake River agreed to take Ferro Carbo in bulk from Carborundum, bag it, and distribute the bagged product to Carborundum’s customers. To handle the Ferro Carbo, Lake River had to install a new bagging system at a cost of $89,000. To ensure recovery of the cost of this system, Lake River insisted on a minimum-​quantity ​guarantee provision, which required Carborundum to ship 22,500 tons of Ferro Carbo to Lake River for bagging during the initial three-​year term of the contract. If Carborundum failed to meet this minimum Carborundum was to pay for the shortfall at the then-​prevailing bagging rate under the contract. As Judge Posner recognized, this was essentially a liquidated-​damages provision.8 The contract was signed in 1979. Thereafter the demand for domestic steel, and accordingly for Ferro Carbo, fell dramatically. As a result, by the time the initial three-​year period expired in late 1982, Carborundum had shipped only 12,000 of the 22,500 tons it had guaranteed, and 4.  (1829) 19 Eng. Rep. 1234; 6 Bing. 141. 5.  Id. at 1237; 6 Bing. at 148. 6.  Id. 7.  769 F.2d 1284 (7th Cir. 1985). 8.  Id. at 1288.

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Lake River demanded payment of $241,000 under the liquidated-​damages provision. The court held that the provision was unenforceable. Judge Posner pointed out that Lake River had expected to make a profit of $107,000 net of all expenses, including the cost of the bagging system, if Carborundum had shipped the full guaranteed quantity. He then demonstrated the extraordinary way the provision operated under other scenarios. For example, if Carborundum had breached the contract before shipping any Ferro Carbo, and the liquidated-​damages provision was enforceable, Lake River would make a profit of $444,000, or more than four times the profit it would have made if Carborundum had performed. If, as actually occurred, Carborundum breached after 55  percent of the Ferro Carbo had been shipped, and the liquidated-​damages provision was enforceable, Lake River would make a profit of $260,000, or two-​and-​a-​half times the profit it would have made if Carborundum had performed. In short, if the provision was enforceable it would generate damages to Lake River ranging up to 434 percent of the profits that Lake River stood to make by full performance. According to Judge Posner’s analysis, if the liquidated-​damages provision was enforced at any of various times between the beginning and nearly the end of Lake River’s performance, it would generate a windfall ranging from 130 percent to 400 percent of Lake River’s expected contract profits, even assuming that the bagging system had no value apart from the contract. It is almost inconceivable that the parties understood and intended that the provision would operate in that way, or that Carborundum, almost undoubtedly the stronger party, would have agreed to the provision if it had understood how the provision operated. The overwhelming likelihood is that, as in Kemble, because of the special bite of the limits on cognition on liquidated-​damages provisions neither Carborundum nor Lake River managed to think through how the provision would operate under various breach scenarios. Cases such as Kemble and Lake River, which are not unique,9 forcefully illustrate that as a result of the limits of cognition the premise underlying the bargain principle—​that a contracting party will act to rationally maximize his expected utility—​does not apply to liquidated-​damages provisions. Since the underlying premise of the bargain principle does not apply, neither should the principle itself. Rather, special scrutiny of liquidated-​damages provisions is justified because such provisions are subject to the limits of cognition in a special way. This explanation of the liquidated-​damages principle is important not only because it justifies special scrutiny of liquidated-​damages provisions but also because it shapes the form this scrutiny should take. Recall that under the traditional rule a liquidated-​damages provision is enforceable only if actual damages would be difficult to determine and the liquidated amount is a reasonable estimate of the actual loss. This general formulation leaves open two critical and parallel questions of application. Difficulty of Determination. The first question concerns the meaning of the test that damages must be difficult to determine. This test is susceptible to two very different interpretations. It may mean that the amount of actual damages if breach occurs is difficult to determine at the 9.  See, e.g., Meltzer v.  Old Furnace Dev. Corp., 254 N.Y.S.2d 246, 249 (1964) (invalidating mortgage provisions that rendered mortgagors liable for an additional 25  percent of mortgage debt for default, because a default of one day would result in the same damages as a default of several months); Alvord v.  Banfield, 166  P.  549, 552 (Or. 1917)  (holding that a lease provision requiring payment of $2,500 for any breach, regardless of magnitude, was a penalty clause); Stewart v. Basey, 245 S.W.2d 484, 487 (Tex. 1952) (holding that a damage stipulation that “was not carefully drawn” should not bind the parties).

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time the contract is made. Alternatively, this test may mean that when the contract is made it is clear that if breach occurs the amount of actual damages will be difficult to determine at the time of breach. These alternatives will be referred to as the time-​of-​contract and time-​of-​breach approaches. The theoretical and practical differences between these two approaches are great. For example, suppose the amount of actual damages if there is a breach will depend on the difference between the contract price and the market price at the time of breach. Under the time-​of-​contract approach the requirement that damages must be difficult to determine will almost always be satisfied because future market prices can almost never be predicted at the time a contract is made. In contrast, under the time-​of-​breach approach this requirement will almost never be satisfied because at that time market price is usually easy to determine. The ambiguity of the difficult-​to-​determine requirement is manifested by a split in the case law. For example, in Lee Oldsmobile, Inc. v. Kaiden10 the court invalidated a liquidated-​damages provision under a time-​of-​the-​breach approach. Kaiden gave Lee, a Rolls-​Royce dealer, a $5,000 deposit on the purchase of a new Rolls-​Royce. Lee then sent an order form to Kaiden, which Kaiden signed and returned. The order form provided that if the purchaser refused to accept delivery of the car Lee could retain any cash deposit as liquidated damages. A dispute then arose concerning the date of delivery. As a result, Kaiden canceled her order and demanded the return of her deposit. Lee refused, and Kaiden brought suit to recover the deposit. The court held that Kaiden was entitled to recover the amount of her deposit, minus actual damages, “because at the time the contract was made, it was clear that the nature of any damages which would result from a possible future breach was such that they would be easily ascertainable.”11 In contrast, in Hutchison v.  Tompkins12 the Florida Supreme Court adopted the time-​of-​ the-​contract approach. The complaint alleged that Buyers agreed to purchase land for $125,000 and deposited $10,000 with an escrow agent toward the purchase price. The contract contained a liquidated-​damages provision under which Sellers could elect to retain the deposit if Buyers failed to perform. Sellers claimed that Buyers breached the contract by refusing to complete the purchase, and sued for the amount of the deposit.13 The trial court dismissed the complaint on the ground that the liquidated-​damages provision was invalid.14 On appeal the Florida Supreme Court began by re-​examining two of its earlier decisions. In Pembroke v. Caudill15 the court applied the time-​of-​breach approach and held that if damages can be readily determined at the time of breach a liquidated-​damages provision will be treated as a penalty even if damages were difficult to determine at the time the contract was made.16 In contrast, in Hyman v. Cohen17 the court had applied the time-​of-​contract approach and held that a liquidated-​damages provision

10.  363 A.2d 270 (Md. 1976). 11.  Id. at 274. 12.  259 So. 2d 129 (Fla. 1972). 13.  Id. at 129–​30. 14.  Id. at 130. 15.  37 So. 2d 538 (Fla. 1948). 16.  Id. at 540–​41. 17.  73 So. 2d 393 (Fla. 1954).

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was enforceable if damages for breach were difficult to determine at the time the contract was made.18 In Hutchison the court followed Hyman rather than Pembroke: Damages, especially in real estate transactions, are nearly always ascertainable at the time a contract is breached, because, as the Pembroke opinion points out, the measure of damages involves determining the difference between the agreed purchase price and the market value of the land as of the date of breach. Accordingly, the rule in Pembroke must have, when followed in letter and spirit . . . a chilling effect on contract negotiations where the parties wish to include a provision for liquidated-​damages.19

Reasonableness. The reasonableness requirement is subject to the same ambiguity as the difficult-​to-​determine requirement. The reasonableness requirement could be based on any of the following standards: (A) The liquidated damages must be a reasonable estimate of the probable loss looking forward from the time the contract was made. (B)  The liquidated damages must not be disproportionate to the loss that was actually sustained. (C) The liquidated damages must satisfy either standard A  or standard B.  (D) The liquidated damages must satisfy both standard A  and standard B.  In this book, standards A  and C will be referred to as forward-​ looking standards and standards B and D will be referred to as second-​look standards. The traditional test for the enforceability of liquidated-​damages provisions is forward-​ looking, that is, turns on the reasonableness of the estimate of future damages at the moment the estimate is made. This test is a corollary of the concept that the reason liquidated-damages provisions should receive special scrutiny is that they are peculiarly susceptible to blameworthy exploitation and one-​sidedness, because whether there was blameworthy exploitation and one-​ sidedness should be judged as of the time the contract is made.20 In contrast, the cognitive justification for special scrutiny of liquidated-​damages provisions suggests a second-​look standard that compares the liquidated-​damages with the actual loss, because a gross discrepancy between forecast and result suggests that the liquidated-​damages provision was a product of limited or defective cognition. Despite the traditional emphasis on the time-​of-​the-​contract, forward-​looking approach to the reasonableness requirement, the second-​look approach seems to be gaining ground. As a predictive matter, even courts that profess a purely forward-​looking approach are likely to take into account the loss actually sustained.21 More important, the second-​look approach has a good deal of support.22 For example, recall that in Hutchison v. Tompkins, the Florida court, following 18.  Id. at 400–​01. 19.  Hutchison, 259 So. 2d at 132. 20.  See, e.g., United States v. Bethlehem Steel Co., 205 U.S. 105, 119–​21 (1907); Sw. Eng’g Co. v. United States, 341 F.2d 998, 1003 (8th Cir. 1965). 21.  Justin Sweet, Liquidated-​Damages in California, 60 Cal. L. Rev. 84, 135–​36 (1972). Sweet concludes that when directly faced with the question most California courts will not knowingly enforce a liquidated-​ damages clause where there is no actual damage, id. at 139; see also Freedman v. Rector, 230 P.2d 629, 632 (Cal. 1951) (holding that any provision that leads to forfeiture without regard to the actual damage suffered would be an unenforceable penalty). 22.  See, e.g., Colonial at Lynnfield, Inc. v. Sloan, 870 F.2d 761, 765 (1st Cir. 1989) (invalidating a liquidated-​ damages provision because no actual damage occurred although the damage estimate was reasonable at the time the contract was made); Nw. Fixture Co. v.  Kilbourne & Clark Co., 128 F.  256, 261 (9th Cir.

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Hyman v. Cohen, adopted the time-​of-​contract approach to the difficult-​to-​determine requirement. However, the court balanced this approach by effectively adopting a second-​look approach for the reasonableness requirement: The better result, in our judgment . . . is to allow the liquidated damage clause to stand if the damages are not readily ascertainable at the time the contract is drawn, but to permit equity to relieve against the forfeiture if it appears unconscionable in light of the circumstances existing at the time of breach. For instance, assume a situation in which damages were not readily ascertainable at the time the contract was drawn, and the parties agreed to a liquidated damage provision of $100,000. Purchaser later repudiated the contract; vendor resold the land to another party, which because of fluctuations in the real estate market, resulted in a loss to himself of only $2,000. In such a case a court following the Hyman theory would allow the liquidated damage clause to stand, because damages were not readily ascertainable at the time of drawing the contract, but would, as a court of equity, relieve against the forfeiture as unconscionable.23

Although the court used the language of unconscionability, that principle, as normally understood, is not apt to describe the second-​look approach the court adopted. This is so both because in the court’s hypothetical there is nothing to suggest exploitation or other unfair conduct and because the principle of unconscionability is better reserved for improper conduct at the time a contract is formed. A second-​look approach for liquidated-​damages provisions is justified not because a second look may show that a provision was unconscionable but because it may show that the provision was in all likelihood the product of defects in cognition. To summarize, the following principle, which will be referred to as the liquidated-​damages principle, should govern the enforceability of liquidated-​damages provisions:  If a liquidated

1904)  (denying recovery under a liquidated-​damages provision to a company that sustained no actual damages); Vines v. Orchard Hills, Inc., 435 A.2d 1022, 1028 (Conn. 1980) (considering actual damages at the time of breach in determining the validity of a liquidated-​damages clause); Norwalk Door Closer Co. v. Eagle Lock & Screw Co., 220 A.2d 263, 268 (Conn. 1966) (invalidating liquidated-​damages clause because no actual damages occurred); Huntington Coach Corp. v. Bd. of Educ., 372 N.Y.S.2d 717, 719 (App. Div. 1975) (refusing to enforce $100-​per-​day liquidated-​damages clause for failure to provide school-​bus services to a school district for a five-​day period where the district had not sought other transportation and the bus company had not billed the district for the period), aff ‘d, 357 N.E.2d 1017 (1976); Kenneth W. Clarkson, Roger LeRoy Miller & Timothy J. Muris, Liquidated-​Damages v. Penalties: Sense or Nonsense?, 1978 Wis. L. Rev. 351, 380 (“[I]‌n numerous cases where the clause was clearly no longer reasonable ex post, the court refused enforcement.”); Restatement Second § 356 cmt. b (1979) (“If . . . it is clear that no loss at all has occurred, a provision fixing a substantial sum as damages is unenforceable”). Illustrations 3 and 4 to § 356 provide as follows: 3. A contracts to build a grandstand for B’s race track for $1,000,000 by a specified date and to pay $1,000 a day for every day’s delay in completing it. A delays completion for ten days. If $1,000 is not unreasonable in the light of the anticipated loss and the actual loss to B is difficult to prove, A’s promise is not a term providing for a penalty and its enforcement is not precluded on grounds of public policy. 4. The facts being otherwise as stated in Illustration 3, B is delayed for a month in obtaining permission to operate his race track so that it is certain that A’s delay of ten days caused him no loss at all. Since the actual loss to B is not difficult to prove, A’s promise is a term providing for a penalty and is unenforceable on grounds of public policy.

23.  Hutchison, 259 So. 2d at 132 (Fla. 1972).

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damages amount is significantly greater than the promisee’s real loss—​that is, the promisee’s loss in fact, not simply his legal damages—​the provision should be unenforceable unless it is established that the parties had a specific and thought-​through intention that the provision would apply in a scenario of breach like the one that actually occurred. This principle has several important implications. One implication is that the mere fact that a liquidated-​damages provision is intended as a penalty should not make the provision unenforceable, David Feller offered an example of a case in which a penalty should be enforceable: Many of the contractual rules governing employee compensation include penalties and are intentionally negotiated as such. For example, premium pay for hours worked on Saturday and Sunday, or before and after the normally scheduled hours, is often intended to penalize improper scheduling. The punitive character of these compensation rules is evidenced by the magnitude of such weekend and overtime premiums as compared to the much smaller premiums for shift work in the same industry, or by comparing the premiums paid for Sunday work in continuous-​process industries, where Sunday work is expected, with the premiums paid in all other industries.24

A second implication of the liquidated-​damages principle is that the difficult-​to-​determine requirement should be dropped, because that test is irrelevant to determining whether a liquidated-​damages provision is a product of the limits of cognition. This modification of the liquidated-​damages principle is not as drastic as it might seem. Cases such as Hutchison, which hold that the application of the difficult-​to-​determine requirement is based on a time-​of-​ contract approach, effectively drop the difficult-​to-​determine requirement, because at the time a contract is made it is usually impossible to determine what the actual damages will be in the event of a breach. A third implication is that the courts should normally take a less searching look at liquidated-​ damages provisions that take the form of deposits. A liquidated-​damages provision that takes that form is less likely to involve cognitional problems than a simple liquidated-​damages provision, partly because the act of putting down money powerfully focuses the mind, and partly because a deposit is instantiated, concrete, vivid, and present. Even though under the liquidated-​damage principle a liquidated-​damage provision will often be unenforceable (as is the case even under traditional principles), the liquidated-​damages principle gives significant effect to liquidated-​damages provisions. Under that principle a liquidated-​ damages provision should relieve the promisee of the burden of proving damages by shifting to the promisor the burden of establishing that the liquid-​damages provision is unenforceable. Furthermore, a liquidated-​damages provision should allow the promisee to recover actual losses that would not otherwise be allowed as expectation damages. For example, through the use of a liquidated-​damages provision a promisee should be able to recover nonpecuniary losses and losses whose recovery would otherwise be barred by the principle of Hadley v. Baxendale or the certainty principle. Finally, under the liquidated-​damages principle a liquidated-​damages provision should be enforceable if the promisee’s actual loss is only determinable within a range and the amount fixed by the provision is within that range.

24.  David E. Feller, The Remedy Power in Grievance Arbitration, 5 Indus. Rel. L. J. 128, 133 (1982).

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In summary, it is a well-established rule that liquidated-damages provisions should receive special scrutiny by the courts. It is often thought that the rationale for this rule is that such provisions peculiarly lend themselves to blameworthiness. This rationale is difficult to support. Because that rationale is weak the case law is often incoherent: like cases are often decided differently, and results are often difficult to predict. The true rationale for the special-scrutiny rule is that the formulation of liquidated-damages is peculiarly susceptible to the limits of cognition. The cognitive justification of the liquidated-​damages principle drives to the surface the real reason to give special scrutiny to liquidated-​damages provisions and also suggests the form such scrutiny should take. That scrutiny should be directed to whether both parties fully understood the potential ramifications of the liquidated-​damages provision. The reasonableness of the provision ex ante, and the accuracy of provision ex post, should inform this scrutiny, but if the court is convinced that the parties intended the provision to apply in the circumstance of breach that actually arose, the provision should be upheld even if there is a substantial disparity between the liquidated amount and the actual loss. Otherwise, not.

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an alternative form of relief. The most prominent alternative is specific performance—​a judicial decree that orders the promisor to render the contracted-​for performance, on pain of a penalty for contempt of court. Under traditional contract doctrine, specific performance is an exceptional remedy, to be granted only if damages would not be adequate. This basic doctrine is elaborated by three important rules: (1) damages are not considered adequate when the subject-​matter of the contract is unique, (2) real property is normally deemed to be unique, and (3) even if damages would not be adequate, specific performance will not be awarded in the case of contracts for personal services or if specific performance would require undue judicial supervision.1 The commentators generally agree that the adequacy test that lies at the center of traditional doctrine is an unsatisfactory instrument for determining when specific performance should be granted, and the test therefore has lost much of its power. As Dan Dobbs and Caprice Roberts put it: The adequacy rule, as a rule that simply bars the gate, is virtually dead and probably should be. Laycock’s immense scholarship and biting analysis will make it difficult to return to that simple shibboleth as a means for exercising discretion, even if we would like to do so. Unqualified support for a general adequacy rule is hard to find. The rule today seems to be one of those rules judges grab off the rack without really trying it on; it doesn’t fit, but it is easy to state with citations.2 1.  See, e.g., Restatement (Second) of Contracts §§ 357, 359–​60, 366–​67 (Am. Law Inst. 1981) [hereinafter Restatement Second]; Lon L. Fuller & Melvin Aron Eisenberg, Basic Contract Law 334–​ 35, 338–​40 (8th ed. 2006). 2. 1 Dan B. Dobbs and Caprice L. Roberts, Law of Remedies § 2.5(3), at 100 (3d ed. 2018) (footnotes omitted); see also Arthur Linton Corbin, Corbin on Contracts § 63.7 (Joseph M. Perillio ed., 2003 ed.) (“Objections on the ground of inadequacy of money damages are less often made than formerly and are given less consideration by the judges.”); Thomas S. Ulen, The Efficiency of Specific Performance: Toward a Unified Theory of Contract Remedies, 83 Mich. L. Rev. 341, 374–​75 (1984); Walgreen Co. v. Sara Creek Prop. Co., 966 F.2d 273 (7th Cir. 1992) (adequacy is often not mentioned in the cases, and where mentioned

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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The commentators also generally agree that specific performance is granted more freely today than traditional doctrine suggests.3 Beyond this point of agreement, however, what principles should govern specific performance has been the subject of intense dispute among warring contracts scholars. Some scholars have enlisted in the Specific Performance Army, which defends the position that specific performance should be routinely granted.4 Others have enlisted in the Damages Army, which defends the position that specific performance should be awarded only with great restraint.5 Both positions have been illuminating, but none of the scholars has convinced members of the opposing Army to defect, and even within each Army most scholars have operated as independent units, largely out of contact with their comrades. This chapter sets up its flag in the admittedly dangerous zone between the two Armies. The principle developed in this chapter is as follows: A court should award actual specific performance unless (1) a special moral, policy, or experiential reason suggests otherwise in a given class of cases; or (2) the promisee can achieve virtual specific performance, that is, he can find in the market a commodity that he could not in good faith reject as an equivalent of the breached performance, given his demonstrable preferences. This principle will be referred to as the Specific Performance Principle. Section I of this chapter discusses three reasons that favor a regime of routine specific performance: the Indifference Principle, the bargain principle, and informational effects. Section II then shows that although these reasons are weighty enough to put a thumb on the scale in favor of specific performance, they are not sufficiently weighty to justify a regime of routine specific performance, because there are a number of countervailing reasons against such a regime, including the nature of the enforcement process and problems of mitigation, opportunism, and jury trial. Section III further develops the Specific-​Performance Principle and compares it to traditional doctrine. Section IV considers the application of the Specific Performance Principle to contracts for the sale of goods, real estate, and services.

I .   T H R E E R E A S O NS I N  FAVOR O F   A R E G I ME O F   R OUT I NE S P E C I F I C P E R F OR M A NCE A.  THE INDIFFERENCE PRINCIPLE A major goal of remedies for breach of a bargain contract should be to satisfy the Indifference Principle—​that is, to make the promisee indifferent in subjective terms between (1) a state of the world in which the promisor breaches and then is required to remedy the breach, and (2) a state is not given much weight); Douglas Laycock, The Death of the Irreparable Injury Rule 253–​54 (1991). 3.  Laycock, supra note 2, at 245–​46. 4.  Alan Schwartz, The Case for Specific Performance, 89 Yale L.J. 271, 281 (1979). 5. This position is implicit in the theory of efficient breach. See, e.g., Anthony T. Kronman, Specific Performance, 45 U. Chi. L.  Rev. 351 (19778); Timothy J. Muris, The Costs of Freely Granting Specific Performance, 1982 Duke L.J. 1053; Edward Yorio, In Defense of Money Damages for Breach of Contract, 82 Colum. L. Rev. 1365 (1982).

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of the world in which the promisor performs. The Indifference Principle is well grounded in both policy and fairness.6 However, expectation damages fall far short of satisfying the Principle, partly because in the case of market-​price damages the judicially constructed market price often fails to account for the buyer’s subjective value, but more importantly because a buyer’s lost profit is often cut off by the principle of Hadley v. Baxendale, the certainty principle, or other damage-​limiting rules. Specific performance comes closer than expectation damages to satisfying the Indifference Principle because it potentially gives the promisee the very performance he bargained for. Accordingly, one reason to favor a regime of routine specific performance is that this regime better effectuates the Indifference Principle than does expectation damages.

B.  THE BARGAIN PRINCIPLE It is a fundamental premise of contract law that voluntary and well-​informed actors are the best judges of how to maximize their own utility. Accordingly, contracts should normally be enforced according to their terms, absent defenses such as fraud, mistake, or unconscionability. An expectation-​damages regime does not enforce contracts according to their terms: it offers a monetary equivalent of performance rather than performance itself. The terms of a contract normally require performance, not performance or its monetary equivalent. If A promises to sell her home to B, that is what A promises to do—​not to either sell B her home or pay B damages.7 It is one thing to monetize injuries caused by a tort. In that case there is no alternative to monetization because the law cannot restore life or limb. In a breach-​of-​contract case, however, the law frequently can give a promisee just what he would have had if the promisor had acted properly by ordering the promisor to perform. Why shouldn’t the law do so?

C.  INFORMATIONAL EFFECTS Often, both parties to a contract could be made better off by termination of the contract than by performance. However, there is an important difference between mutual termination and unilateral breach. There is little or no reason to suppose that a promisor will always or even typically know the value the promisee places on the contracted-​for performance at the time the promisor makes a perform-​or-​breach decision. In contrast, a regime of routine specific performance would ensure that a promisor normally could not terminate a contract without the 6.  See supra Chapter 10. 7.  Oliver Wendell Holmes Jr. famously said that “the duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it,—​and nothing else.” Oliver W. Holmes, Jr., The Path of the Law, 10 Harv. L. Rev. 457, 462 (1897). This aphorism is often interpreted to mean that in Holmes’s view a contract is only a promise to perform or to pay damages. However, Joseph Perillo has shown that taking Holmes’s writings as a whole, this was not Holmes’s view. Joseph M. Perillo, Misreading Oliver Wendell Holmes on Efficient Breach and Tortious Interference, 68 Fordham L. Rev. 1085 (2000). For example, in a letter to Sir Frederick Pollock, Holmes took issue with “the impression that I say that a man promises either X or to pay damages. I don’t think a man promises to pay damages in contract any more than in tort. He commits an act that makes him liable for them if a certain event does not come to pass, just as his act in tort makes him liable simpliciter.” Letter from Oliver W. Holmes to Sir Frederick Pollock (December 11, 1928), in 2 Holmes-​Pollock Letters, 223 (Mark D. Howe ed., 2d ed. 1961).

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promisee’s consent. Such a regime would therefore drive to the surface, before a termination decision is made, information concerning the value that the promisee places on the contracted-​ for performance.

I I.  R E A S O N S A G A I NS T   A R EGI M E OF  RO U T I N E S P E C I F I C PER F OR M A NCE The reasons in favor of a regime of routine specific performance are weighty enough to justify abandoning the traditional doctrine that specific performance is an exceptional remedy, to be awarded only if damages are inadequate. However, these reasons are not sufficiently weighty to justify a regime of routine specific performance, because reasons of policy, morality, and experience often weigh against specific performance. Some of these reasons are general in nature; others apply only to certain categories of cases. The general reasons concern the enforcement process, jury trial, mitigation, opportunism, and suits by sellers. These reasons are discussed in this Section.

A.  THE ENFORCEMENT PROCESS The process by which an award of specific performance is enforced differs radically from the process by which an award of damages is enforced. An award of damages is embodied in a judgment that states that the defendant is liable to the plaintiff for a designated amount of money. In the ordinary case if a judgment is neither paid nor settled the court issues a writ of execution to a sheriff in a county in which the defendant has property or income. The sheriff then seizes and sells the property or levies on the defendant’s income to pay the judgment.8 In contrast, an award of specific performance is embodied in a decree that orders a promisor to perform. Violation of such a decree constitutes contempt of court and is punishable by jail, a civil fine, or both.9 Against that background, at the remedy stage specific performance raises problems concerning social norms and the risk of error.

1. Social Norms In our society there is a general preference for market solutions over intrusive state action. Specific performance is a very intrusive remedy: the state orders an actor to perform a designated and often complex action. Furthermore, specific performance is a highly coercive remedy. Not only does the court order an actor to take a designated action, it threatens to treat her as a

8.  See 1 Dobbs, supra note 2, § 1.4, at 14–​16. 9.  Judgments are enforceable by a variety of techniques known collectively as supplementary proceedings. Supplementary proceedings may occasionally include orders to the defendant or others to implement the proceedings, and violation of these orders may be treated as contempt, but such orders are out of the ordinary course. See id. § 1.4, at 18.

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kind of criminal if she does not do so, by jailing or fining her. The prospect of jailing or fining one person to enhance another’s private gain is inharmonious with social norms concerning the appropriate use of the state’s monopoly on force. It is also inharmonious with the moral idea that there should be proportionality between wrongs and sanctions. Although breach of contract is a wrong it is a low-​intensity wrong as compared with, for example, injuries to the person, fraud, or breach of trust.10

2.  The Risk of Error The legal system may make errors at two stages of a contracts case: the liability stage and the enforcement stage. At the liability stage the likelihood and consequence of errors are unlikely to differ greatly between damages and specific performance. At the enforcement stage, however, there may be significant differences. The risk of error in determining whether a money judgment has been satisfied is very small; in contrast, the risk of error in determining whether a defendant has properly performed under a decree of specific performance may be significant. Contracts often leave much room for interpretation concerning exactly what performance must be rendered, and a decree that requires performance will leave the same room. Accordingly, where specific performance is awarded either the promisor may interpret the contract incorrectly, and therefore mistakenly violate the decree, or the court may interpret the contract incorrectly, and therefore mistakenly conclude that the promisor has violated the decree. Furthermore, the consequences of an error at the enforcement stage are much more severe in specific-​performance cases than in damages cases. In the case of an error concerning whether a judgment for damages has been satisfied the defendant may be required to pay either more or less than she really owes. In contrast, in the case of an error concerning whether a decree of specific performance has been complied with the defendant may improperly be fined or sent to jail. There are ways to ameliorate this problem. For example, in a contempt hearing the court might either give the promisor the benefit of the doubt or give her a second bite at the apple. Nevertheless, the threat of jail or a fine always lies behind a decree of specific performance and these consequences provide another reason why specific performance should not be routinely awarded.

B.  THE PROBLEM OF JURY TRIAL For constitutional and historical reasons a contracting party is normally entitled to a jury trial in a suit for damages but not in a suit for specific performance.11 However, a promisee who has a right to sue for specific performance does not for that reason lose his right to sue for damages. 10.  See Henrik Lando & Caspar Rose, On the Enforcement of Specific Performance in Civil Law Countries, 24 Int’l Rev. L. Econ. 473, 483 (2004). See also Doug Rendleman, The Inadequate Remedy at Law Prerequisite for an Injunction, 33 U. Fla. L. Rev. 346, 355–​56 (1981).   It is true that technically speaking, a promisor who is held in contempt for failing to render specific performance is punished for disobeying the court, not for breaking a contract. However, this is true only technically speaking, because if the contract is performed there will be no contempt. 11.  See 1 Dobbs & Roberts, supra note 2, § 2.6(2), at 107.

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Therefore, in most cases where a promisee has a right to sue for specific performance that right is effectively an option to sue for damages or specific performance—​an option the promisor does not have. Accordingly, a routine right to specific performance would undesirably vest in promisees an option to deny promisors the right to a jury trial simply by suing for specific performance.

C.  THE PROBLEM OF MITIGATION The arguments in favor of routinely granting specific performance often seem to implicitly assume that specific performance is awarded instantaneously, but in reality litigation takes time. It is true that specific performance, especially in the form of temporary injunctive relief, can sometimes be awarded very quickly. Often or even typically, however, a suit for specific performance is not finally resolved until a significant time after the breach.12 In the context of specific performance the element of delay can give rise to problems concerning the mitigation of damages. It is a general principle of contract law that an aggrieved party should take reasonable steps to mitigate his loss and therefore the promisor’s damages.13 The duty to mitigate is desirable as a matter of policy because it reduces social costs. It is also desirable as a matter of morality. If, in a contractual setting, a promisor is at risk of incurring a significant loss, and the promisee could prevent that loss by taking an action that would not require forgoing a significant bargaining advantage, undertaking a significant risk, or incurring some other significant cost, then as a matter of fairness the promisee should be under a duty to take that action.14 A regime of routine specific performance would conflict with the principle of mitigation because under such a regime a promisee could get specific performance even if he had not mitigated. The problem can be illustrated by the following paradigm case: B, a buyer, has contracted to purchase from S, a seller, a commodity that takes time to produce. B instructs S to stop performance because B determines that the value to her of the completed commodity would be less than the contract price. In cases that fall within this paradigm specific performance would involve significant private and social costs, because by continuing performance the seller drives up both the buyer’s costs and social costs without significantly benefiting herself. The problems raised by this paradigm case are well illustrated by Rockingham County v.  Luten Bridge Co.15 Rockingham County and Luten Bridge had entered into a contract under which Luten would construct a bridge for the County. After Luten had begun to build the bridge the County decided that it didn’t want a bridge and instructed Luten to stop work. Separately the County cancelled construction of a road that was to lead to the bridge. Luten disregarded the instruction, completed the bridge, and sued for the contract price. Because the County didn’t want

12.  See, e.g., Weathersby v. Gore, 556 F.2d 1247, 1250 (5th Cir. 1977) (contract made in 1973, appeal decided in 1977). 13.  See generally Charles J. Goetz & Robert E. Scott, The Mitigation Principle: Toward a General Theory of Contractual Obligations, 69 Va. L. Rev. 967, 969 (1983). 14.  See supra Chapter 10. 15.  35 F.2d 301 (4th Cir. 1929).

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the bridge, and indeed in the absence of the road had no possible use for the bridge, the cost of completing the bridge would have been a social loss.16 Moreover, the social loss in the paradigm case is not offset by a private benefit to the seller. In cases that fall within the paradigm, the seller’s damages are typically measured by the contract price minus the variable costs remaining to be incurred by the sellor at the time of breach.17 Under this formula if the buyer countermands, the service-​provider recovers its lost profit whether or not it continues to perform. Continuing to perform therefore drives up the buyer’s damages but not the seller’s gain. For example, assume that in Rockingham County the contract price was $100,000, the variable costs of building the bridge were $80,000, and the County countermanded when Luten had incurred $40,000 of the projected variable costs. In that case if Luten stopped work when the County countermanded, Luten’s damages would have been $60,000—​the $100,000 contract price minus the $40,000 variable costs remaining to be incurred. However, Luten’s gain from the damages would have been only $20,000, because $40,000 of the $60,000 damages would merely reimburse Luten for the variable costs it had incurred before breach. Now suppose that instead of stopping performance Luten completed performance (as in fact it did). If that were permissible Luten’s damages would simply be the contract price, $100,000. (There would be no deduction for variable costs remaining to be incurred because no such costs would remain.) However, Luten’s gain would still be only $20,000, because $80,000 of the $100,000 damages would merely reimburse Luten for its variable costs incurred. Accordingly, Luten’s continuation of performance after the County’s countermand would increase the County’s loss from $60,000 to $100,000 without making Luten any better off. In such cases, the service-​provider should not be entitled to specific performance. Another facet of the conflict between the mitigation principle and a regime of routine specific performance is illustrated by Weathersby v. Gore.18 On March 6, Gore, a farmer, agreed to sell Weathersby the cotton that Gore produced on 500 acres of land during the year, at a price of 30¢ per pound. On May 3, Gore gave Weathersby notice that he was canceling the contract. Weathersby could have covered by buying cotton from another vendor, but he did not. Soon after May 3, cotton was selling for around 35¢. On September 28, Weathersby sued for specific performance. By that date cotton had soared to 80¢. Awarding specific performance to Weathersby would have conflicted with the strong policy reasons in favor of the duty to mitigate, and the court properly held that Weathersby was not entitled to specific performance because he could have covered. As the court said: Weathersby was adequately protected from any damages occasioned by Gore’s breach of the contract, if any occurred. He could have acquired additional cotton on the open market when Gore informed him he would no longer perform under the contract. He did not do so and thus, if

16.  The court properly held that Luten could not recover the contract price. Id. at 307. This is the American rule, although the English rule may be different. See White & Carter (Councils) Ltd. v. McGregor, [1962] A.C. 413 (HL) 427 (appeal taken from Scot.); Melvin A. Eisenberg, The Duty to Rescue in Contract, 71 Fordham L. Rev. 647, 656–​57 (2007). 17.  Under an equivalent formula, the seller’s damages are measured by lost profits, based on the contract price minus total variable costs, plus variable costs incurred prior to the breach. Both formulas are subject to an offset for amounts previously paid by the buyer, which can be disregarded for present purposes. Both formulas lead to the same results. 18.  556 F.2d 1247 (5th Cir. 1977).

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Specific Performance entitled to damages at all, must settle for the difference between the contract and the market price at the time Gore cancelled.19

In short, a regime of routine specific performance would sometimes or often conflict with the principle that a victim of breach has a duty to take reasonable actions to mitigate his damages.

D.  SUITS BY A SELLER A regime of routine specific performance would also normally be inappropriate in suits by sellers. In case of breach by a seller a buyer’s market-​price damages often fall far short of satisfying the Indifference Principle, partly because the constructed market price of a differentiated commodity often fails to account for the buyer’s subjective value and partly because a buyer’s lost profit is often cut off by the principle of Hadley v.  Baxendale, the certainty principle, or other damage-​limiting rules. In contrast, normally the only obligation of a buyer is to pay money. Accordingly, breach by a buyer normally does not involve the problem of measuring the promisee’s subjective valuation, because no given dollar has a different subjective value from any other given dollar. Similarly, breach by a buyer seldom involves problems under the principle of Hadley v. Baxendale because a seller normally will not forgo profitable opportunities simply because a given buyer has not made a payment. Ordinarily, therefore, a seller would be indifferent between damages for the nonpayment of money and a decree ordering the buyer to pay the money, except insofar as the seller sets an emotional value on the draconian sanctions that may be imposed for noncompliance with a decree. Accordingly, in the case of breach by a buyer a seller’s suit for damages for the nonpayment of money is equivalent to a suit for virtual specific performance, and the availability of such a suit should preclude a suit for actual specific performance. A right to routine specific performance against buyers would also be inappropriate because it would deny buyers a right to a jury trial and subject them to the threat of imprisonment for debt, for no sufficient reason.

E.  THE PROBLEM OF OPPORTUNISM Alan Schwartz has made the following argument in favor of a regime of routine specific performance:  (1) Specific performance is often an unsatisfactory remedy because a promisor whose performance is coerced is likely to render a defective performance. (2)  Therefore, a promisee will sue for specific performance only if damages would be inadequate to put the promisee where he would have been if the contract had been performed. (3) That being so, if a promisee sues for specific performance we know that damages are inadequate. (4) Accordingly, specific performance should be routinely granted.20 This argument is defective because the second premise is incorrect. It is not the case that a promisee will sue for specific performance only if damages would be inadequate. Instead, in the

19.  Id. at 1258–​59; see also Duval & Co. v. Malcom, 214 S.E.2d 356, 359 (Ga. 1975). 20. Schwartz, supra note 4, at 276–​78.

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case of a contract of sale a promisee may sue for specific performance opportunistically, because specific performance offers the potential for a kind of extortion. Take, for example, Weathersby v. Gore, the sale-​of-​cotton case. Cotton of a given grade is normally fungible, and nothing in the case indicated that there was anything special about Gore’s cotton. Accordingly, Gore, the farmer, presumably could have satisfied a decree of specific performance either by delivering his own cotton or by purchasing an equivalent amount of cotton of the same grade on the market and then delivering the purchased cotton. With one major caveat, therefore, an award of specific performance against Gore would have been indistinguishable from a suit for expectation damages measured by the difference between the contract price and the market price. Here is the caveat: a promisee who has a right to specific performance also has a right to sue for damages in lieu of specific performance. If the promisee sues for damages, his damages will be measured by the market price at the time of the breach. In contrast, if the promisee sues for specific performance, he can effectively force the seller to purchase the commodity, for redelivery to the buyer, at the market price at the time of the decree. In such cases, therefore, under a regime of routine specific performance an opportunistic buyer will initially bring suit for both specific performance and damages. If the price of the commodity rises after the breach the buyer will drop his suit for damages and make the seller purchase the commodity for the buyer at the market price at the time of the decree, or, more likely, make the seller settle for an amount approaching the difference between the market price at that time and the contract price. If, on the other hand, the price of the commodity falls after the breach, the buyer will drop his suit for specific performance and collect damages based on the market price at the time of breach. But where the buyer could have covered at the time of breach the law should not allow him to opportunistically put the seller in this fork.21 A regime of routine specific performance would also create a potential for opportunism where a seller breaches and the difference between the seller’s cost of performance and the value of the performance to the buyer is so great it is clear that the buyer does not really want specific performance. Instead, the buyer only wants a decree that he can opportunistically use as a lever to capture a portion of the difference between the seller’s cost and the buyer’s value. For example, in Eastern Steamship Lines, Inc. v. United States22 the Government requisitioned Eastern’s vessel, Acadia, for use in World War II. The Government agreed that before it redelivered the Acadia it would either restore the vessel to the condition the vessel it was in when it was delivered to the Government or pay Eastern the amount required to restore the vessel to that condition. The Government did neither, and Eastern brought suit for the projected cost of restoration. The cost of restoring the vessel would have been $4 million, but the value of the Acadia as restored would have been only $2 million. The court properly held that Eastern was not entitled to the cost of restoration. Now suppose Eastern sued for specific performance. Since the Government was in breach, under a regime of routine specific performance that remedy would be granted. But since Eastern would not really want specific performance, it would not have enforced the decree. Instead it would have opportunistically bargained with the Government to surrender its right to specific performance in exchange for a payment of some amount between $2 million and $4 million.

21.  See 3 Dobbs, supra note 2, § 12.8(1), at 195. 22.  112 F. Supp. 167 (Ct. Cl. 1953).

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Similarly, in Jacob & Youngs, Inc. v. Kent,23 Jacob & Youngs contracted to build a country house for Kent. The contract required the use of cast-​iron plumbing pipe manufactured by Reading. After the house had been completed, Kent learned that Jacob & Youngs had installed cast-​iron pipe manufactured by Cohoes. Cohoes pipe was equal in quality, appearance, market value, and cost to Reading pipe—​“indeed, the same thing, though manufactured in another place.”24 Because the pipe was largely encased within the walls of the completed house, installation of Reading pipe in place of the Cohoes pipe would have required a large expenditure to demolish and then reconstruct substantial parts of the house. If a court ordered Jacob & Youngs to specifically perform, clearly Kent would not have enforced the decree. Instead, he would have opportunistically bargained with Jacob & Youngs to surrender his right to specific performance in exchange for an amount between (1) the value to him of the difference between the Cohoes pipe and the Reading pipe, and (2) the cost of demolishing and reconstructing the house. Cases such as Eastern Steamship and Jacob & Youngs further illustrate that just because a promisee sues for specific performance doesn’t mean he wants it.

I I I .   T H E S P ECI F I C P E R F O R M A N C E PR I NCI PL E The Specific Performance Principle—​that actual specific performance should be awarded unless a special moral, policy, or experiential reason suggests otherwise in a given class of cases or the promisee can achieve virtual specific performance—​balances the considerations for and against routine specific performance. The Principle requires actual specific performance to be awarded unless a special moral, policy, or experiential reason suggests otherwise in a given class of cases or the promisee can achieve virtual specific performance. Under this Principle, specific performance should be liberally but not routinely granted. Often, the result under the Specific Performance Principle would be the same as the result under traditional doctrine. There are, however, three major differences between the Principle and traditional doctrine. First, the tests under traditional doctrine are court-​centered; that is, the tests depend on whether, in the view of the court, damages are adequate, or readily measurable, or the contracted-​ for commodity is unique. This is true even for the most elegant version of traditional doctrine, developed by Anthony Kronman, which conflates the issues of measurability and uniqueness: Although it is true in a certain sense . . . that every good has substitutes—​this is an empty truth. What matters, in measuring money damages, is the volume, refinement, and reliability of the available information about substitutes for the subject matter of the breached contract. When the relevant information is thin and unreliable, there is a substantial risk that an award of money damages will either exceed or fall short of the promisee’s actual loss. Of course this risk can always be reduced—​but only at great cost when reliable information is difficult to obtain. Conversely, when there is a great deal of consumer behavior generating abundant and highly dependable 23.  129 N.E. 889 (N.Y. 1921). 24.  Id. at 890.

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information about substitutes, the risk of error in measuring the promisee’s loss may be reduced at much smaller cost. In asserting that the subject matter of a particular contract is unique and has no established market value, a court is really saying that it cannot obtain, at reasonable cost, enough information about substitutes to permit it to calculate an award of money damages without imposing an unacceptably high risk of undercompensation on the injured promisee.25

In contrast to traditional doctrine, the Specific Performance Principle is promisee-​centered. The question under this Principle is whether at the time of breach a commodity that the promisee could not in good faith reject as an equivalent of the breached commodity, given the promisee’s demonstrable preferences, was readily available in the market. Accordingly, as Tom Ulen states: [S]‌ubjective valuation rather than uniqueness . . . makes specific performance attractive. Clearly, there is a relationship between uniqueness and subjective valuation: someone is more likely to attach a value greater than market value to a rare, one-​of-​a-​kind item than to a highly fungible item. However, the class of things to which someone attaches a subjective valuation is greater than the class of unique items.26

A second difference between the Specific Performance Principle and traditional doctrine is that often the Principle will lead easily to the conclusion that specific performance should be granted in cases where a court applying traditional doctrine could reach that conclusion only with difficulty, if at all. For example, in Allegheny Energy, Inc. v. DQE, Inc.,27 the issue was whether Allegheny, a large publicly held utility, could specifically enforce a merger contract with another large publicly held utility, DQE. Applying traditional doctrine, the district court denied specific performance on the ground that damages were adequate. The Court of Appeal also applied traditional doctrine, but reversed and granted specific performance on the basis of a long analysis exploring in great detail why damages were inadequate because they were difficult to measure. In contrast, under the Specific Performance Principle no detailed analysis would have been required. There were no special policy, moral, or experiential reasons not to grant specific performance, and it would strain credulity to believe that Allegheny could have achieved virtual specific performance by finding an alternative merger partner that had the business and financial characteristics of DQE and was willing to merge on the same terms and conditions as was DQE. A third difference between the Specific Performance Principle and traditional doctrine is that the Principle provides a relatively clear standard while traditional doctrine does not. As Dobbs points out, adequacy of damages has become transformed from a test to a factor. Once that transformation occurred, traditional doctrine ceased to provide a standard to govern when specific performance should be awarded. In effect, the rules of traditional doctrine became a mere checklist with highly uncertain application. In contrast, the Specific Performance Principle is both a better explanation of the cases and a better predictor of results.

25. Kronman, supra note 5, at 362. 26. Ulen, supra note 2, at 375–​76. 27.  171 F.3d 153 (3d Cir. 1999).

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I V.   A P P L I C AT I O N OF   T HE S PECI F I C P E R F O R M A N C E PR I NCI PL E TO  IM P O RTA N T T Y P E S OF   CONT R A CT S This Section will elaborate the Specific Performance Principle by illustrating its application to contracts for the sale of goods, real estate, and services.

A.  CONTRACTS FOR THE SALE OF GOODS Whether specific performance of a contract for the sale of goods should be awarded under the Specific Performance Principle depends on four variables: whether the buyer or the seller breached the contract, the degree of the goods’ differentiation, the nature of the market, and the purpose of the contract.

1.  Seller’s Breach of a Contract for the Sale of Goods For purposes of considering whether specific performance should be ordered in contracts for the sale of goods, goods can be divided into three categories: undifferentiated or fungible—​that is, homogeneous goods; highly differentiated goods; and moderately differentiated goods.

a.  Homogeneous Goods to be Delivered in the Near Future The concept of homogeneous goods typically conjures up basic commodities, such as wheat, coal, or steel. For purposes of specific performance, however, new manufactured goods may also be homogeneous. So, for example, new 2016 Toyota Camry LEs with a given set of factory-​ installed options are homogeneous, and so are new Timken roller bearings of given specifications. However, neither new cars as a class nor new roller bearings as a class are homogeneous. The normal case. In the normal case homogeneous goods are sold on a relatively thick market for delivery in the relatively near future. In such a case specific performance should not be granted for breach by the seller, because the buyer can accomplish virtual specific performance by purchasing an identical substitute on the market and suing for the difference between the cover price and the contract price. The result will not produce a shortfall as compared to actual specific performance. Because the commodity is homogeneous, subjective valuation is not an issue. Because a covering buyer normally will not incur a lost profit as a result of the breach, neither the principle of Hadley v. Baxendale nor the certainty principle should present problems. For example, assume that Seller agrees to sell 1,000 bushels of No. 2 wheat to Buyer at $4.00/​ bushel, with delivery on September 1. Buyer plans to use the wheat to fill a contract he has made to sell No. 2 wheat to T at $4.50/​bushel. On September 1, Seller breaches. At the time of breach, the market price of No. 2 wheat is $4.25/​bushel. If Buyer were instantaneously awarded specific performance he would obtain the wheat from Seller at $4.00/​bushel, deliver the wheat to T, and earn a profit of 50¢/​bushel. If specific performance is not an available remedy, Buyer will cover

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at $4.25/​bushel, deliver the wheat to T, and sue Seller for cover damages. Buyer will again earn 50¢/​bushel—​a profit of 25¢/​bushel on his sale to T, and damages of 25¢/​bushel against seller—​ and therefore will have accomplished virtual specific performance. A similar analysis applies if Buyer purchases the wheat for use rather than resale—​for example, if Buyer is a baker who plans to use the wheat to make bread to sell to supermarkets. Of course, Buyer will not be as well off with virtual specific performance as he would have been if the contract had been performed, because to accomplish virtual specific performance the buyer must pay the costs of dispute-​resolution and may not be adequately compensated by prejudgment interest. However, those shortfalls will also occur if the buyer seeks actual specific performance. Accordingly, even though the buyer is not as well off with virtual specific performance as he would have been if the contract had been performed, he is as well off as he would have been with actual specific performance. Alan Schwartz has argued that specific performance should be routinely available even in the case of homogeneous goods. A lynchpin of his argument is that a seller can cover just as effectively as a buyer and can then specifically perform by transferring the replacement goods to the buyer.28 This is not self-​evident. Sellers are experts in knowing the best channels through which to sell, but cover involves a purchase, and buyers are experts in knowing the best channels through which to buy. Furthermore, even if a seller can cover as easily as a buyer that would not provide a sufficient reason to grant actual specific performance when the buyer can easily accomplish virtual specific performance. Why use a highly intrusive and coercive remedy, and deny the seller the right to a jury trial, when a market transaction will put the buyer in exactly the same position? Moreover, in the normal case of a contract for the sale of homogeneous goods specific performance is not only unnecessary but inappropriate, because it would conflict with the principle of mitigation, as illustrated by Weathersby v. Gore, the cotton case.

b.  Long-​Term Supply Contracts Suppose that a contract for the sale of homogeneous goods is a long-​term supply contract rather than a contract to deliver goods in the near future. In that case specific performance should be required because of two related respects in which long-​term contracts for the sale of homogeneous goods differ from the normal case. First, buyers who enter into a long-​term contract for the supply of homogeneous goods often do so because they place an especially high premium on the reliability of supply. Usually, only actual specific performance will provide the buyer with the high degree of reliability for which he bargained. Second, and more important, in a long-​term contract for the supply of homogeneous goods the subject-​matter of the contract is not just the goods. What the buyer contracts for is not a certain number of goods at a given price, but a certain number of goods at a given price over a given period of time. Accordingly, the issue is not whether the goods are homogeneous, but whether contracts to supply such goods over the same period of time are homogeneous. Where the buyer has contracted for a long-​term supply of goods the fact that goods of the same kind are readily available on the market does not mean that the buyer can cover. Rather, the buyer can cover only if contracts for the sale of such goods over the same period of time are readily available on the

28. Schwartz, supra note 4, at 286.

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market. Normally that will be unlikely. As a result, actual specific performance should normally be granted in such cases. These points are nicely illustrated by Laclede Gas Co. v. Amoco Oil Co.29 In 1970, Amoco and Laclede (more accurately, their predecessors in interest) entered into a master contract. This contract was designed to allow Laclede to provide local propane-​gas-​distribution systems to residential developments in Missouri until natural-​gas mains were extended to a given development. The master contract contemplated that a developer would apply to Laclede for a local propane-​distribution system. Laclede could then request Amoco to supply propane to Laclede for the development. Laclede would make such a request in a letter agreement whose form was prescribed by the master agreement. If Amoco decided to supply propane to the development it would bind itself to do so by signing the letter agreement. Laclede, for its part, agreed to pay for the propane it bought from Amoco at Amoco’s posted price for propane plus 4¢ per gallon. Since Laclede agreed to pay an ever-​changing price that was geared to the market, clearly the primary purpose of the contract was to ensure reliability of supply, not reliability of price. In breach of the letter agreements it had made, Amoco stopped supplying propane to Laclede. At the time of the breach, propane was readily available on the open market. The court nevertheless properly ordered specific performance, because even though propane was readily available on the market there was uncontradicted expert testimony “that Laclede probably could not find another supplier of propane willing to enter into a long-​term contract such as the Amoco agreement, given the uncertain future of worldwide energy supplies.”30

c. Goods Not Readily Available in the Market Specific performance of a contract for the sale of homogeneous goods should also be granted if the goods are not readily available in the market. This would be the case, for example, where the seller is a monopolist and there is no well-​developed aftermarket for its goods, or where the relevant kind of goods have come into critically short supply—​perhaps because of a shock such as war—​and obtaining the goods on the market would be very difficult. For example, in Kaiser Trading Co. v. Associated Metals & Minerals Corp.31 Associated agreed to supply Kaiser with 4,000 tons of cryolite, a chemical compound indispensable to the production of aluminum, for use in Kaiser’s aluminum plants, but had only supplied 500 tons at the time of Kaiser’s suit.32 At the time of Kaiser’s suit only a few hundred tons of cryolite were available on the open market. The court properly ordered specific performance. Similarly, in Eastern Air Lines, Inc. v. Gulf Oil Corp.,33 Gulf contracted to supply Eastern with its requirements of aviation fuel in certain cities. Gulf renounced the contract during the energy crisis caused by the OPEC oil boycott in the 1970s. The court found that if Gulf ceased to supply Eastern with fuel “the result will be chaos,” and ordered specific performance.34 29.  522 F.2d 33, 40 (8th Cir. 1975). 30.  Id. 31.  321 F. Supp. 923 (N.D. Cal. 1970). 32.  Id. at 925. 33.  415 F. Supp. 429 (S.D. Fla. 1975). 34.  Id. at 442. See also Texas Co. v. Cent. Fuel Oil Co., 194 F. 1, 10–​11, 24 (8th Cir. 1912) (crude oil); Kann v. Wausau Abrasives Co., 129 A. 374, 378–​79 (N.H. 1925) (garnets); G.W.S. Serv. Stations, Inc. v. Amoco

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2.  Highly Differentiated Goods If a good is highly differentiated—​one of a kind—​then by hypothesis virtual specific performance is not available, and actual specific performance normally should and will be granted. The high degree of differentiation may be either objective or subjective. As both an objective and subjective matter, an Old Master painting is highly differentiated from any other painting. So is any other nontrivial work of art, or a controlling block of shares in a closely held corporation. Even a dollar bill can be highly differentiated as a subjective matter if it is the first dollar that a business earned.

3.  Moderately Differentiated Goods Suppose a contract for the sale of goods involves goods that are moderately differentiated. An example is a good that is similar, but not identical, to other used goods of the same kind. For example, suppose Timken Roller Bearings Company agrees to sell Buyer 20,000 400-​millimeter spherical roller bearings. The bearings are substantially but not completely identical to 400-​ millimeter spherical roller bearings made by other manufacturers. Timken breaches. There is no significant aftermarket for Timken roller bearings. Under the Specific-​Performance Principle the issue should not be whether other manufacturers’ 400-​millimeter spherical roller bearings are objectively close substitutes for Timken’s. Instead, it should be whether the buyer can in good faith decline to accept other manufacturers’ roller bearings as replacements on the basis of its demonstrable preferences—​because, for example, a certain aspect of Timken roller bearings is especially useful for its purposes, or because it wants all of its machines to have the same roller bearings, or because Timken roller bearings have a special reputation for reliability. In any of these cases the buyer cannot achieve virtual specific performance by a market transaction, and therefore should be entitled to actual specific performance. This approach is reflected in an illustration in Restatement Second: A contracts to sell to B the racing sloop “Columbia,” this sloop being one of a class of similar boats manufactured by a particular builder. Although other boats of this class are easily obtainable, their racing characteristics differ considerably and B has selected the “Columbia” because she is regarded as a witch in light airs and, therefore, superior to most of the others. A repudiates the contract and B sues for specific performance. Specific performance may properly be granted.35

Oil Co., 346 N.Y.S.2d 132, 143 (N.Y. Sup. Ct. 1973)  (gasoline); DeMoss v.  Conart Motor Sales, Inc., 72 N.E.2d 158, 160 (Ohio Ct. C.P. 1947), (new autos), aff ’d, 78 N.E.2d 675 (Ohio 1948). Furthermore, even if a commodity is generally available, specific performance should and will be granted if the commodity is not available promptly or in the local marketing area. See Bomberger v. McKelvey, 220 P.2d 729, 735–​36 (Cal. 1950) (salvaged plate glass and skylights); Cumbest v. Harris, 363 So. 2d 294, 297 (Miss. 1978) (stereo components). 35.  Restatement Second § 360 cmt. b, illus. 2.

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4.  Breach by the Buyer In the normal case a seller of goods should not be awarded specific performance for a breach by a buyer: Because a buyer normally only agrees to pay money, a seller ordinarily can achieve virtual specific performance by reselling the contracted-​for commodity on the market and then bringing a damages action for the difference between the resale price and the contract price plus the cost of making the second sale. This is just the position taken in the Uniform Commercial Code. Article 2 of the Code contemplates actions for specific performance, in appropriate cases, by buyers or goods, but not by sellers.36 Suppose that the seller is unable, after reasonable effort, to resell the goods at a reasonable price or the circumstances indicate that such an effort will be unavailing. UCC Section 2–​709 provides that if the seller has identified the contracted-​for goods to the contract—​that is, earmarked the goods for delivery to the buyer—​he can bring an action against the buyer for the price of the goods. This action has sometimes been characterized as one for specific performance,37 probably because it requires the buyer to do exactly what he promised to do—​that is, to pay the purchase price. In fact, however, the action is at law for damages and therefore constitutes virtual, not actual, specific performance. Because the action is at law the buyer is entitled to a jury trial and the judgment is enforceable by a levy on the buyer’s prop­ erty or income, not by contempt.

B.  CONTRACTS FOR THE SALE OF REAL PROPERTY 1.  Breach by the Seller Where a seller breaches a contract to sell real property the traditional rule is that specific performance will be awarded. This rule is rested on the ground that all real property is unique.38 That proposition is inaccurate. Real property may be either highly differentiated, such as a Frank Lloyd Wright home or a landmark commercial building; moderately differentiated, such as most homes and commercial properties; or homogeneous, such as much tract housing and raw land. A few cases recognize this reality and criticize the traditional rule. For example, in Semelhago v. Paramadevan,39 decided by the Canadian Supreme Court, the seller breached a contract to sell a home. Although the case did not involve a decree of specific performance, the court forcefully pointed out that not all real estate is unique: While at one time the common law regarded every piece of real estate to be unique, with the progress of modern real estate development this is no longer the case. Residential, business and industrial properties are mass produced much in the same way as other consumer products. If a deal falls through for one property, another is frequently, though not always, readily available.

36.  Compare U.C.C. § 2-​703 (Am. Law Inst. & Unif. Law Comm’n 2002) (seller’s remedies in general) with U.C.C. § 2-​711 (Am. Law Inst. & Unif. Law Comm’n 2002) (buyer’s remedies in general). 37.  See, e.g., Laycock, supra note 2, at 252. 38.  Restatement Second § 360 cmt. e. 39.  [1996] 2 S.C.R. 415.

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It is no longer appropriate, therefore, to maintain a distinction in the approach to specific performance as between realty and personality. It cannot be assumed that damages for breach of contract for the purchase and sale of real estate will be an inadequate remedy in all cases. . . . 40

In Watkins v. Paul,41 decided by the Idaho Supreme Court, the court refused, on comparable grounds, to order specific performance of an option to purchase a tract of land: The evidence fails to show that the plaintiffs need the land in question for any particular, unique purpose, which is one of the main reasons for granting specific performance; on the contrary, the plaintiffs’ own evidence shows that they seek to obtain the land only so that they may resell it for profit. Under these circumstances, specific performance would bring the plaintiffs no greater relief than would damages in the amount of their lost profit.42

Semelhago and Watkins represent a minority view. Although they are correct in stating that some real property is homogeneous, there are two related reasons why contracts to sell real prop­erty nevertheless should be specifically enforceable by the buyer in all cases. The first reason concerns administrability. Homogeneous real property is the exception, not the rule. Most real property has special characteristics that would justify a buyer’s good-​ faith determination that a substitute is not readily available in the market, given the buyer’s demonstrable preferences. Because most real property will have such characteristics it is administratively preferable to adopt a simple rule covering all real property rather than to engage in expensive case-​by-​case analysis. The second reason why contracts to sell real property should routinely be specifically enforceable by the buyer is that specific performance against a seller of real property usually does not raise all of the problems that are frequently associated with that remedy. Under modern statutes an action for specific performance of a contract to sell real property normally does not terminate in a decree against the seller enforceable by contempt. Instead, such an action normally terminates in a self-​executing decree that has the effect of a deed and can be recorded in the Registry of Deeds.43 Accordingly, the seller’s property is normally transferred without any action on her part, so that specific performance in this context is normally neither highly intrusive nor highly coercive and is not subject to a serious risk of error at the enforcement stage.

2.  Breach by the Buyer In contracts for the sale of real property, specific performance is also usually appropriate against buyers. Almost invariably, the purpose of a decree in such cases is not to require the buyer to pay money but simply to cut off—​foreclose—​the buyer’s interest in the property so that the seller can resell the property free and clear. Although a foreclosure decree is commonly referred to as specific performance, it is self-​executing. Therefore, like a decree against a defaulting seller of

40.  Id. at 428. 41.  511 P.2d 781 (Idaho 1973). 42.  Id. at 783. 43.  See, e.g., Ga. Code Ann. § 9-​11-​70 (2017); See also Silverman v. Alday, 38 S.E.2d 419, 423 (Ga. 1946).

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property, a decree against a defaulting buyer usually does not entail the problems that may be raised by a suit for specific performance.

C.  CONTRACTS FOR THE PROVISION OF SERVICES The application of the Specific-​Performance Principle to contracts for the provision of services raises several kinds of problems. This Section begins with contracts for personal services, such as employment contracts,44 and then considers contracts for the provision of services more generally.

1.  Contracts for Personal Services a.  Breach by the Employee Where an employee breaches an employment contract her employer will often be unable to achieve virtual specific performance because he will be unable to find an equivalent employee. Nevertheless, specific performance should not and will not be awarded to an employer because of a special moral problem: a decree ordering an employee to specifically perform an employment contract would seem too much like involuntary servitude or peonage. As Doug Laycock puts it: The reason for [the rule that employment contracts will not be specifically enforced against employees] is a substantive law commitment to free labor. Despite the vast social distance between chattel slavery and specific performance of contracts with professional athletes and entertainers, similar policies apply to both. . . . An order to work on pain of contempt produces servitude that is involuntary when the services are performed.45

In theory, there is less objection to simply enjoining a breaching employee from working for a competitor of the employer during the remaining duration of the breached contract. Often, however, such an injunction would be tantamount to ordering specific performance because if the employee cannot work for a competitor she might be unable to earn a reasonable living. In that case she may be forced to choose between working for her original employer or not working at all. Accordingly, the rule in such cases should be and largely is that a breaching employee will not be enjoined from working for a competitor if the injunction would effectively force her to go into a different line of work or to work for her former employer.46

44.  For ease of exposition, the term employee will be used to mean a person who contracts to provide personal services and the term employer will be used to mean a person who contracts to have personal services rendered. Accordingly, for present purposes, contracts with professionals and agents are treated as employment contracts. 45. Laycock, supra note 2, at 169. 46.  Restatement Second § 367(2).

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b.  Breach by the Employer The moral prohibition on involuntary servitude does not provide a reason for refusing specific enforcement against a breaching employer. Moreover, an employer is not like an ordinary purchaser of services, who simply pays cash for the performance of work. Instead, an employer also provides the employee with an opportunity to learn skills, to flourish, and to be a member of a workplace community. Accordingly, an employee usually cannot obtain virtual specific performance through a market transaction. However, where an employment relationship involves an important element of trust and confidence—​for example, in the case of a management-​level employee, a professional, or an agent—​specific enforcement against the employer would be undesirable for a different reason: trust and confidence cannot be imposed by judicial decree, and without trust and confidence such a relationship would differ from what the employer bargained for. Requiring an employer to rehire an employee whose employment involves trust and confidence would therefore force the employer to pay for something that he can no longer obtain, albeit due to his own breach. On the other hand, where the employment relationship does not involve trust and confidence, as is the case with assembly-​line workers or many other nonmanagement employees, specific performance should be granted against the employer. That is not the law now, but in some respects it is the practice. Labor arbitrators commonly order reinstatement of improperly discharged employees who are covered by a union agreement.47 Reinstatement is also routinely ordered by the National Labor Relations Board in cases of a discharge in violation of the National Labor Relations Act.48 Other federal statutes also provide for reinstatement of an employee who is discharged for a reason that violates the statute.49

2.  Other Contracts for the Provision of Services Courts often refuse to specifically enforce contracts for the provision of services—​particularly construction contracts—​even when personal services are not involved, on the ground that specific performance in such cases would require undue judicial supervision. For example, in London Bucket Co. v.  Stewart50 London Bucket had agreed “to furnish and install (subletting installation)” a heating system in Stewart’s motel guaranteed to heat the motel to seventy-​five degrees in winter and to supervise all work.51 Stewart alleged that London Bucket had installed the system “in an incompleted, unskilled unworkmanlike manner, never finishing same, and

47.  See Martha S. West, The Case against Reinstatement in Wrongful Discharge, 1988 U. Ill. L. Rev. 1, 22 (“The universal arbitration remedy for an improper discharge is reinstatement. . . .”). 48.  29 U.S.C. § 160(c) (2015); See also Paul Weiler, Promises to Keep:  Securing Workers’ Rights to Self-​ Organization under the NLRA, 96 Harv. L.  Rev. 1769, 1791 (1983) (explaining that reinstatement is a “standard form of relief ” under the NLRA). 49.  See Civil Rights Act of 1964 § 706(g), 42 U.S.C. § 2000e-​5(g)(1) (2015); Americans with Disabilities Act § 107, 42 U.S.C. § 12117 (2015); Age Discrimination in Employment Act § 7(b), 29 U.S.C. § 626(b) (2015). 50.  237 S.W.2d 509 (Ky. 1951). See also, e.g., N. Del. Indus. Dev. Corp. v. E.W. Bliss Co., 245 A.2d 431, 432–​33 (Del. Ch. 1968). 51.  London Bucket Co., 237 S.W.2d at 509.

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of such size, type and inferior quality of materials that same does not to a reasonable degree perform the purpose contemplated.”52 Stewart asked that London Bucket be compelled to specifically perform the contract before cold weather set in. The Kentucky Supreme Court declined to award specific performance on the ground that “[i]‌t is the general rule that contracts for building construction will not be specifically enforced . . . in part, because of the incapacity of the court to superintend the performance.”53 Courts apply the undue-​need-​for-​judicial supervision rule irregularly and inconsistently. In London Bucket itself the lower court had awarded specific performance, relying on two Kentucky cases, Schmidt v.  Louisville & N.R. Co.54 and Pennsylvania Railroad Co. v. City of Louisville.55 In Schmidt the defendant was ordered to operate a railroad under the terms of a lease. In Pennsylvania Railroad several railroad companies were ordered to eliminate grade crossings as they had contracted to do. In reversing the lower court in London Bucket, the Kentucky Supreme Court distinguished these cases on very thin grounds. Both cases, the court said, “involve[d]‌matters of great magnitude and were of public interest and welfare. In each case the court in effect said, ‘Proceed to do what you contracted to do.’ There was no question of partial or incomplete or faulty performance of a building contract.”56 Hmm? There is a reason why the courts apply the supervision rule irregularly and inconsistently. Denying specific performance of a contract to provide services on the ground that it would entail undue judicial supervision is almost never justified, because normally no more judicial oversight is required for specific performance than for damages. Take London Bucket. If the court had awarded specific performance it would have issued a decree requiring London Bucket to fulfill its obligations under the contract. If thereafter Stewart (the owner of the motel) believed that London Bucket had not fulfilled its obligations under the contract he would bring London Bucket back to court for a contempt hearing. At that hearing Stewart would introduce evidence to show that London Bucket had not fulfilled its obligations under the decree—​that is, under the contract. The evidence at such a hearing would be identical to the evidence at a hearing on damages. To put this differently, in contracts cases a decree of specific performance against a service-​ provider normally will not require the judge either to leave the courtroom or to make a determination that is materially different from the determination that would be required in a suit for damages. There may be some cases, probably rare, in which this would not be true. In such cases the court can properly decline to grant specific performance on the ground that the decree would not be easily administrable. There is no justification, however, for a general rule that treats construction or other service contracts as a special case on the ground that specific performance would require undue judicial supervision.

52.  Id. 53.  Id. at 510. 54.  41 S.W. 1015 (Ky. 1897). 55.  126 S.W.2d 840 (Ky. 1939). See also, e.g., City Stores Co. v. Ammerman, 266 F. Supp. 766 (D.D.C. 1967), aff ’d mem., 394 F.2d 950 (D.C. Cir. 1968). 56.  237 S.W.2d at 834.

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Once the supervision issue is put off the table the question is squarely raised: When should contracts for the provision of nonemployment services be specifically enforceable against the service-​provider? Under the Specific-​Performance Principle actual specific performance of contracts for the provision of services should be awarded unless a special moral, policy, or experiential reason suggests otherwise in a given class of cases or the promisee can achieve virtual specific performance. As in the case of goods, virtual specific performance of contracts for the provision of services has two advantages over actual specific performance. First, virtual specific performance avoids the problems of intrusiveness, coercion, and opportunism; the potentially drastic effect of error at the enforcement stage; and the denial of a jury trial at the option of the promisee. Second, because promisees can obtain virtual specific performance immediately, while they often cannot obtain actual specific performance for a significant period of time, virtual specific performance normally diminishes the social and private losses that result from delay. It might be thought that because services usually are differentiated, a purchaser of services ordinarily would not be able to find in the market a commodity that he could not in good faith reject as an equivalent of the breached performance, given his demonstrable preferences. That is not the case. A  basic principle of contract law, embodied in Restatement Second Section 318, is that a promisor can delegate her contractual duties to a third person unless the promisee has a “substantial interest in having [the promisor] perform or control the acts promised.”57 The Comment to this section adds, “Delegation of performance is a normal and permissible incident of many types of contract. . . . The principal exceptions relate to contracts for personal services and to contracts for the exercise of personal skill or discretion.”58 The thrust of Section 318 is exemplified by Illustration 3: “A contracts to build a building for B in accordance with specifications, and delegates the plumbing work to C. Performance by C has the effect of performance by A.”59 This reasoning should apply to most contracts for the provision of services, as in Illustration 3. If a promisor who has agreed to provide services could have delegated performance under the contract, the promisee has implicitly agreed that performance by a third person is equivalent to performance by the promisor. Accordingly, in such cases the promisee can often or even usually achieve virtual specific performance by making a replacement contract with an appropriate alternative service-​provider. Since the promisee can achieve virtual specific performance by making such a contract and suing the promisor for replacement-​price damages, he should not be entitled to actual specific performance. Conversely, if the promisor’s performance could not be delegated because either the contract or the law of assignments prohibits delegation, then a replacement performance usually would not constitute virtual specific performance, and actual specific performance should normally be awarded.

57.  Restatement Second § 318(2). 58.  Id. § 318 cmt. c. 59.  Id. § 318 cmt. a, illus. 3. Indeed, several cases have held that where a contractor knows it will be unable to perform, it is obliged to find a replacement contractor to perform in its place. See Travelers Indem. Co. v. Maho Mach. Tool Corp., 952 F.2d 26, 30–​31 (2d Cir. 1991); Shea-​S & M Ball v. Massman-​Kiewit-​Early, 606 F.2d 1245, 1249–​50 (D.C. Cir. 1979); S.J. Groves & Sons Co. v. Warner Co., 576 F.2d 524, 529–​30 (3d Cir. 1978).

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V.   C O N C L US I ON In contrast to expectation damages, specific performance gives the promisee just what he contracted to obtain, at least if we put aside the limits that are endemic to all legal remedies. Accordingly, specific performance comes much closer than conventional expectation damages to satisfying the Indifference Principle and effectuating contracts. A  right to specific performance also puts desirable pressure on promisors who wish to terminate a contract to do so efficiently and properly through a mutually negotiated termination based on full information about the value the promisee places on performance, rather than inefficiently and improperly through a unilateral breach based on limited information. However, specific performance has costs as well as benefits. It is highly intrusive and highly coercive. It is backed by draconian penalties that may be out of scale with the end to be achieved. It can give rise to opportunistic exploitation. It effectively gives a promisee a unilateral right to decide whether his case will be tried by a judge or by a jury. It can conflict with the principle of mitigation. Error at the enforcement stage has peculiarly severe consequences. Motivated by the benefits of specific performance, some argue that specific performance should be routinely awarded. Motivated by the costs, others argue that the remedy should be exceptional. Both kinds of argument are typically based on a single metric, such as the inadequacy of expectation damages, on the one hand, or the theory of efficient breach, on the other. For the reasons discussed in Chapter 24, single-​metric arguments will not stand up to scrutiny. Where a choice involves both costs and benefits, as is true of specific performance, there is no escape from the need to craft a principle that, based on prudential judgment, gives appropriate weight to all costs and benefits, rather than a principle based on a single metric that inevitably ignores some of the costs, some of the benefits, or both. The Specific Performance Principle, which puts a thumb on the scale in favor of specific performance—​but only a thumb—​is based on such a judgment. Under that Principle actual specific performance should be awarded unless either special moral, policy, or experiential reasons suggest otherwise in a given class of cases or the promisee can accomplish virtual specific performance.

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The Role of Restitution in Contract Law This c hap t er 1 c overs t h e t h ree basi c t y pes of cases i n w hi ch

the damages awarded to a plaintiff are described as restitutionary. In all three types of cases the plaintiff has performed the contract partly or fully. In the first type of case the defendant has breached the contract. The plaintiff elects to recover restitutionary damages measured by the cost of his performance rather than to recover expectation or reliance damages. In the second type of case it is the plaintiff who has materially breached the contract after rendering partial performance. The defendant has not yet paid the plaintiff for his performance. The plaintiff requests restitutionary damages for the benefit his partial performance has conferred on the defendant. In the third type of case the plaintiff has performed pursuant to an agreement that is unenforceable as a contract because of the Statute of Frauds, indefiniteness, illegality, mistake, changed circumstances, or some other ground. Unable to bring a claim on the contract, the plaintiff requests restitutionary damages, which can be measured either by the cost of his performance or by the benefit his performance had conferred on the defendant. Formally the plaintiff ’s cause of action in all of these cases is in the law of restitution, which is why the damages are described as restitutionary. The location of these actions in the law of restitution is an accident of history. Under the old forms of action—​for example, for money had and received, quantum meruit, and quantum valebat—​the plaintiff would have brought an action with a name that described the character of his performance. The plaintiff would have brought the action for money had and received if his performance involved payment of money; he would have brought the quantum meruit action if his performance involved service or construction; and he would have brought the quantum valebat action if his performance involved delivery of goods. Damages in these actions were usually based on the price of the performance, which could either be a reasonable price or be the price the defendant had agreed to pay for the performance. After the abolition of the old forms of action, the work done by these performance-​based actions was divided between the law of contract and the law of restitution. The claims covered in this section came to be associated with the law of restitution because classical contract law made it impossible to classify the claims as contractual. In the first type of case the plaintiff is not seeking normal contract damages. In the second type of case the plaintiff has no claim on 1.  Mark P. Gergen is the coauthor of this chapter.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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the contract because he has committed a material breach. In the third type of case the contract is unenforceable. The association of these claims with the law of restitution is unfortunate for it has led to confusion over the measure of damages. Damages in the law of restitution generally are benefit-​ based. This follows from the central concern of the law of restitution, which is to prevent unjust enrichment. Restitutionary damages in the cases covered in this chapter often are not benefit-​ based. Damages in the first type of case, in which the plaintiff elects restitutionary damages as a remedy for breach of contract, generally are compensatory and resemble reliance damages. Damages in the third type of case, in which the contract is unenforceable, can be compensatory (and resemble reliance damages) or the damages can be benefit-​based, depending on the reason why the contract is unenforceable. Restitutionary damages are invariably benefit-​based only in the second type of case, in which the plaintiff is the party in breach of contract. But even in this type of case the measure of damages is explained by the expectation principle of contract law: restitutionary damages will not be awarded if this places the defendant in a worse position than performance. It is possible to describe the different damage measures in the three types of cases as restitutionary because of an ambiguity in the term restitution. People use that term to describe both a remedy that restores to the plaintiff something that the plaintiff once had, and a remedy that makes the defendant give back something to which he is not entitled. Sometimes a restitutionary remedy will do both things at once. For example, an order of specific restitution that requires the defendant to return the plaintiff ’s property to the plaintiff results in both restoration and disgorgement. But often in the cases covered in this chapter the measure of compensatory damages will diverge from the measure of benefit-​based damages because the plaintiff ’s cost of performing the contract will diverge from the benefit the defendant derived from the plaintiff ’s performance. When cost and benefit diverge it is important to be clear about whether restitutionary damages are compensatory or benefit-​based. Often when compensatory damages and benefit-​based damages diverge there is a loss, and the question is, as between the plaintiff and defendant, who should bear the loss from what is a failed attempt by the parties to achieve what was intended to be a mutually beneficial exchange. It should come as no surprise that in this situation the law casts the loss on the party who is more at fault.2 In the first type of case it is the defendant who has breached the contract, so damages are compensatory, not benefit-​based, casting any loss on the defendant. In the second type of case it is the plaintiff who is at fault because he has breached the contract, so damages are benefit-​based and not compensatory, casting any loss on the plaintiff. The common theme is that the loss when the cost of performance exceeds the benefit is cast on the party in breach. In both types of cases a court may consider the fact that the breach was in bad faith when deciding whether to award or to deny restitutionary damages. For example, restitutionary damages may be denied to a plaintiff who breaches a contract in bad faith so as to punish the plaintiff, even though the denial of restitutionary damages will leave the defendant with a windfall in the sense that the defendant will be in a better position than she would have been with performance. The measure of restitutionary damages in the third type of case may be either compensatory or benefit-​based, depending on the reason why the contract is unenforceable. Again, considerations of fault loom large in explaining when damages will be compensatory and when 2.  See supra Chapter 12 (The Role of Fault in Contract Law).

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damages will be benefit-​based. Thus courts generally award what are functionally compensatory damages when an oral contract falls within the Statute of Frauds. This reflects a widely held view that the Statute of Frauds should not shield a promisor who breaches an oral contract from liability for the harm he has caused by breaking his promise. On the other hand, when a contract fails as a result of mutual misunderstanding courts generally award what are functionally benefit-​based damages. Although courts will not permit a party who is not at fault to reap a windfall as a result of a mutual misunderstanding, courts will not cast a loss on a party who is not at fault. The association of these claims with the law of restitution also has led to confusion concerning the relevance of the parties’ contract to the availability and the measure of restitutionary damages. It is a basic principle of contract law that a valid contract determines the rights and obligations of the parties to the contract with respect to matters that are within the scope of the contract. This principle does not change merely because the remedy that is being used to give effect to the contract is formally associated with the law of restitution. In the first type of case restitutionary damages function as a surrogate for expectation damages in cases in which the usual measures of expectation damages generally would not adequately compensate the promisee for her loss from the breach. In the second type of case restitutionary damages function as an implied contract term that prevents forfeiture when there is part performance. In the third type of case the parties’ agreement in fact generally is the touchstone for determining the availability and measure of restitutionary damages. even though the agreement is not enforceable as a contract because of some defect, such as the absence of a writing to satisfy the Statute of Frauds.

I .   R E S T I T U T I O N A RY DA M A GES WHEN T H E   D E F E N D A NT I S I N  BR EA CH On a total breach of contract the promisee may elect to recover restitutionary damages instead of expectation damages. Typically the promisee will elect restitutionary damages as a remedy for breach of contract when her loss from the breach is difficult to value and so cannot be recovered as expectation damages. The restitutionary remedy provides a surrogate for expectation damages, much like the claim for reliance damages when expectation damages are uncertain. Osteen v. Johnson3 illustrates. The Osteens hired Johnson to produce two records of country-​ music songs written and performed by their daughter, Linda, and to mail out the records to disc jockeys throughout the country. Under the contract Johnson was obligated to produce and mail out the second record only if the first record met with success. The Osteens paid Johnson $2,500 in advance for his work on both records. The first record met with a fair bit of success, receiving favorable reviews and a high rating in a trade magazine, but Johnson refused to produce and mail out the second record. The Court of Appeals held that the Osteens were entitled to restitution of $1,250, which was half of the $2,500 fee they had paid Johnson. The Osteens could not recover expectation damages for whatever loss they suffered as a result of Johnson’s refusal to produce and mail out the second record because it was impossible to assign a dollar value to that loss. The Osteens could have overcome this problem by 3.  473 P.2d 184 (Colo. App. 1970).

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paying someone else to produce and mail out the second record. This would have enabled them to recover the cost of the replacement transaction as expectation damages.4 Or the Osteens could have tried to establish what the cost of a hypothetical replacement transaction would be and sue for this amount as expectation damages.5 The claim for restitutionary damages was a third alternative. The claim gave the Osteens meaningful compensation for whatever loss they suffered from Johnson’s breach without their having to incur the cost of engaging in a replacement transaction or of establishing the cost of a hypothetical replacement transaction. The most straightforward claim for restitutionary damages involves cases in which the promisee seeks to recover the price she paid to the promisor in exchange for a performance that she did not receive. The price she paid is used to measure the value to her of the performance she did not receive. The premise is that the price paid by the promisee should represent the minimum value the promisee expected to receive from the performance.6 When the promisee has received part performance that is or could be of some value to her the concern arises that giving her back the price she paid may give her something for nothing, and so put her in a better position than she would be if the contract had been performed. The requirement that there be a total breach before a promisee may elect restitutionary damages is one check against a claim for restitution giving the promisee a windfall. In determining whether a breach is total a court should engage in result-​oriented reasoning. A court should ask whether an award of restitutionary damages is an appropriate remedy, and declare the breach to be total if it is. The principle factors to be considered are: (1) the extent to which the remedy of restitutionary damages is needed to put the promisee in as good as position as she would be in if the contract had been performed, (2) the extent to which the promisor would suffer forfeiture if he was made to pay restitutionary damages, and (3) whether the promisor’s breach was in bad faith.7 In this context, forfeiture generally refers to the loss the promisor would suffer as a result of not being compensated for his part performance whereas bad faith generally refers to the case in which the promisor deliberately breaches an undisputed obligation without a legitimate justification. The first factor is the most important. A court should award restitutionary damages whenever the alternative is that the promisee would recover no damages although she may have suffered a material loss on the breach. The presence of forfeiture and the absence of bad faith will justify the denial of restitutionary damages only when the promisee did not suffer a material loss

4.  See supra Chapter 15. 5.  See supra Chapter 13. Had the Osteens sought damages on this basis Johnson would have been allowed to contest the amount by arguing that the cost of the hypothetical replacement transaction was grossly disproportionate to the Osteens’ loss from the breach. 6.  Similar reasoning applies when the promisee seeks specific restitution of property she transferred to the promisor in exchange for a performance that she did not receive any part of (or that is clearly of no value to her). 7.  The same three factors determine when A’s breach of contract is a material breach, justifying B to withhold a performance that would otherwise be due under the contract. In deciding whether A’s breach is material the court should consider: (1) the extent to which B needs to withhold performance to avoid suffering a loss as a result of A’s breach that damages would not adequately compensate, (2) the extent to which A will suffer forfeiture if B withholds performance, and (3) whether A’s breach was in bad faith. See Mark P. Gergen, A Theory of Self-​Help Remedies in Contract, 89 B.U. L. Rev. 1397, 1411 (2009).

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from the breach, or when the award of expectation damages would adequately compensate the promisee for her loss from the breach. The facts in Jacob & Youngs v. Kent8 illustrate. A homebuilder inadvertently substituted Cohes pipe for Redding pipe. The two types of pipe were of the precise same quality. If the homeowner had sought to recover money he paid the homebuilder as restitutionary damages, then the court would have denied the claim, finding the breach not to be a total breach, based on the absence of a material loss to the promisee as a result of the breach, the presence of forfeiture, and the absence of bad faith on the part of the homebuilder.9 On the other hand, if the homebuilder had knowingly substituted Cohoes pipe for Redding pipe to save money, then the court might have found the breach to be a total breach, and awarded the homeowner restitutionary damages, to punish the homebuilder for not obtaining the homeowner’s consent to the substitution. A court also has the option to award partial restitution when the court concludes that partial recovery of the price paid would adequately compensate the promisee for her loss from the breach. The award of half of the fee the Osteens paid to Johnson is an example of an award of partial restitution. The court could have used one of two legal rules to justify the award of partial restitution. The court could have treated the contract as a divisible contract for two records at a price of $1,250 per record. Or the court could have subtracted $1,250 as the value of the benefit the Osteens received by Johnson’s part performance of a contract for two records.10 The claim for restitutionary damages as a remedy for breach of contract is similar to the claim for reliance damages. Both damage measures are a surrogate for expectation damages that a promisee generally seeks when the usual measures of expectation damages would not adequately compensate the promisee for her loss from breach. The restitutionary and reliance damage measures differ in two respects:

(1) Restitutionary damages comprise a subset of reliance damages. Restitutionary damages are limited to performance costs and may not include costs of preparing to perform.11 Reliance damages include performance costs, costs of preparing to perform, and reliance costs that are not performance related. For example, in Osteen v. Johnson restitutionary

8.  129 N.E. 889 (N.Y. 1921). 9.  The presence of forfeiture and the absence of bad faith may justify the court resolving doubts about whether the promisee suffered a material loss from the breach in favor of the promisor to deny restitutionary damages. The handling of a side issue in Osteen v.  Johnson illustrates. The Osteens argued that Johnson had breached the contract with respect to the first record by listing another person as coauthor of a song that had been written solely by their daughter. Johnson testified that he listed the coauthor to make it more likely that the record would be played by disc jockeys. The court had plausible grounds for not requiring Johnson to make full restitution The harm to the Osteens from their daughter sharing credit for one of the two songs was speculative and may well have been offset by the benefit to the Osteens of the record getting more airplay; requiring Johnson to repay the entire fee would have resulted in forfeiture, for Johnson would be paid nothing for his work on the first record, and Johnson acted in good faith when he listed a coauthor on one of the songs. 10.  Formally when the promisee seeks restitutionary damages for breach of contract he is required to rescind the contract and make counter-​restitution of the value of the performance he has received. Generally the promisee may sue for expectation damages and restitutionary damages in the alternative and make this election after she learns the restitutionary damages are greater than expectation damages. 11.  The line between performance costs and costs of preparing to perform is notoriously difficult to draw and to justify.

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damages are limited to the fee the Osteens paid Johnson. Reliance damages could include other expenses incurred by Osteens that were wasted as a result of Johnson’s breach, such as money the Osteens had paid to a backup band to perform on the second record. (2) When the promisee seeks reliance damages the promisor is given an opportunity to establish that the promisee would have suffered an eventual loss had the contract been fully performed. The promisor bears the burden of proof on this point. If the promisor is able to establish that the promisee would have suffered an eventual loss, then the amount of the loss will be subtracted from the promisee’s reliance costs. This is done so that the damage award does not put the promisee in a better position than he would be if the contract had been fully performed.12 In contrast, the promisee’s eventual loss on full performance will not be subtracted from restitutionary damages.

The fact that the promisee’s eventual loss on full performance is not subtracted from restitutionary damages creates the possibility that the award of restitutionary damages could put the promisee in what clearly is a better position than the promisee would have been in if the contract had been fully performed. This happens occasionally. For example, in Bush v. Canfield13 a buyer of corn who prepaid part of the purchase price was allowed to recover his full prepayment when the seller failed to deliver the corn, though the buyer would have suffered an eventual loss on the contract because of a drop in the price of corn. If the buyer had sued for the prepayment as reliance damages, then the eventual loss would have been subtracted. Some theorists treat the outcome in Bush v. Canfield as a feature and not a bug of the claim for restitutionary damages on breach. These theorists take the position that a promisee who is met with a total breach “is entitled to disregard the contract and deal with the breaching party as if the performance in question had been rendered in the absence of contract.”14 On this view the buyer in Bush v. Canfield is in the same position as a plaintiff who is seeking to recover money he mistakenly paid to the defendant. On this view the buyer is entitled to his money back because the breach renders the payment non-​consensual and the basis for the claim is the seller’s unjust enrichment. Restatement Third, Restitution and Unjust Enrichment wisely rejects this position. It establishes the general principle that “[a]‌valid contract defines the obligations of the parties as to matters within its scope, displacing to that extent any inquiry into unjust enrichment.”15

12.  Beefy Trail, Inc. v.  Beefy King Int’l, Inc., 267 So. 2d 853, 859 (Fla. Dist. Ct. App.  1972) (Owen, J., concurring in part and dissenting in part). See also L. Albert & Son v. Armstrong Rubber Co., 178 F.2d 182, 189–​90 (2d Cir. 1949) (L. Hand, J.). 13.  2 Conn. 485 (1818). 14. Restatement (Third) of Restitution &Unjust Enrichment, ch. 4, topic 2, intro. note 2 (Am. Law Inst. 2011) [hereinafter Restatement Third]. The Reporter, Professor Andrew Kull, puts the problem in context: The remedy long called “restitution for breach” . . . is one of the most controversial topics under the name “Restitution”—​though in the analysis of this Restatement it is not properly part of the law of restitution at all. The entire controversy is generated, however, by the handful of untypical cases in which the party who seeks the remedy has been performing at a loss. Such cases are rare and anomalous to begin with, for the simple reason that a defendant who is entitled to performance at below cost has powerful incentives to avoid any breach. Id. at § 38, reporter’s note d.

15.  Id. § 2(2).

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It follows from this general principle that the claim for restitutionary damages when the defendant is in breach is a contract-​based claim that has “no necessary relation to unjust enrichment.”16 To avoid confusion the new Restatement proposes that the damages be described as “performance-​based” rather than restitutionary. It also proposes a new rule that could alter the results in a small set of cases. The new rule more closely aligns the claim for restitutionary damages with the claim for reliance damages while not changing the result in Bush v. Canfield. Before explaining the new rule in the Restatement Third it is important to be clear about the narrowness of the issue on which there is any disagreement. No one argues that the promisee’s loss from the breach is wholly irrelevant to the availability and measure of restitutionary damages. For example, all agree the promisee’s loss from the breach is relevant to the availability of restitutionary damages (i.e., the question of total breach), and to whether the promisor should be given a credit for the value to the promisee of part performance.17 The Third Restatement divides claims for restitutionary damages into two types, covered by two different rules in Section 37 and Section 38. The rule in Section 37 covers cases such as Osteen v. Johnson and Bush v. Canfield in which the promisee paid money in advance of performance. The rule gives the promisee who paid money in advance of performance the right to rescind the contract and recover the money he paid on a total breach even when the recovery would put the promisee in a better position than performance.18 For example, in a scenario in which the Osteens had become estranged from their daughter, Johnson could not avoid his obligation to return the fee the Osteens paid him for work that he did not do by establishing that the work would have been of no value to the Osteens. Osteen v. Johnson is representative of the typical case in which the rule in Section 37 applies. The performance the promisee did not receive has no ascertainable market value in Osteen v. Johnson. The price the promisee paid for the performance serves as a simple proxy for the value the promisee attached to the performance that he did not receive. Cases such as Bush v.  Canfield “are rare, because a prepaid seller will almost never forfeit a profit that might be earned, at the Seller’s option, by performing the contract.”19 In Bush v. Canfield the seller left money on the table because he could easily have purchased corn at the market price and fulfilled the contract to pocket the higher contract price. The authors of the Third Restatement decided that it was better to have a simple rule that foreclosed inquiry into the actual loss to the promisee in cases such as Osteen v. Johnson without creating an exception to cover rare cases such as Bush v. Canfield.

16.  Id., ch. 4, topic 2, intro. note 2. 17.  Also all agree that when supervening events for which the promisee bore the risk under the contract reduce the value of part performance to the promisee these events are disregarded in valuing the part performance for purposes of awarding restitutionary damages. For example, if the Osteens had become estranged from their daughter before Johnson produced and mailed out the first record, making Johnson’s part performance of the contract of no value to the parents, the court would disregard this fact for the Osteens bore this risk under the contract. 18.  Restatement Third, Restitution and Unjust Enrichment § 37, Comment b. Illustration 2 is based on Bush v. Canfield. The remedy in Section 37 is also available when the promisee seeks specific restitution of property she transferred to the promisor. 19.  Id.

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The rule in Section 38 makes the promisee’s eventual loss on performance relevant to the measure of restitutionary damages, bringing the measure of restitutionary damages closer to the measure of reliance damages. United States v. Algernon Blair, Inc.20 illustrates the type of case the new rule is meant to address. The plaintiff, a subcontractor, underbid a contract to erect the steel structure of a building. A dispute arose concerning who was obligated to pay the cost of renting cranes that were used in erecting the steel structure. When the general contractor refused to make payments for crane rental, the plaintiff stopped work. The court held that the general contractor materially breached the contract by refusing to make payments for crane rental, justifying the termination of the contract by the plaintiff. The defendant proved that if the plaintiff had completed the work, the plaintiff would have lost more than the unpaid balance of the contract price. The Court of Appeals held this fact was irrelevant when the claim was for restitutionary damages: “While the contract price may be evidence of reasonable value of the services, it does not measure the value of the performance or limit recovery.” The Third Restatement rejects this rule. The restitution claim in Algernon Blair would be covered by the rule in Section 38, which provides that the measure of restitutionary damages is “the market value of the plaintiff ’s contractual performance, not exceeding the price of such performance as determined by reference to the parties’ agreement.”21 The rationale for the rule in Section 38 is clear if one assumes that the dispute in Algernon Blair had arisen when the subcontractor had completed 90  percent of the work on the subcontract when the dispute occurred (rather than 28 percent) and that the subcontractor’s unpaid costs at that time significantly exceeded the unpaid contract price. The Algernon Blair rule creates poor performance incentives in this situation. The rule would give the subcontractor an incentive to escalate any dispute and declare a total breach in order to escape a bad bargain and recover more than the unpaid contract price on a claim for restitutionary damages. Allowing the subcontractor to recover more than the unpaid contract price does not promote remedial simplicity. The opposite is true. Capping restitutionary damages at the unpaid contract price eliminates the incentive the subcontractor otherwise would have to try to establish performance costs in excess of the unpaid contract price. The rule in Section 38 would allow the subcontractor to recover only 90 percent of the contract price as restitutionary damages when the subcontractor had completed only 90 percent of the work at the time of the total breach. On the actual facts of the case, restitutionary damages would be capped at 28 percent of the contract price, because this was the percentage of the work completed by the subcontractor.22 This is somewhat more generous to the promisee than an award of reliance damages (which cannot exceed expectation damages), and would be the cost incurred minus the eventual loss on full performance. The rule in Section 38 of the Third Restatement is clearly superior to the Algernon Blair rule because it reduces the windfall to the promisee on the breach of what would be a losing

20.  479 F.2d 638 (4th Cir. 1973). 21.  Restatement Third § 38(2)(b). Comment d underscores the point:  “When the plaintiff who has been performing at a loss seeks damages measured by the value of performance, some authorities allow a recovery ‘off the contract’ unlimited by the contract price; but this Restatement rejects that outcome.” 22.  Id. § 38, cmt. c & illus. 11.

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contract. This reduces the incentive the promisee otherwise would have to find grounds for declaring a total breach to avoid the losing contract. But why not abolish the claim for restitutionary damages entirely in cases not covered by the rule in Section 37? Why retain a rule that could put the promisee in a better position than he would have been if the contract had been fully performed, once the decision has been made to calculate expectation damages? To answer this question it is necessary to place the promisee’s claim for restitutionary damages under the rule in Section 38 alongside the alternative damage rules. The basic damage rule when a service purchaser breaches a contract for services before the service provider fully performs the contract is the unpaid contract price minus what it would have cost the service provider to complete performance. To recover expectation damages under this rule the service provider must establish her cost to complete. The service provider may forgo trying to establish the cost to complete and instead sue for cost-​incurred as reliance damages. But if the service provider sues for cost-​incurred damages the service-​purchaser will be given an opportunity to establish the service-​provider’s cost to complete. If the service-​purchaser were able to establish that the service-​provider would have suffered an eventual loss on the contract (i.e., the service-​purchaser is able to establish that the cost incurred plus the cost to complete exceeds the unpaid contract price), then this amount would be subtracted from reliance damages. The claim for restitutionary damages reduces the loss to the service-​provider on this scenario by dividing the cost incurred by what the total cost to perform would have been and giving the service-​provider that percentage of the contract price as damages. When all is said and done the rule in Section 37 subtracts a fraction of the eventual loss from the plaintiff ’s costs incurred. The fraction subtracted increases with the percentage of completion. Determining the service-​provider’s cost to complete involves prediction, which creates a risk of error. The restitutionary damage rule reduces the impact on the damage award of an error in predicting cost to complete by subtracting a fraction of the estimated loss on full performance from cost incurred rather than the full amount of the estimated loss. Subtracting a fraction of the estimated loss puts a thumb on the scale in favor of the promisee. This is consistent with the general policy of resolving factual uncertainty against the party who created the uncertainty. The fraction of the eventual loss subtracted from the cost incurred increases with the percentage of completion. This is sensible, because uncertainty about the size of the eventual loss decreases as performance nears completion. The rule should also reduce claim-​ resolution costs. The service-​purchaser (the defendant) should discount the eventual loss on full performance that he expects to be able to establish by the service-​provider’s percentage of completion when the service purchaser decides whether to investigate and to present evidence of the cost to complete. The rule in Section 38 is a good solution to a difficult problem. The rule reduces the size of the potential windfall to the promisee in a case such as Algernon Blair while preserving some of the advantage to the promisee of the rule in Algernon Blair. The rule also preserves the simplicity of the rule in Algernon Blair. It requires no new information beyond the information that is needed to calculate reliance damages (cost incurred) or expectation damages (cost to complete). The rule merely cushions the effect on the promisee in a case in which the promisor is able to establish that cost incurred plus cost to complete would exceed the unpaid contract price by subtracting a fraction of the promisee’s eventual loss on full performance.

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II.   RE S T I T U T I O N A RY DA M A GES WHEN T H E   P L A I N T I F F IS I N  BR EA CH Suppose A  partly performs a contract with B before breaching, or that A  attempts to fully perform but A’s performance is deficient in some respect. Suppose further that B has not yet rendered the promised counter-​performance. If A’s performance satisfies the substantial performance test, then A would be entitled to a judgment for the unpaid contract price (or the value of B’s promised counter-​performance), minus whatever damages B could establish were due to him for the deficiency in A’s performance. If A’s performance does not satisfy the substantial performance test, then A’s claim would be for restitutionary damages. A’s claim for restitutionary damages is a fairly recent innovation in the common law. Often there is no need for the claim. Typically a person in A’s position who performs his contract in installments or over a period of time will insist that B pay the contract price (or render the promised counter-​performance) in matching installments or over the same period of time. This arrangement reduces A’s risk of loss in the event B defaults on the contract, which is likely to be A’s principal concern. A byproduct of this arrangement is that it reduces the need for A to bring a claim for restitutionary damages when A is the party in default since A is likely to have already been paid for the performance he rendered before he defaulted. When A has been paid part of the contract price for his part performance it is B who is likely to seek damages when A fails to complete performance, because B’s loss from A’s breach will exceed the unpaid balance of the contract price. A will need to bring a restitutionary claim only when he did not have the foresight to secure part payment for part performance. Britton v. Turner23 is one of the first cases to allow a party in breach to recover restitutionary damages for the benefit of his part performance to the other party. The plaintiff was hired to work for a year for $120, to be paid at the end of the year. The plaintiff quit without justification after working for almost ten months. This was held to be a breach of contract. The trial court held that the plaintiff could recover nothing on a contract claim, but that he could recover for the reasonable value of his work on a quantum meruit claim. The jury awarded $95. Justice Parker affirmed, writing an opinion that exemplifies what Karl Llewellyn described as the “Grand Style” of judicial reasoning.24 Parker’s opinion describes the right of an employee to be compensated for “the service actually performed” to be an implied term of the employment contract that was in accord with “the general understanding of the community” and was in the interest of the parties, because it would “leave no temptation to the [employer] to drive the laborer from his service, near the close of his term, by ill treatment, in order to escape from payment.”25 Restitution claims such as that in Britton v. Turner are a thing of the past since state wage-​ payment laws now require that wages be paid every month or two weeks. These laws require that people who work for wages be paid for the work they do, and prevent an employer from holding back wages to deter an employee from breaching his employment contract. There is a similar rule that protects a buyer who prepays for goods from forfeiting his prepayment in the event of default. Section 2-​718(2) provides that a buyer who breaches a contract to purchase a good has a 23.  6 N.H. 481 (1834). 24.  Karl N. Llewellyn, The Bramble Bush 157–​58 (1951). 25.  6 N.H. at 493–​494._​_​_​_​_​.

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right to recover payments made to the seller, minus whatever damages the seller is able to establish.26 The statute does allow the seller to retain the lesser of 20 percent of the contract price or $500 as statutory liquidated damages, without having to establish damages. A seller is permitted to stipulate that a prepayment be forfeited as liquidated damages in the event the buyer breaches, but the term must pass scrutiny under the rule prohibiting penal liquidated damage terms.27 The claim for restitutionary damages is narrowly circumscribed. To recover restitutionary damages, A (the party in default) must establish that B is a better position having received part performance for which he has not paid than B would be if A had fully performed the contract.28 Restitutionary damages are calculated to ensure that B gets the benefit of his bargain. When A  is a purchaser who made part payment before breaching his contract this usually involves showing that B’s loss on resale was less than the amount of the part payment. When A is a seller who renders incomplete or defective performance this usually involves showing that B obtained substitute performance for less than the unpaid balance of the contract price. For example, if B spends $8,000 to correct defects in A’s performance of a construction contract when the unpaid balance of the contract price is $10,000, then the measure of restitutionary damages will be $2,000. This ensures that B pays no more than the contract price for full performance. Since the burden is on A to establish a right to restitutionary damages, B will not be required to pay restitutionary damages when there is a possibility that this could leave B in a worse position than performance because of an intangible or speculative loss that was suffered by B as a result of A’s breach. For example, if B spends $2,000 less than the unpaid balance of the contract price to correct defects in A’s construction, but B is able to persuade the court that the delay in correcting the defects caused him material harm in the form of lost opportunities of speculative value, then A’s claim for restitutionary damages will be denied. B will be allowed to retain the $2,000 savings in construction costs as indirect compensation for the intangible or speculative harm caused by the delay. When B eventually obtains performance while paying less than the contract price, and B argues he should be allowed to retain the savings as indirect compensation for some intangible or speculative harm caused by the breach, a court must balance the extent to which A will suffer forfeiture, if A does not recover restitutionary damages, with the risk B will be left to bear an uncompensated loss if B is made to pay restitutionary damages. A court may deny restitutionary damages though this imposes forfeiture on A, and gives a windfall to B, when A’s breach involves bad faith.29 For these purposes, a breach is considered to be in bad faith when it is deliberate and without legitimate justification. You will not go far wrong in thinking of a defaulter’s claim for restitutionary damages as an implied contract term. Thus the claim may be precluded by a valid liquidated damage clause or by a term that conditions B’s obligation to pay for A’s performance on complete performance by A.30 26.  U.C.C. § 2-​718(2) and (3) (Am. Law Inst. & Unif. Law Comm’n 2017). 27.  U.C.C. § 2–718(1) (Am. Law Inst. & Unif. Law Comm’n. 2017). . 28.  Kutzin v. Pirnie, 591 A.2d 932, 941–​42 (N.J. 1991); Restatement Third § 36(2). 29.  Kutzin, 591 A.2d at 938–​40; Restatement Third § 36(4) (referring to a breach that “involves fraud or other inequitable conduct”). 30.  Kutzin, 591 A.2d at 942; Restatement Third § 36(3).

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III .   R E S T I T U T I O N ARY DA M A GES I N   T H E A B S E N CE OF   A N E N F O R C E A B L E CONT R A CT In the third type of case A does an act at the request of B, or A does an act that may benefit B, in the belief that he has a contract with B. It turns out that this belief is mistaken. B may have a defense to a contract claim under the Statute of Frauds, or on grounds such as unilateral mistake, mutual mistake, or changed circumstances. A may be unable to make out a prima facie contract claim because of a problem such as mutual misunderstanding or indefiniteness. Or B may persuade a court that he did not intend to assent to the contract, and that A’s belief that he had B’s assent was unreasonable. In all of these cases A  will bring a restitution claim against B because he cannot bring a contract claim. The nature of A’s restitution claim will turn on the reason why A does not have a contract claim. If a contract claim is unavailable because B has asserted the Statute of Frauds as a defense, or B has persuaded the court the contract is too indefinite to support an award of expectation damages, then restitutionary damages serve a compensatory function, and are not benefit-​based. Kearns v. Andree31 illustrates. The defendant refused to honor an oral agreement to purchase a house owned by the plaintiff. At the defendant’s request, the plaintiff had made alterations in the house that reduced its value. The trial court held the work done by the plaintiff was sufficient to take the contract out of the Statute of Frauds, but the agreement was unenforceable on the ground of indefiniteness. The Connecticut Supreme Court held the plaintiff was entitled on a restitution claim to recover the costs he incurred in making the alterations requested by the defendant, but not the cost he incurred in restoring the house to its original condition. A promissory estoppel claim would now be available to the plaintiff in Kearns v. Andree, eliminating the need for a claim for restitutionary damages when the problem is one of indefiniteness.32 A promissory estoppel claim would enable the plaintiff to recover the cost he incurred in restoring the house to its original condition, as well as the cost he incurred in making the alterations requested by the defendant. If courts adopted the modern rule that provides for reimbursement for reliance when an oral contract falls within the Statute of Frauds, this would eliminate the need for restitutionary damages in this case as well.33 The restitution claim remains important in states that do not follow the modern rule. The restitution claim allows the plaintiff to recover a subset of his reliance losses. The subset is the plaintiff ’s cost of performing the contract. It is difficult to justify limiting the plaintiff to a restitution claim for a subset of his reliance losses when the defendant asserts a Statute of Frauds defense. To recover on the restitution claim the plaintiff must establish all of the elements of a contract claim (e.g., that the defendant broke a promise that he made as part of a bargain). The absence of a writing to satisfy the Statute of Frauds may create lingering evidentiary concerns about the existence of the promise.

31.  139 A. 695 (Conn. 1928). 32.  Hoffman v. Red Owl Stores, Inc., 133 N.W.2d 267, 275–​77 (Wis. 1965); Neiss v. Ehlers, 899 P.2d 700, 706–​07 (Or. Ct. App. 1995). 33. Restatement (Second) of Contracts § 139 (Am. Law Inst. 1981).

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Or it may create lingering cautionary concerns that the defendant did not intend to make the promise. These lingering evidentiary and cautionary concerns may justify limiting damages to the plaintiff ’s reliance losses. Perhaps these concerns even may justify limiting damages to a subset of reliance losses in some cases. But it is difficult to see how they could justify a categorical rule that limits the plaintiff to the cost of performance and precludes recovery of the cost of preparing to perform and opportunity costs. Restitutionary damages are benefit-​based in the case in which A  does an act that may benefit B in the belief that B had agreed to pay for the act, but the court finds that B did not intend to agree to pay for the act, and that A was more at fault than B in the misunderstanding about B’s intent. To recover restitutionary damages in this case, A must persuade the court that the award of restitutionary damages will put B in no worse position than B would have been if A had not performed the act. This can be straightforward when A’s act involves the payment of money or the delivery of property to B, because restitution can be in kind. The court will order B to return the money or property to A, unless B can establish that she changed her position in the reasonable belief the money or property was hers to dispose of in a way that would subject her to a loss if she was required to repay the money or pay the market value of the property. For example, B might not be required to return money A paid to her by mistake if B lost the money in a wager B would not otherwise have made.34 When A’s act involves rendering a service, A is likely to recover in restitution only if he can persuade a court the service saved B a necessary expense or that B has revealed a willingness to pay for the service.35 These rules cast on A any loss resulting from his mistake regarding B’s agreement to pay for the act. Sometimes a contract will fail for a reason for which neither party bears greater fault. For example, a contract may fail because of a mutual mistake, impossibility, impracticability, frustration of purpose, or mutual misunderstanding. A  may bring a restitution claim against B when A has done an act that benefits B pursuant to the unenforceable contract.36 The measure of restitutionary damages will generally cast any loss to the parties from the failure of the contract on A. Vickery v. Ritchie37 illustrates. An architect duped a property owner and a contractor to proceed with a project to construct a bathhouse on the owner’s land. The architect misled the owner to believe that the price was $23,200 and the contractor to believe the price was $33,721. The deception was discovered after the work was concluded. At trial, the value of the improvement was established to be $22,000 and the “fair value” of the contractor’s labor and materials was established to be $33,499.30. The Restatement Third, Restitution and Unjust Enrichment takes the position that the appropriate measure of damages is $23,200, which is the price that the

34.  B would have a change of position defense in this case. See Restatement Third § 65. 35.  Id. § 9. 36.  See id. § 34. The discussion here focuses on the case in which the contract fails because of mutual misunderstanding. Section 34 also considers the cases in which a contract fails because of impossibility, impracticability, or frustration of purpose. It argues that courts should take a flexible approach and sometimes award reliance damages or modified expectation damages, while taking account of gains and losses to both parties that arose prior to the occurrence of the event that made the contract unenforceable, or that proximately resulted from the contract. 37.  88 N.E. 835 (Mass. 1909).

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owner revealed he was willing to pay for the work.38 This casts the entire loss resulting from the architect’s deception on the contractor. The Restatement Third argues that it is unfair to cast any of the loss on the owner because this would subject him to a “forced exchange.” But the result imposes a forced exchange on the contractor, for he is required to accept $23,200 as payment for his labor and materials.

38.  Restatement Third § 10, illus. 27. In the actual case the court awarded $33,499.30, treating the claim as an implied contract claim.

3

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THE DISGORGEMENT INTEREST IN CONTRACT LAW

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twenty-s ​ ix

The Disgorgement Interest in Contract Law I .   I N T R O DUCT I ON Restatement Second of Contracts Section 344 famously provides that judicial remedies in contract law serve to protect one or more of three interests of a promisee: (a) his expectation interest, which is his interest in having the benefit of his bargain by being put in as good a position as he would have been in had the contract been performed, (b) his reliance interest, which is his interest in being reimbursed for loss caused by reliance on the contract by being put in as good a position as he would have been in had the contract not been made, or (c) his restitution interest, which is his interest in having restored to him any benefit that he has conferred on the promisor.

There is a striking omission from this list—​the disgorgement interest, which is the promisee’s interest in requiring the promisor to disgorge a gain that was made possible by her breach but did not consist of a benefit conferred upon her by the promisee. The disgorgement interest and the corresponding disgorgement measure are the mirror images of the expectation interest and the expectation measure. The expectation measure is intended to place a promisee in the position he would have been in if the promisor had performed. In contrast, the disgorgement measure is intended to place a promisor in the position that she would have been in if the contract had been performed. Accordingly, perfect disgorgement would make the promisor indifferent between performing on the one hand, and paying damages on the other. As stated by Cooter and Ulen: When disgorgement is perfect, the injurer is indifferent between doing right, on the one hand, or doing wrong and paying disgorgement damages, on the other hand. Thus, perfect disgorgement is identical to perfect compensation, with the roles of injurer and victim reversed. The injurer achieves no gain from the wrongdoing net of perfect disgorgement damages, just as the victim suffers no harm from the injury net of perfectly compensatory damages.1 1.  Robert Cooter & Thomas Ulen, Law & Economics 320 (6th ed. 2012). See also Robert Cooter & Bradley J. Freedman, The Fiduciary Relationship: Its Economic Character and Legal Consequences, 66 Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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The omission of the disgorgement interest in Section 344 was plainly deliberate. For one thing the section is written as an exclusive catalog. For another, shortly after publication of Restatement Second, Allan Farnsworth, the Reporter for much of that Restatement, including Section 344, wrote a leading article, “Your Loss or My Gain?,” arguing, on normative grounds, against recognition of the disgorgement interest.2 Furthermore, at the time Restatement Second was published it was often assumed that as a matter of positive law the disgorgement interest was not protected in contract law. For example, Dobbs’s leading treatise on remedies stated: Writers recognize that there is no general rule allowing restitution of profits [for breach of contract], and plaintiffs seldom seek such restitution. . . . It is “commonly assumed” that the breacher is not liable for collateral benefits. . . . The assumptions and practices of the bar, the implications of exceptional cases and the commentary all justify the belief that there is, in practice, a rule against restitution of profits . . .3

In contrast to the positions of Farnsworth, Dobbs, and some other scholars, contract law both should and does protect the disgorgement interest. This chapter shows that the disgorgement interest is widely recognized outside contract law. It addresses the puzzle why, in that light, Restatement Second rejected the disgorgement interest in contract law, develops categories of cases in which the disgorgement interest should be protected in contract law, and shows that notwithstanding Restatement Second, Farnsworth, and Dobbs, many cases have done exactly that. This chapter also discusses normative arguments against disgorgement, addresses the question whether contract law should and does protect the disgorgement interest, and answers why we don’t see more disgorgement cases than we do. Finally, this chapter considers whether

N.Y.U. L Rev. 1045, 1051 (1991) (in cases involving fiduciary obligations, perfect disgorgement is “a sanction that restores the wrongdoer to the same position that she would have been in but for the wrong. In other words, perfect disgorgement strips the agent of her gain from misappropriation, and leaves her no better or worse than if she had done no wrong.”) (emphasis in original). 2.  E. Allan Farnsworth, Your Loss or My Gain? The Dilemma of the Disgorgement Principle in Breach of Contract, 94 Yale L.J. 1339 (1985). 3.  3 Dan Dobbs, Law of Remedies § 12.7(4), at 171 n.5 (2d ed. 1993) (emphasis in original). Also, Dobbs stated: Writers sometimes argue for applying the tort rules to contract cases, or to some particular kinds of contracts cases. But the practice in contract cases is to the contrary: one who merely breaches a contract is not required to restore collateral profits or gains facilitated by the breach. It is convenient to speak of this strong practice as a rule. . . . The “rule” merely permits the breacher to retain gains or profits that result from his own breach but that are not the result of the plaintiff ’s own performance.

Id. at 171. (Note the quotation marks around the word rule.) See also, e.g., Lon L.  Fuller & Robert Braucher, Basic Contract Law 55 (rev. ed. 1964) (“Perhaps surprisingly, there is no general principle permitting recovery of benefits derived by the defendant as a result of his breach of contract”); 1 George E. Palmer, The Law of Restitution § 4.9, at 438 (1978) (“Although the issue has gone largely unexplored, it has been commonly assumed that mere breach of contract will not make the defendant accountable for benefits thereby obtained, whether through dealings with a third person or otherwise”); John P. Dawson, Restitution or Damages?, 20 Ohio St. L.J. 175, 187 (1959) (“. . . the prevention of profit through mere breach of contract is not yet an approved aim of our legal order”).

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and when a promisor’s gain from breach should be apportioned between the promisor and the promise.

I I .   T H E D I S G O R GEM ENT I NT ER ES T O U T S I D E   C ONT R A CT   L AW Damages in private law are usually based on the loss that the plaintiff has suffered as a result of the defendant’s wrong. Often, however, a plaintiff ’s recovery is measured not by his loss but by the wrongdoer’s gain. Cases involving the recovery of a wrongdoer’s gain are of two types. In the first type the plaintiff seeks to recover the value of a benefit the plaintiff conferred upon the wrongdoer. This type of recovery protects the interest that Restatement Second Section 344 calls the restitution interest. In the second type the plaintiff seeks to recover the value of a gain that resulted from or was made possible by the defendant’s wrong but did not consist of a benefit that the plaintiff conferred on the defendant. This type of recovery protects the disgorgement interest.4 Disgorgement is an important remedy in various fields of law. For example, it is a central remedy in the law of fiduciary obligations. A fiduciary who wrongfully makes a personal gain through use of his position or of property or information that he holds through his position must disgorge that gain to his beneficiary even if the beneficiary has suffered no loss from the wrong. This principle is exemplified in Illustration 1 to Section 8.05 of the Restatement Third of Agency: P, who owns a stable of horses, employs A to take care of them. While P is absent for a month, and without P’s consent, A rents the horses [for his own personal gain] to persons who ride them. Although being ridden is beneficial to the horses, A  is subject to liability to P for the amount A receives for the rentals.5

A fiduciary is made liable for his gain in such cases partly because a person should not be allowed to profit from his own wrong, partly because requiring disgorgement by the fiduciary gives effect to the beneficiary’s implicit expectations, and partly because disgorgement is an instrument of efficiency since it shapes the conduct of fiduciaries to reflect the reasonable expectations of beneficiaries and provides fiduciaries with correct incentives.6 4.  Peter Birks argued that both types of gain-​based recovery should be referred to as restitution. Peter H. Birks, A Letter to America: The New Restatement of Restitution, 3 Global Jurist Frontiers Issue 2, at 5–​ 10 (Berkeley Electronic Press 2003). Others argue that the term restitution should be reserved for cases in which the plaintiff has conferred a benefit on the defendant, whereas the term disgorgement should be used where the defendant made a gain that resulted from or was made possible by the wrong but did not consist of a benefit that was conferred on the defendant by the plaintiff. See, e.g., James Edelman, Restitutionary Damages and Disgorgement Damages for Breach of Contract, 2000 Restitution L. Rev. 129, 143–​44; Lionel D. Smith, The Province of the Law of Restitution, 71 Can. B. Rev. 672, 683–​86, 694–​99 (1992). The latter terminology is preferable because cases that center on a benefit conferred raise different issues than cases that center on the recovery of gains made possible by a defendant’s breach. 5.  Restatement (Third) of Agency § 8.05, illus. 1 (Am. Law Inst. 2006). 6.  See Cooter & Freedman, supra note 1, at 1049–​56.

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Disgorgement is also commonly awarded where property interests are involved. For example, if a wrongdoer appropriates an owner’s property the wrongdoer is liable to the owner in conversion. Normally the owner’s damages will be measured by the owner’s loss, consisting of market price of the converted property at the time of conversion. However, if the wrongdoer later sells the property to a third person at a higher price the owner can require the wrongdoer to disgorge that price instead of just paying the owner’s loss.7 Correspondingly, if the wrongdoer uses the converted property the owner can require the wrongdoer to disgorge the rental value of the property even though that value exceeds the market value of the property.8 Similarly, a number of cases have held that if an actor trespasses on an owner’s land the owner can require the wrongdoer to disgorge the use value of the trespass even though the owner was not harmed by the trespass.9 This result is reflected in Illustration 3 to Section 40 of the Restatement Third of Restitution and Unjust Enrichment: Blackacre is a vacant lot in a commercial area. Purchaser acquires Blackacre from Developer, intending to improve the property by constructing a supermarket. (Purchaser erects a sign announcing that the lot is the “future home” of Purchaser’s business but does not initiate construction for the time being.) Developer is meanwhile engaged in grading streets for a nearby subdivision. Developer stores the dirt temporarily removed in grading by dumping it on Blackacre. (After grading is completed, leaving a substantial pile of dirt on Blackacre, Developer posts a sign saying “Free Dirt,” with the result that by the time of trial all of the dirt has been removed by members of the public.) Purchaser sues Developer alleging trespass. The court finds that Purchaser has suffered no quantifiable injury. Blackacre has been restored to its original condition, and Developer’s trespass did not interfere with any use Purchaser would have made of it. On the other hand, Developer has been unjustly enriched by its unauthorized use of the property. Developer’s liability in restitution is measured by the rental value of Blackacre during the months the dirt was present, liberally estimated in favor of Purchaser.

7.  Historically this remedy was commonly known as waiving the tort and suing in assumpsit (contract), on the fiction that the owner can elect to treat the wrongdoer as an agent who made the sale of the converted property on the owner’s behalf. See 1 Dobbs, supra note 3, § 4.2(3), at 584–​85. 8.  See, e.g., Olwell v. Nye & Nissen Co., 173 P.2d 652, 654 (Wash. 1946). 9.  See, e.g., Quality Excelsior Coal Co. v. Reeves, 177 S.W.2d 728, 732 (Ark. 1944) (“ ‘[W]‌hen the defendant has beneficially occupied the property, he may be held liable in an action of trespass for its fair rental value, even though the plaintiff was not hindered or obstructed in any use which he expected to make of the property’ ”); Baltimore & Ohio R.R. Co. v. Boyd, 10 Atl. 315, 317–​18 (1887) (Railroad had for a number of years trespassed on the plaintiff ’s land. The court said “It is true, there is no evidence whatever of any special damages sustained, or that the plaintiffs were hindered or obstructed in any proposed use of their lot, by reason of the presence and use of the railroad tracks; but, nevertheless, we are of opinion that the plaintiffs are entitled to a reasonable compensation for the use of their land, and we think this is measured by what would be a fair rental value for the ground. . . .”); Anchorage Yacht Haven, Inc. v. Robertson, 264 So. 2d 57, 61 (Fla. 4th DCA 1972) (action for trespass when defendant’s boat sank in plaintiff ’s basin; the court held that damages could include the reasonable rental value of the space occupied by the boat); Slovek v. Bd. of Cty. Comm’rs, 697 P.2d 781, 783 (Colo. Ct. App. 1984); Bourdieu v. Seaboard Standard Oil Corp., 119 P.2d 973, 978 (Cal. 1941) (“reasonable rental value affords a proper measure of damages in a case of trespass.”).

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I I I .   T H E PUZ Z L E O F   R E S TAT E MENT   S ECOND Given the well-​accepted protection of the disgorgement interest outside contract law, what explains Restatement Second’s position that contract law does not protect the disgorgement interest? One possible explanation turns on positive-​law arguments. As Dobbs’s treatise illustrates, until recently it was often and perhaps commonly assumed in the scholarly literature that contract law does not protect the disgorgement interest. However, there was (and is) only limited support for that assumption in the case law, especially at the appellate level. Farnsworth cited no cases that directly supported this proposition. Dobbs cited only one case and relied primarily on “writings,” “assumptions,” and the “practices of the bar.”10 The single case that Dobbs cited—​Burger King Corp. v. Madison11—​is of doubtful authority. Burger King was a diversity case that purported to apply Florida law. However, the Florida Supreme Court, in cases decided both before12 and after13 Burger King, gave strong protection to the disgorgement interest in contract law. The Restatement Second position seems to be supported only by a few appellate cases, principally United States Naval Institute Press v. Charter Communications, Inc.14 and a smattering of lower-​court cases.15 In Naval Institute Tom Clancy had written a first novel, The Hunt for Red October. The novel was published in hardcover by Naval Institute Press, which owned the copyright. On September 14, 1984, Naval licensed Berkley Publishing Group to publish the paperback edition of the novel. Paragraph 2 of the licensing contract provided that the term of the license “will begin 10.  See 3 Dobbs, supra note 3, at 171 n.5. 11.  710 F.2d 1480 (11th Cir. 1983). 12.  See Gassner v.  Lockett, 101 So. 2d 33 (Fla. 1958)  (disgorgement required of profits that defendant made as a result of the breach of a contract to sell a home, followed by breach and a sale to a third party at a higher price). 13.  See Coppola Enter. v. Alfone, 531 So. 2d 334, 335–​36 (Fla. 1988) (same). This case is discussed in the text at notes 31–​32, infra. 14.  936 F.2d 692 (2d Cir. 1991). See also Axford v. Price, 61 S.E.2d 637, 642 (W. Va. 1993), where the West Virginia Supreme Court held that “the measure of damages recoverable for the breach of a covenant of the seller of a business not to reengage in the business in competition with the purchaser is the value of the business lost by plaintiff and not the gain of defendant resulting from his breach of the covenant.” This holding is out of step with the great majority of cases on the measurement of damages in this context. See text at note 40, infra, and cases cited in notes 40–​43. In Abex Corp. v. Controlled Systems, Inc., Nos. 92–​1368, 92–​1423, 92–​1550, 1993 WL 4836, at *10 (4th Cir. 1993), a diversity case involving a similar context, the court, relying on Axford, held that disgorgement was an inappropriate remedy under West Virginia contract law. The court also cited Burger King and based its holding in part on the incorrect premise that “awarding more than expectation damages prevents an efficient breach.” Id. at n.11. The opinion in Abex was not published. Under the Fourth Circuit’s Local Rule 36(c), in the absence of unusual circumstances the court will not cite an unpublished opinion, and citation of unpublished opinions in briefs to the court is disfavored. 15.  See, e.g., Topps Co., v. Cadbury Stani S.A.I.C., 380 F. Supp. 2d 250, 261–​64 (S.D.N.Y. 2005); Curley v. Allstate Ins. Co. 289 F. Supp. 2d 614, 620–​21 (E.D. Pa. 2003); Dethmers Mfg. Co. v. Automatic Equip. Mfg. Co., 73 F. Supp. 2d 997, 1008 (N.D. Iowa 1999); Glendale Fed. Bank, ESB v. United States, 43 Fed. Cl. 390, 407–​08 (1999).

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on the date written above” and continue until five years after the date of Berkley’s first publication. Paragraph 4 provided that Berkley would not publish the paperback edition sooner than October 1985. The Hunt for Red October unexpectedly was a huge bestseller. Probably for this reason Berkley shipped out the paperback edition earlier than the contract permitted, so that retail sales of the paperback began on September 15, 1985, rather than in October. The paperback sales were so large that before the end of September the book was near the top of paperback bestseller lists. Naval brought suit against Berkley in federal court for copyright infringement and breach of contract. The case went through two appeals. On the first appeal the Second Circuit held that Berkley had breached the contract by causing voluminous paperback retail sales before October 1985, and remanded the case for entry of a judgment awarding Naval appropriate relief.16 On remand from that decision Naval claimed that Berkley’s sales of the paperback edition prior to October 1985 infringed Naval’s copyright and sought a judgment for Berkley’s profits on those sales. Then-​district-​court-​judge Pierre Leval found that Naval’s copyright had been infringed by the pre-​October sales, and awarded both ordinary contract damages of $35,380, based on Naval’s losses from Berkley’s wrongful pre-​October publication, and disgorgement damages of $7,760, based on Berkley’s profits from the infringement. Judge Leval measured Naval’s ordinary contract damages by the profits Naval lost as a result of Berkley’s wrongful pre-​October publication—​more specifically, the profits that Naval would have earned from hardcover sales in September 1985 if Berkeley had not wrongfully offered the paperback edition for sale that month. As to disgorgement, Judge Leval held that Naval was entitled to the profits that Berkley made from sales to customers who would not have bought the paperback but for the fact that it became available in September. The logic of Judge Leval’s analysis can be understood as follows. Book buyers can be divided into three categories: Spenders, Savers, and Supersavers. Spenders always buy the hardcover edition of a book even if a paperback edition has already been published. Savers buy the hardcover edition of a book if, but only if, the paperback edition has not yet been published; if the paperback edition has been published, Savers buy the paperback. Supersavers buy only paperbacks and therefore always wait until the paperback edition is published. Berkeley’s premature publication of the paperback in September did not affect Naval’s sales to Spenders because Spenders bought the hardcover even after the premature publication of the paperback. Premature publication of the paperback edition also did not affect Naval’s sales to Supersavers, because Supersavers wouldn’t have bought the hardcover in any event. The situation regarding Savers, however, was different. Because Savers would have bought the hardcover if, but only if, the paperback had not yet been published, premature publication of the paperback caused Naval to lose the profits it would have made on sales of the hardcover to Savers in September if the paperback had not yet been published. Premature publication of the paperback also resulted in gains from breach for Berkley in the amount of the profits from sales of the paperback to Savers in September, because but for the premature publication Savers would have purchased the hardcover in September. On appeal from Judge Leval’s decision the Second Circuit began by holding that Berkley had not infringed Naval’s copyright. Paragraph 2 of the contract provided that Berkley’s license

16.  United States Naval Institute v. Charter Communications, Inc., 875 F.2d 1044 (2d. Cir. 1989).

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took effect on “the date written above.” The only date written above Paragraph 2 was the heading of the contract—​“Agreement made this 14th day of September 1984.” The court concluded that the license therefore began on that date. Accordingly, the court held that Berkley’s publication in September 1985 did not constitute copyright infringement, and that Judge Leval’s $7,760 disgorgement award based on Berkley’s gain from breach was improper, because the general principle in contract law is that the promisee can recover only its own losses, not the promisor’s gains. However, the Second Circuit affirmed Judge Laval’s ordinary-​contract-​damages award, based on Naval’s lost profits on the sales it would have made to Savers who would have purchased the hardcover edition in September but for Berkley’s breach, because even if Berkley had not infringed Naval’s copyright it had breached the contract.17 Naval Institute illustrates the shaky nature of the distinction between property rights and contract rights in regard to disgorgement, because resolution of the property-​law question—​ when did Berkley’s license begin—​depended entirely on an interpretation of the contract. Section 2 of the contract provided, somewhat cryptically, that the license began “on the date written above.” The Second Circuit concluded that the license began on September 14, 1984, the date set out in the heading of the contract, because that was the only date that appeared before Section 2. This interpretation is not entirely convincing. The license was to last until five years after Berkley’s first publication, which could properly be made only in October 1985. Why would Naval license Berkley for almost a year during which Berkley had no right to publish? Why wouldn’t the license begin when Berkley first had a right to publish? Indeed, that is just how Judge Leval construed the contract at the first trial of the case. The Second Circuit’s decision in the second appeal in Naval Institute is also questionable. For one thing, the decision was hyper-​technical. Suppose the Second Circuit had concluded that Berkley did not have a license to publish the paperback edition in September 1985, so that publication in September infringed Naval’s copyright. Presumably in that case the court would have allowed Naval to recover Berkley’s gains from premature publication, because premature publication would have violated Naval’s property rights, that is, its interest in its copyright. In contrast, because the court concluded that Berkley’s license took effect in September 1984, Berkley’s only wrong was a breach of contract, which in the court’s view did not provide a basis for disgorgement. Accordingly, the decision rested on a scholastic and unconvincing distinction between contract rights, on the one hand, and property rights that wholly depend upon contract rights, on the other. To put this differently, even if the Second Circuit’s interpretation of the contract was correct, once the wrongfulness of the September publication was established why should the availability of disgorgement turn on whether the wrongful publication fit into a property box or a contract box? A second reason why the decision is questionable is that Naval would almost certainly have been entitled to enjoin Berkley from publishing the paperback edition in September if it had known of Berkley’s plan. That being so, the disgorgement interest should have been protected to prevent promisors like Berkley from subverting the remedy of specific performance by running a quick end-​around. A third reason why the Naval Institute decision is questionable is that the decision probably frustrated a purpose of the contract. The court failed to consider the purpose of the contractual provision that prohibited Berkley from publishing the paperback before October 1985. As

17.  United States Naval Institute v. Charter Publications, Inc., 936 F. 2d 692 (2d. Cir. 1991).

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a result, that purpose cannot be definitively known, but it is clear that Naval believed it was in its interest that the paperback not be published before October, and the reasons that was so can be easily imagined. Retail booksellers usually can return unsold books to the publisher for full credit. Therefore, Naval would want to know when the paperback would be published so that it could adjust its printing schedule and not be stuck with excessive returns of the hardcover edition after the softcover edition was published. Naval might also have wanted to adjust the timing of its promotional efforts for the hardcover edition so that Berkley would not free-​ride on advertising by Naval that would do little or nothing to promote sales of the hardcover once the paperback was on the market. Berkley’s breach threw a monkey wrench into these and probably other types of planning. Because Naval’s consequent losses would be very difficult to establish with sufficient certainty to qualify for expectation damages, disgorgement damages would serve as a surrogate.

I V.   E F F I C I E N C Y A R GUM ENT S A G A I N S T   D I S GOR GEM ENT To summarize, positive law does not present a barrier to protection of the disgorgement interest in contract law. There are, however, two arguments based on efficiency that might seem to present a barrier. One argument is based on the theory of efficient breach. This theory, which is discussed at length in Chapter 6, holds that breach of contract is efficient, and therefore desirable, if the promisor’s gain from breach, after payment of expectation damages, will exceed the promisee’s loss from breach. Since disgorgement, where appropriate, would require the promisor to surrender his gain from breach, the theory, if justified, would militate against disgorgement. However, as shown in Chapter 26, the theory is unjustified and indeed inefficient. Another argument against disgorgement might proceed as follows:  Expectation damages promote efficiency by causing a promisor to internalize the promisee’s potential gains under the contract, and therefore give the promisor appropriate incentives in making perform-​or-​breach decisions and in deciding how much precaution to take to ensure that she will be able to perform when the time comes. Generally speaking, however, a promisee will seek disgorgement damages only when they exceed expectation damages. Therefore, the argument would go, protection of the disgorgement interest would provide the promisor with excessive incentives for performance and precaution. There are several problems with such an argument. To begin with, the expectation measure is highly imperfect, at least under present law, because it systematically fails to make promisees indifferent between performance and breach.18 Next, where expectation damages are difficult to measure the best way to ensure protection of the expectation interest may be to use disgorgement as a surrogate for expectation damages, just as reliance is sometimes used as a surrogate for expectation damages.19 18.  See supra Chapters 20, 22. 19.  See, e.g., Sec. Stove & Mfg. Co. v. Am. Ry. Express Co., 51 S.W.2d 572, 575 (Mo. App. 1932).

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Finally, the expectation measure is not an end in itself. Rather, the expectation measure is normally the best way to provide efficient incentives for precaution and performance, to facilitate surplus-​enhancing reliance, and, more generally, to effectuate bargain contracts. However, as discussed below, in certain categories of cases protection of the disgorgement interest is the best or even the only way to provide efficient incentives and to effectuate bargain contracts. And, as also discussed below, frequently disgorgement damages are expectation damages, because the promisee bargained for disgorgement of any gains the promisor made from breach.

V.   W H Y C O N T R A CT L AW S H O U L D A N D DOES PR OT ECT T H E   D I S G O R G EM ENT I NT ER ES T Although at one time the assumption that contract law does not protect the disgorgement interest was widely accepted in the secondary literature, beginning in the 1950s this began to change. To start with, there were periodic expressions of support for disgorgement in the secondary literature. Some of this support was relatively conclusory.20 Some was well developed, but was based on either principles of unjust enrichment,21 the theory that a promisee often has a property-​like entitlement to performance,22 or both, rather than efficiency. An extensive and important analysis along entitlement lines was made by Daniel Friedmann in his article

20.  For example, in his treatise on restitution, George Palmer stated: Although the issue has gone largely unexplored, it has been commonly assumed that mere breach of contract will not make the defendant accountable for benefits thereby obtained, whether through dealings with a third person or otherwise. . . . But while the [contrary] principle has not gained general acceptance, and is not likely to do so, it cannot be wholly rejected. It has enough force to be brought into play when the whole circumstances of a case point to the conclusion that the defendant’s retention of a profit is unjust. In time a principle of limited application may emerge, but it is too soon to say that this has occurred.

1 Palmer, supra note 3, § 4.9 at 438. Similarly, John Dawson stated: . . . . [A]‌n alternative form of money judgment remedy . . . could be used wherever the delivery of a specific asset or a defined course of action . . . had been promised and through breach and resale to another the promisor was enabled to secure a readily measured gain. It may well be that the obstacle [to recovery in such cases] is nothing more than that well-​known ailment of lawyers, a hardening of the categories.

John Dawson, Restitution or Damages?, 20 Ohio St. L. Rev. 175, 186–​87 (1959). 21.  See, e.g., Gareth Jones, The Recovery of Benefits Gained from a Breach of Contract, 99 L.Q. Rev. 443 (1983). 22.  See, e.g., James Edelman, Gain-​Based Damages:  Contract, Tort, Equity and Intellectual Property 149–​89 (2002) (stressing cases in which the promisee has a “legitimate interest in performance,” see id. at 189, although also giving some attention to efficiency considerations). A related critique was that there was no sufficient reason for distinguishing, in regard to disgorgement, between property and fiduciary law, on the one hand, and contract law, on the other. See, e.g., Lionel D. Smith, Disgorgement of the Profits of Breach of Contract: Property, Contract, and “Efficient Breach,” 24 Can. Bus. L.J. 121 (1994).

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“Restitution of Benefits Obtained Through the Appropriation of Property or the Commission of a Wrong”23: . . . Contract relations may . . . give rise to interests that come within the ambit of “property” for purposes of restitution. . . . Under the approach advocated here, the central issue in evaluating a claim for restitution of benefits obtained through a breach of contract can be presented as follows: When performance is promised under a contract, is the promisee “entitled” to it in such a way that if this performance is withheld, appropriated, or otherwise “taken,” the promisee can be regarded as having been deprived of an interest that “belonged” to him?24

Moral intuitions are important here as elsewhere in the law. Bargains consist of both express and implied terms. What terms can properly be implied in a contract depends partly on social morality, because a promisee’s reasonable expectations depend partly on his reasonable beliefs concerning the moral obligations that a given type of promise conventionally entails. Moreover, protection of the disgorgement interest in appropriate cases gives a promisor who wishes not to perform an incentive to renegotiate with the promisee rather than unilaterally breaching. This incentive has an efficiency dimension, but it also has a moral dimension. A promise is a morally binding commitment. That doesn’t mean that a promisor can never morally fail to perform a promise. For example, failure to keep a promise may be morally excused if the breach is inadvertent. However, where nonperformance would not be morally excused, a promisor who wishes to not perform owes a moral duty of respect to the promisee. This duty requires the promisor to seek a mutual accommodation rather than to commit a breach and thereby convert the promisee from a voluntary actor to an involuntary litigant. An idea of this sort was expressed by Judge Posner, in a different context, in Taylor v. Meirick.25 It is true that if [a copyright] infringer makes greater profits than the copyright owner lost, because the infringer is a more efficient producer than the owner or sells in a different market, the owner is allowed to capture the additional profit even though it does not represent a loss to him. It may seem wrong to penalize the infringer for his superior efficiency and give the owner a windfall. But it discourages infringement. By preventing infringers from obtaining any net profit it makes any would-​be infringer negotiate directly with the owner of a copyright that he wants to use, rather than bypass the market by stealing the copyright and forcing the owner to seek compensation from the courts for his loss. Since the infringer’s gain might exceed the owner’s loss, especially as loss [is] measured by a court, limiting damages to that loss would not effectively deter this kind of forced exchange.26

23. 80 Colum. L. Rev. 504, 513–​27 (1980). 24.  Id. at 513, 515. Friedmann made parallel arguments in Daniel Friedmann, The Efficient Breach Fallacy, 18 J. Leg. Stud. 1 (1989) and Daniel Friedmann, Restitution for Wrongs:  The Measure of Recovery, 79 Tex. L.  Rev. 1879 (2001). Friedmann’s arguments led to protection of the disgorgement interest by the Israel Supreme Court in CA 20/​82 Adras v. Harlow & Jones Gmbh, [1988] 42(1) PD 221 (in Hebrew), 3 Restitution L. Rev. 235 (1995) (in English). 25.  712 F.2d 1112 (7th Cir. 1983). 26.  Id. at 1120.

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The principle of unjust enrichment is also relevant to disgorgement. That principle overlaps with morality. The law does not require everyone who is enriched by another’s action to restore the value of the benefit: only benefits whose retention would constitute unjust enrichment must be restored. Restatement Second Section 344(c) conventionally defines the restitution interest in contract law as the promisee’s interests in having restored to him any benefit that he has conferred on the promisor. Where such a benefit is involved, unjust-​enrichment protection of the disgorgement interest is unnecessary, because protection of the restitution interest would suffice. For the most part, therefore, cases in which the disgorgement interest should be protected in contract law do not involve unjust enrichment in an obvious way. As will be shown below, however, in certain types of cases protection of the disgorgement interest is a necessary or important instrument to prevent unjust enrichment, because the promisor’s unjust retention of a benefit, although real, may not be obvious. In any event, in important and recurring types of cases, protection of the disgorgement interest is justified by efficiency considerations. Some of these cases are discussed in the balance of this chapter.

V I.   C A S E S I N   W H I CH T HE  PR OM I S EE H A S B A R G A INED F OR   T HE P R O MI S O R ’ S G A IN F R OM   BR EA CH In contrast to Naval Institute, appellate cases decided by the United States Supreme Court, the House of Lords, various state appellate courts, and the highest courts of other common law jurisdictions have awarded disgorgement damages in a contract setting. These cases do triple duty: they provide positive-​law support for the principle of disgorgement, they exemplify some of the reasons why disgorgement is often justified, and they delineate some of the categories of cases in which disgorgement should be and is awarded. For example, in EarthInfo, Inc. v. Hydrosphere Resource Consultants, Inc.,27 Hydrosphere had made a series of contracts with EarthInfo28 under which Hydrosphere agreed to develop hydrological and meteorological CD-​ROMs and software. EarthInfo, in turn, agreed to prepare users’ manuals for the CD-​ROMs, to package and market the CD-​ROMs and the manuals, and to pay Hydrosphere a fixed hourly development fee and royalties on new products. The contracts vested all copyright, patent, and other ownership rights in EarthInfo. In June 1990, Hydrosphere and EarthInfo became embroiled in a dispute over whether certain products developed by Hydrosphere were new, so that EarthInfo was obliged to pay Hydrosphere royalties on the products. On June 30 EarthInfo suspended payment of all royalties, including those it admittedly owed. In response, in December Hydrosphere notified EarthInfo that it was rescinding the contracts and brought suit for both rescission and restitution for the work it had done. The trial court determined as follows: EarthInfo’s suspension of royalties was a substantial breach and the appropriate remedy was rescission and restitution. The court set June 30, 1990, as the date of rescission, and ordered EarthInfo to return to Hydrosphere all tangible property that Hydrosphere had developed under the contracts and to disgorge the net profits it had realized 27.  900 P. 2d 113 (Colo. 1995). 28.  More accurately, Hydrosphere had made a series of contracts with EarthInfo’s predecessor in interest. For ease of exposition, I use the term EarthInfo to mean both EarthInfo and its predecessor.

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on sales of the CD-​ROMs after June 30. On appeal, the Colorado Supreme Court held there is no rule that disgorgement is unavailable as a remedy for breach of contract. Instead, the rule is that the courts have power to award disgorgement in appropriate cases. In EarthInfo itself, the court held, disgorgement was appropriate because the breach was conscious and substantial. In some contracts cases efficiency requires the disgorgement interest to be protected because the promisee has bargained for the gain that the promisor has made through breach. Ironically, the leading such case is the poster child for the theory of efficient breach, that is, the Overbidder Paradigm. As discussed in Chapter 26, it is implied in a contract for the sale of a commodity that the seller will neither seek out nor accept offers from overbidders. Furthermore, a buyer will normally pay an implicit premium for that implied promise. At the time a contract for the sale of a differentiated commodity is made the buyer and the seller know that an overbid might be made later.29 Just as the buyer takes the negative or downside risk that the value of the commodity may fall before delivery, so the buyer takes—​and the seller forgoes—​the positive or upside risk that an overbidder may turn up. Because the buyer and the seller know this, the buyer will need to pay the seller an implicit premium for forgoing the positive risk. The amount of this premium will be the expected value of an overbid, based roughly on a probability-​weighted average of potential overbid prices. To put this differently, if the seller is economically rational her price will include a premium for her implied promise to take the contracted-​for commodity off the market—​a premium equal to the reduction in price that the buyer would demand for giving the seller a right to resell to an overbidder. If, in such cases, the seller breaches and sells to an overbidder, what looks like disgorgement of the seller’s gain is actually a form of expectation damages, because the promisor has paid for the right to any profit derived from selling to the overbidder. Making a forward contract for the sale of a differentiated commodity reflects a decision by the seller, embodied in a binding commitment, that her best bet is to take the buyer’s present offer, including the implicit premium, rather than waiting for a possible higher offer in the future. If the seller accepts a higher offer she is reneging on her bet. The buyer’s bargained-​for payoff is the seller’s gain from breach. This point is brought out in a line of cases concerning contracts for the sale of real property in which the seller breaches to sell to an overbidder and the buyer brings suit. Some cases hold that on those facts the buyer is only entitled to the difference between the contract price and the market price, and that the price paid by the overbidder is only evidence of the market price.30 In most cases, however, the courts have either treated the resale price as virtually conclusive 29.  As Alan Schwartz states: [Markets for unique goods] often are well organized; the antique market provides an example. Such markets have two distinguishing features. First, they are usually characterized by greater price dispersion than obtains in the market equilibria for roughly fungible goods. In addition, sellers face a lower “rate of arrival” of potential buyers than do sellers of roughly fungible goods. These two phenomena are related; a high “buyer arrival” rate implies extensive comparison shopping among firms, whereas the degree of price dispersion a market can sustain varies inversely with the amount of comparison shopping. [A seller of differentiated] goods consequently has grounds to believe that the offers he receives are to some extent random, and that later offers could be much higher than earlier ones.

Alan Schwartz, The Case for Specific Performance, 89 Yale L.J. 271, 281 (1979). Schwartz uses the term unique, rather than differentiated, but it is clear from his text that he is referring to non-​homogeneous—​ that is, differentiated—​goods. 30.  See, e.g., Grummel v. Hollenstein, 367 P.2d 960, 963 (Ariz. 1962); Kemp v. Gannett, 365 N.E.2d 1112, 1113 (Ill. App. 1977); Reed v. Wadsworth, 553 P.2d 1024, 1036 (Wyo. 1976); cf. Triangle Waist Co. v. Todd, 119 N.E. 85, 86 (N.Y. 1918) (Cardozo, J.) (“The price received upon a genuine sale either of property or

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evidence of the market price,31 which is economically equivalent to granting disgorgement, or have granted disgorgement directly.32 For example, in Coppola Enterprises v.  Alfone33 Alfone contracted with Coppola to purchase, for $105,690, a single-​family home, known as Unit 53, to be constructed by Coppola. The contract provided that the closing was to occur after ten days’ written notice from Coppola. Closing was projected for winter 1978–​1979, but due to construction delays was rescheduled for late summer 1980. At that point Alfone was unable to acquire financing within the required ten-​day period and requested additional time. Coppola refused, and subsequently sold Unit 53 for $170,000. The trial court found that by refusing to offer Alfone a reasonable time to close and terminating the contract Coppola had not acted in good faith, and awarded Alfone Coppola’s profit on the resale. The Florida Supreme Court affirmed, but held that Alfone was entitled to disgorgement even if Coppola had acted in good faith: The district court was correct to award damages to Alfone equal to the profit made by Coppola on the subsequent sale. . . . Coppola was obligated to sell Unit 53 to Alfone under their contract. . . . Alfone was entitled to a reasonable time in which to acquire the funds to pay the balance due on the property. Once Coppola breached its contract with Alfone and was unable to perform due to the sale of Unit 53 to a subsequent purchaser, Alfone was entitled to damages equal to Coppola’s profits from the sale. We need not address whether Coppola’s decision to sell Unit 53 to a subsequent purchaser involved bad faith. Resolution of that issue is not dispositive here. . . . [T]‌he buyer is entitled to these damages whether the sale to a subsequent purchaser involved bad faith or was merely the result of a good-​faith mistake. A seller will not be permitted to profit from his breach of a contract with a buyer, even absent proof of fraud or bad faith, when the breach is followed by a sale of the land to a subsequent purchaser.34

of services is some evidence of value”); Murphy v. Lifschitz, 49 N.Y.S.2d 439, 441 (1944), aff ’d mem., 63 N.E.2d 26 (N.Y. 1945). 31.  See, e.g., Mercer v. Lemmens, 40 Cal. Rptr. 803, 807 (Ct. App. 1964); Newman v. Cary, 466 So. 2d 774, 777 (La. Ct. App. 1985). 32.  See, e.g., Defeyter v.  Riley, 671  P.2d 995, 997, 999 (Colo. Ct. App.  1983); Seaside Cmty. Dev. Corp. v. Edwards, 573 So.2d 142, 147 (Fla. Ct. App. 1991); Colby v. Street, 178 N.W. 599, 602–​03 (Minn. 1920); Taylor v. Kelly, 56 N.C. 240, 245 (1857); Timko v. Useful Homes Corp., 168 A. 824 (N.J. Ch. 1933). 33.  531 So. 2d 334 (Fla. 1988). 34.  Id. at 335–​36. Restatement Third of Restitution and Unjust Enrichment § 39(1) provides for disgorgement of a promisor’s profit if the breach is deliberate. A requirement of deliberate breach is neither appropriate nor supported by the case law. Strikingly, the Illustrations to Section 39 are inconsistent with the text. Some of the Illustrations are based on the facts of cases that did not involve deliberateness but add to those facts a statement that the breach was deliberate—​as if, counterfactually, the results in the cases would have been different if the breach was not deliberate. Other Illustrations properly conclude that disgorgement is required although the breach is not characterized as deliberate. Illustration 13, which resembles Jacob & Youngs, infra notes 53–​55, is particularly striking: Builder and Owner agree on the construction of a house at a price of $2 million. The specifications call for foundations to be made of Vermont granite, and the work has been bid and priced on that basis. By mistake and inadvertence, builder constructs the foundations of granite quarried in New Hampshire. This fact comes to light when construction has been completed. The difference in the appraised value of Owner’s prop­erty as a result of the nonconformity is nil. The cost to cure the default would far exceed the total price of the house. Because New Hampshire granite is less expensive than comparable stone from Vermont,

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Disgorgement in such cases is sometimes rationalized as consistent with the position of Restatement Second on the theory that because the buyer of real property has a right to specific performance he is the “equitable owner” of the property and the seller is only a “trustee,” so that disgorgement is justified by trust and property rules.35 This kind of reasoning is hyper-​technical and brittle, and did not drive the analysis in Coppola. Farnsworth pointed out that treating a seller of real property as a trustee “would, if taken literally, lead to extraordinary results by subjecting the seller to all of the restraints imposed on a trustee.”36 The trust and property rationales were also rejected in favor of a straight disgorgement theory in Laurin v. DeCarolis Construction Co.,37 decided by the Massachusetts Supreme Judicial Court. In March 1971 the Laurins agreed to purchase, for $26,900, a home that DeCarolis was then constructing. The home was situated on a well-​wooded lot. Prior to the closing, the Laurins found that after the contract had been signed DeCarolis had bulldozed many of the trees on the property, apparently for its own use. The Laurins ordered DeCarolis to desist, but DeCarolis continued to bulldoze trees and also removed gravel and loam worth $6,480. The Laurins paid the purchase price at the closing and then sued DeCarolis for the value of the trees, gravel, and loam that DeCarolis had removed. The case was tried by a master, who concluded that the Laurins were the equitable owners of the property from the signing of the agreement onward, so that DeCarolis had unlawfully converted the trees, gravel, and loam. In other words, the master reasoned that the Laurins were entitled to disgorgement under a property theory. The Massachusetts Supreme Judicial Court upheld the lower masters result but rejected this reasoning on the ground that under Massachusetts law “the rights of the purchaser of real prop­ erty prior to closing are contract rights rather than property rights.” Accordingly, the Court concluded, “[this] case must be decided, not as [an] action for injury to or conversion of prop­ erty, but as a claim for a deliberate and willful breach of contract. . . .” This left a contract theory. The problem was that the taking of trees, gravel, and loam by DeCarolis had not diminished the value of the property. Therefore, although DeCarolis had made a gain from breach the Laurins had not suffered a loss. Nevertheless, the Court held that the Laurins were entitled to disgorgement because DeCarolis should not be allowed to retain its gains from a willful breach of contract: . . . Particularly where the defendant’s breach is deliberate and willful, we think damages limited to diminution in value of the premises may sometimes be seriously inadequate. “Cutting a few

Builder has saved $15,000 as a result of his negligent breach of contract. Owner may recover damages of $15,000 for builder’s breach . . . 

The conflict between this illustration and the text of Section 39 is admitted, and then “explained” as follows: The case is not within the rule of § 39 (because Builder’s default is unintentional), but principles of unjust enrichment reinforce the conclusion that saved expenditure makes an appropriate measure of contract damages in such a case.

Id. But this “explanation” only underlines the defects in Section 39. If disgorgement for breach of contract should be allowed outside the limit of the text of Section 39, as should be and is, then the artificial limit of Section 39 serves no function, as it should not and does not. 35.  See, e.g., Timko v. Useful Homes Corp., 168 A. 824 (N.J. Ch. 1933). 36. Farnsworth, supra note 2, at 1364. 37.  363 N.E.2d 675 (Mass. 1977).

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trees on a timber tract, or taking a few hundred tons of coal from a mine, might not diminish the market value of the tract, or of the mine, and yet the value of the wood or coal, severed from the soil, might be considerable. The wrongdoer would, in the cases instanced, be held to pay the value of the wood and coal, and he could not shield himself by showing that the property from which it was taken was, as a whole, worth as much as it was before.” . . . This reasoning does not depend for its soundness on the holding of a property interest, as distinguished from a contractual interest, by the plaintiffs. Nor is it punitive; it merely deprives the defendant of a profit wrongfully made, a profit which the plaintiff was entitled to make. . . .38

V I I .   D I S G O R G EM ENT I N  L I EU O F   S P E C I F I C PER F OR M A NCE The disgorgement interest should also be protected where the promisee would have been awarded specific performance except for the fact that before he brought suit the promisor took an action that put specific performance beyond reach—​for example, by selling the contracted-​for commodity to a bona fide purchaser. Disgorgement is necessary in such cases to prevent the promisor from subverting the promisee’s right to specific performance by completing an irreversible breach before the promisee can get to court.39

V III.   D I S G O R G E M E NT A S   A S UR R OGAT E F O R   E X P E C TATI ON DA M A GES Another category of cases where disgorgement should be awarded consists of cases in which disgorgement serves as a surrogate for the expectation measure, in the same way that reliance is used as a surrogate for the expectation measure when expectation damages are too uncertain.40 For example, there is a line of cases concerning the measure of damages where the defendant has competed with the plaintiff in breach of a noncompete agreement or of an agreement to give the plaintiff exclusive territorial rights over some activity. In many or most of these cases, the courts have awarded the plaintiff damages based on the defendant’s profits, that is, disgorgement.41 In some of these cases disgorgement is used as a surrogate for the

38.  Id. at 692–​93. 39.  See Edward Yorio, In Defense of Money Damages for Breach of Contract, 82 Colum. L. Rev. 1365, 1402 at n.196 (1982). 40.  See, e.g., Sec. Stove, & Mfg. Co. v. Ry. Express Co., 51 S.W.2d 572, 575 (Mo. App. 1932). 41.  See, e.g., Cincinnati Siemens-​Lungren Gas Illuminating Co. v. Western Siemen-​Lungren Co., 152 U.S. 200 (1894); Unita Oil Refining Co. v. Ledford, 244 P.2d 881 (Colo. 1952); Automatic Laundry Serv., Inc. v. Demas, 141 A.2d 497 (Md. 1958); Oscar Barnett Foundry Co. v. Crowe, 86 A. 915 (N.J. 1912); Y.J.D. Rest. Supply Co. v. Dib, 413 N.Y.S.2d 835 (N.Y. Sup. Ct. 1979); Buxbaum v. G.H.P. Cigar Co., 206 N.W. 59 (Wis. 1925). But see Vermont Elec. Supply Co. v. Andrus, 373 A.2d 531, 532 (Vt. 1977).

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expectation measure.42 In those cases courts are not protecting the disgorgement interest as such. However, the difference between using disgorgement to protect the expectation interest or to protect the disgorgement interest is not robust.43 Furthermore, in some of these cases the courts did protect the disgorgement as such rather than using disgorgement as a surrogate for expectation.44

I X.   BA R G A I N S D E S I GNED T O  S ERVE I NTE RE S T S O T H E R T H AN PR OF I T M A KI NG Most bargains are made for profitmaking purposes, but some are not. Often, bargains of the latter type can be best or only effectuated, and correct incentives for the promisor can be best or only provided, by protection of the disgorgement interest. Two of the most important cases protecting the disgorgement interest fall in this category. These cases, which are strikingly similar, are Snepp v. United States45 and Blake v. Attorney General.46 These cases were both decided by the highest courts of the United States and Great Britain. In Snepp v. United States, decided by the United States Supreme Court, Frank Snepp had been an employee of the CIA. As a condition to his employment Snepp had signed a contract in which he promised that he would “not . . . publish . . . any information or material relating to the term of [his] employment . . . without specific prior approval by the Agency.” After Snepp left the CIA he published a book about CIA activities in South Vietnam that occurred during the term of his employment. The book contained no classified information, but Snepp published the book without having submitted it to the CIA for prior approval. The Government sued Snepp for disgorgement of his profits on the book. The Supreme Court ordered Snepp to disgorge the profits because he did not submit the book for prior approval, as he had contracted to do. The Court rested its decision in part on the theory that “Snepp’s employment with the CIA involved an extremely high degree of trust,” and that “Snepp violated [t]‌his trust.” This rhetoric, taken at face value, makes Snepp look like a breach-​of-​fiduciary-​duty case. However, the case did not turn on a breach of a fiduciary duty imposed by law, such as the duty of a fiduciary not to transact with his beneficiary on unfair terms. Rather, Snepp was liable because, and only because, he breached his contract. Moreover, although the Court’s decision was at least nominally based in part on the trust relationship, the decision was also explicitly based in part on the view that no remedy other than disgorgement would effectuate the contract. In this regard the Court said that although 42.  See, e.g., Unita Oil Refining Co. v.  Ledford, 244  P.2d 881 (Colo. 1952); Buxbaum, 206 N.W.  at 61 (Wis. 1925). 43.  See, e.g., Unita Oil 244 P. 881 where the court first said that the defendant’s profits may be such as to make possible a reasonable estimate of plaintiff ’s lost profits, and then went on to hold that the plaintiff could recover the defendant’s profits. 44.  See, e.g., Cincinnati Siemens-​Lungren Gas. 152 U.S. at 203–​04; Automatic Laundry, 141A.2d at 501–​02; Oscar Barnett Foundry, 86 A. at 916; Y.J.D. Rest. Supply, N.Y.S.2d at 837. 45.  Snepp v. United States, 444 U.S. 507 (1980). 46.  Blake v. Attorney General [2001] 1 AC 268 (HL) (appeal taken from Eng.).

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the Government was likely harmed by Snepp’s book, proof of that harm would be too difficult, and the Government could not pursue other remedies, such as nominal damages, “without losing the benefit of the bargain it now seeks to enforce.” In short, Snepp was as much a contract-​law case as a fiduciary-​law case, and really much more of a contract-​law case than a fiduciary-​law case. Blake v. Attorney General, decided by the English House of Lords, was extraordinarily similar to Snepp. George Blake, like Snepp, had been a member of his Government’s intelligence service. Blake, like Snepp, had made a contract at the outset of his employment that restricted his rights to publish: “I undertake not to divulge any official information gained by me as a result of my employment, either in the press or in book form. I also understand that these provisions apply . . . after employment has ceased.” Blake, like Snepp, broke his contract by publishing a book relating to his activities as a secret-​intelligence officer. Blake’s book, like Snepp’s book, contained no information that was confidential at the time of publication. The English Government, like the American Government, sought disgorgement of Blake’s profits from the book. The House of Lords, like the Supreme Court, granted that remedy. In Snepp the Supreme Court employed fiduciary-​like rhetoric, at least in part. In Blake the House of Lords did not—​indeed, just the reverse. At trial the English Government had rested its case exclusively on the theory that in writing and publishing his book, Blake had violated his fiduciary duties. However, the trial court held that although former members of the intelligence service owe a lifelong fiduciary duty of nondisclosure in respect of secret and confidential information, they owe no further fiduciary duty. The House of Lords did not challenge this conclusion. As a result the Lords could not rest their decision on fiduciary principles, because Blake did not use secret or confidential information. Instead, the Lords explicitly addressed, in a very sophisticated way, the issue whether contract law should protect the disgorgement interest in appropriate cases. Lord Nicholls wrote the lead opinion in the case. He began by pointing out that although generally the purpose of damages is to compensate for injury, the law makes exceptions to that principle: The Earl of Halsbury L.C. famously asked in The Mediana . . . that if a person took away a chair from his room and kept it for 12  months, could anybody say you had a right to diminish the damages by showing that I did not usually sit in that chair, or that there were plenty of other chairs in the room? To the same effect was Lord Shaw’s telling example in Watson, Laidlaw & Co. Ltd. v. Pott, Cassels, and Williamson. . . . It bears repetition: If A, being a liveryman, keeps his horse standing idle in the stable, and B, against his wish or without his knowledge, rides or drives it out, it is no answer to A for B to say: “Against what loss do you want to be restored? I restore the horse. There is no loss. The horse is none the worse; it is the better for the exercise.”47

Against that background, Lord Nicholls turned to the remedies available for breach of contract. He showed that courts deciding contract-​law cases had recognized the interest of a

47.  Id. at 278–​79.

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promisor in performance (as opposed to an interest in a remedy for breach), by granting specific performance and by sometimes requiring disgorgement of the wrongdoer’s gain: The law recognizes that a party to a contract may have an interest in performance which is not readily measurable in terms of money. On breach the innocent party suffers a loss. He fails to obtain the benefit promised by the other party to the contract. To him the loss may be as important as financially measurable loss, or more so. An award of damages, assessed by reference to financial loss, will not recompense him properly. For him a financially assessed measure of damages is inadequate.48

From that starting point Lord Nicholls went on to lay down the principle that contract law should protect the disgorgement interest by making disgorgement available in appropriate cases: [The] cases illustrate that circumstances do arise when the just response to a breach of contract is that the wrongdoer should not be permitted to retain any profit from the breach. . . . My conclusion is that there seems to be no reason, in principle, why the court must in all circumstances rule out an account of profits as a remedy for breach of contract. . . . Remedies are the law’s response to a wrong (or, more precisely, to a cause of action). When, exceptionally, a just response to a breach of contract so requires, the court should be able to grant the discretionary remedy of requiring a defendant to account to the plaintiff for the benefits he has received from his breach of contract. In the same way as a plaintiff ’s interest in performance of a contract may render it just and equitable for the court to make an order for specific performance or grant an injunction, so the plaintiff ’s interest in performance may make it just and equitable that the defendant should retain no benefit from his breach of contract.49

Snepp and Blake were correctly decided. The contractual purpose of each Government was the management of potentially sensitive information. That purpose could not easily be served by protecting the expectation interest, because the information had no market value and the Governments suffered no economic loss by its publication.50 Specific performance was not an available remedy because the contracts had already been irremediably broken. Reliance damages would be of no use because neither Government had incurred 48.  Id. at 282. 49.  Id. at 284–​85. See also Bank of America Canada v.  Mutual Trust Co., [2002] 2 S.C.R. 601(Can.), discussed in Mitchell McInnes, Restitutionary Damages for Breach of Contract: Bank of Am. Canada v. Mut. Trust Co., 37 Can. Bus. L.J. 125 (2002); cf. CA 20/​82 Adras v. Harlow & Jones Gmbh [1988] 42(1) PD 221 (Isr.) (in Hebrew), 3 Restitution L. Rev. 235 (1995) (in English) (disgorgement interest in contract law protected in a mixed common law/​civil law jurisdiction). 50.  See David Fox, Case and Comment, Restitutionary Damages to Deter Breach of Contract, 60 Cambridge L.J. 33, 34 (2001). Moreover, as John McCamus has pointed out, if Blake had submitted his manuscript for approval and the Crown did not give its approval, Blake would not have written his book and therefore would have earned no royalties, so that performance would not have economically benefitted the Crown. John D. McCamus, Disgorgement for Breach of Contract: A Comparative Perspective, 36 Loy. L.A. L. Rev. 943, 947–​48 (2003).

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demonstrable costs in reliance on the defendant’s promise. Restitutionary damages would be of no use because the Governments had conferred no benefits on the defendants that could be recovered under the law of restitution. Therefore, as the Supreme Court emphasized in Snepp, the best and perhaps only way to effectuate the contracts was to protect the disgorgement interest.51 In short, the rule should be and is that where a bargain contract is not designed for profitmaking purposes the disgorgement interest will be protected to give the promisor efficient incentives to perform and thereby to effectuate contracts of this type.

X .   E X T E RNA L I T I ES The purpose of some contracts is primarily to create an externality, that is, to benefit persons other than the contracting parties. In such cases protection of the promisee’s disgorgement interest will often be the best or only way to effectuate the contract and give the promisor efficient incentives to perform. For example, in British Trade Association v.  Gilbert52 the British Trade Association had created an arrangement with new-​car dealers to hold down new-​car prices during the new-​car shortage that arose in the aftermath of World War II. Under the arrangement new-​car dealers required new-​car buyers to enter into a contract with the Association which provided that if the buyer wanted to resell the car within two years he would sell it to the Association at the original sale price minus a stipulated rate of depreciation. The Association, in turn, agreed that it would resell the car at the price it paid to the buyer. Gilbert bought a new car and entered into the contract with the Association, but within two years he sold the car on the black market at a large profit. The Association sued for disgorgement of the profit. Although Gilbert breached the contract the Association had no expectation damages because if Gilbert had performed the contract by selling the car to the Association, the Association would have been required to resell the car at the price it paid. However, the purpose of the contract was not to benefit either the British Trade Association or new-​car dealers—​at least not in any direct, commercial way. Rather, the purpose of the contract was to create an externality that would benefit the general public by preventing an inflationary black market in cars. The best or only way to effectuate this purpose, and give new-​car-​buyers efficient incentives to perform, was to require breaching buyers to disgorge to the Association the profit they made on resale. The court properly so held. 51.  Punitive damages might seem to be an alternative, but most courts will not grant punitive damages in the absence of actual damages. More important, punitive damages would be less desirable than disgorgement because the amount of such damages would not have a one-​to-​one relationship with either the promisee’s loss or the promisor’s gain. Furthermore, as compared to punitive damages disgorgement has the advantage that a promisor has no moral ground for complaining about a judgment that merely requires her to give up the gain she made from committing a wrong. As stated in Snepp, “since the remedy [of disgorgement] reaches only funds attributable to the breach, it cannot saddle the [defendant] with exemplary [punitive] damages out of all proportion to his gain.” Id. at 515–​16. 52.  [1951] 2 All ER 641 (Ch.) (Eng.).

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X I .   D I S G O R G E MENT OF   COS T S S AV E D B Y   BR EA CH Protection of the disgorgement interest is also necessary to effectuate a contract, to provide efficient incentives for precaution and performance, and to prevent unjust enrichment, in cases where a promisor breaches by taking a wrongful action that reduces her costs but does not cause an equivalent loss to the promisee. Consider two categories of such cases:

A.  SKIMPED SERVICES In one category, sometimes known as skimped-​services cases, A agrees to provide services to or for B on an as-​needed basis during a stated period, and in that connection to make designated personnel and facilities available to perform or support the services during the period. B, in turn, agrees to pay A a flat amount rather than paying for whatever services are actually needed and rendered during the period. As things turn out A wrongfully failed to maintain personnel and facilities at the agreed level but had enough personnel and facilities to perform all the services that B actually needed during the period. For example, suppose that A, a marine salvor, agrees with B, a shipping company, that, in exchange for a flat payment of $1,000,000, during a one-​year period A will station rescue tugboats at strategic locations around the world to come to the aid of B vessels that fall into distress. During the one-​year period A does not station all the tugboats it promised but B suffers no loss because none of B’s vessels fall into distress. In this type of case the purpose of the contract is to assure that the promisor will maintain the promised personnel and facilities in place. Expectation damages do not give the promisor sufficient incentives to perform because the promisee will incur no loss as a result of the breach if, despite the breach, the promisor is able to provide all the services the promisee ends up actually needing. In contrast, protection of the disgorgement interest, measured by the promisor’s saved costs, will give the promisor efficient incentives to perform and therefore will effectuate the contract. Moreover, in the absence of disgorgement the promisor will be unjustly enriched because she will have been paid for a performance that she did not render. Accordingly, if in such a case the promisee has paid the promisor in advance the promisee should be entitled to disgorgement of the promisor’s saved costs. If the promisee has not paid the promisor in advance, the saved costs should be deducted from the contract price.53 53.  A contrary result was incorrectly reached in City of New Orleans v. Firemen’s Charitable Ass’n, 9 So. 486 (La. 1891). There the promisor had agreed to provide a certain number of firemen, and certain lengths of hose and pipe, to fight fires in the City during a given period. After the end of the period the plaintiff discovered that the number of firemen and the lengths of the hose and pipe fell short of the amount required by the contract. The court declined to impose damages on the ground that the City suffered no losses as a result of the shortfalls. In Attorney General v. Blake [1998] Ch 439, the English Court of Appeal properly criticized City of New Orleans, stating “Justice surely demands an award of substantial damages in such a case, and the amount of expenditure which the defendant has saved by the breach provides an appropriate measure of damages.” Id. at 458.

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B. DIMINISHED VALUE A related type of case of arises where a promisor who has agreed to provide services either renders a defective performance or fails to perform at all, and the cost of remediating the performance exceeds the value of the remediation. The normal formula for measuring damages for breach by a service-​provider, known as cost-​of-​completion damages, is based on the cost of remediation. Under that formula, a service-​purchaser is entitled to recover the amount that he must pay a substitute contractor to complete the original service-​provider’s obligations. Under a less commonly used formula, known as diminished-​value damages, the service-​purchaser is entitled to the difference between the value of what he was promised and the value of what he actually received. Use of the diminished-​value formula, rather than the cost-​of-​completion formula, is appropriate where a court can confidently conclude that the service-​purchaser really doesn’t want remediation but instead only wants money damages, which he will put in the bank rather than spend on remediation. However, where diminished-​value damages are appropriate a special problem arises if prior to the breach the service-​purchaser explicitly or implicitly paid for the services that the service-​provider failed to perform. The simplest situations in which to protect the disgorgement interest in skimped-​services and diminished-​value cases are those in which the promiser has paid the cost of the services in advance and wants disgorgement of that payment. However, disgorgement should also be required where the promisee has paid for services indirectly, as in the Peevyhouse Agribusiness hypothetical discussed above, or where the service-​provider brings suit for expectation damages, notwithstanding her breach, under the doctrine of substantial performance, and the service-​purchaser claims a deduction for the cost of services that were unperformed or improperly performed but did not reduce the value of the promisor’s performance. For example, in a New Zealand case, Samson & Samson Ltd. v. Proctor,54 a builder sued an owner for money owed under a contract to construct a building. The owner counterclaimed that the contract was not performed in various respects, the most important of which was that the building’s steel reinforcing was insufficient. The contractor responded that the owner had suffered no loss from the breach, because a few months after occupying the property the owner sold the building for the price he would have been paid if there had been no defects. The court properly held that the builder’s response was irrelevant and the owner was entitled to deduct from the contract price the amount the builder saved by not carrying out the contract.55 Normally, in cases where disgorgement should be awarded based on the costs the promisor saved as a result of breach, disgorgement is an alternative, not a supplement, to diminished-​ value damages. For example, in Jacob & Youngs v. Kent Kent should have been able to recover either the difference between the value of his home with Cohoes pipe and with Reading pipe or the difference in cost between Cohoes and Reading pipe, but not both, because the two

54.  [1975] 1 NZLR 655 (HC). 55.  Id. at 656. See also Healy v. Fallon, 37 A. 495, 497 (Conn. 1897) (owner awarded the difference between the cost of the boards required by the contract and the cost of the boards used by the contractor); Farrington v. Freeman, 99 N.W.2d 388, 391 (Iowa 1959) (owner awarded the difference between the cost of the windows required by the contract and the cost of the windows that the contractor installed).

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damage measures would overlap or even duplicate.56 Similarly, in Peevyhouse Agribusiness, hypothetically discussed in Chapter  15, Peevyhouse Agribusiness should not be awarded both diminished-​value damages and disgorgement of Garland Coal’s saved costs, because if those costs had been invested by Garland in restoring the farm the diminution in the value of the farm would have been significantly reduced.

XII.   T H E C A U S AT I O N A R GUM ENT S A G A I N S T   D I S G OR GEM ENT I N   C O N T R A CT   L AW Allan Farnsworth made three causation arguments against protection of the disgorgement interest in contract law. He called these arguments cause in fact, remote cause, and joint cause. These arguments are flawed in various ways. Among other things, none are really arguments against protection of the disgorgement interest in contract law. Instead, the arguments only concern how disgorgement damages should be measured.

A.  CAUSE IN FACT Farnsworth’s first causation argument was that even if a breach makes possible a gain to the promisor that she would not have realized if she had performed, the breach is not the cause in fact of the entire gain, because the promisor could have arranged to realize the gain through some means other than breach—​in particular, by negotiating a release from the promisee. In that case, Farnsworth’s argument goes, the gain made possible—​caused—​by the promisor’s breach is only the amount that the promisor would have had to pay for the release.57 So, for example, if the breach makes it possible for the promisor to gain $10,000 more than she would have gained from performance, but the promisee would have released the promisor from the contract for

56.  Shawn Bayern has illustrated this point as follows: To explain this idea, imagine a variation on Jacob & Youngs in which the amount the promisor saves by breaching equals the diminished value to the promisor; for instance, suppose that Reading pipe cost $5,000, Cohoes pipe cost $4,000, and the house is worth $1,000 more with Reading pipe than Cohoes pipe. (However, continue to suppose that it’d cost substantially more—​say $50,000—​to replace the pipes.) In this case, the promisor gains $1,000 from breach and the promisee loses $1,000 from breach; the appropriate remedy seems to be a transfer of $1,000, not separate damages for loss and disgorgement for gain. Now, suppose that the owner’s diminished value in this variation of Jacob & Youngs were instead $500. Still, disgorgement seems appropriate, but the total payment should still be $1,000—​right? (That is, just disgorgement—​not disgorgement plus diminished value.) And if the owner’s diminished value were $2,000, no separate disgorgement would be necessary.

Communication from Shawn Bayern to Melvin A. Eisenberg, April 19, 2005. 57.  See Farnsworth, supra note 2, at 1346.

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$4,000, under the cause-​in-​fact argument the gain to the promisor made possible by the breach would be only $4,000, and therefore that is the amount she should disgorge.58 This argument is unpersuasive. To begin with, under any normal conception of cause the promisor’s breach would be a cause—​both a but-​for and a proximate cause—​of her $10,000 gain from breach. After all, the promisor is able to make the $10,000 gain from breach only because she breaches. Putting that aside, the cause-​in-​fact argument is not really an argument against protecting the disgorgement interest in contract law. On the contrary, the argument implicitly recognizes that interest. If a promisee sued for breach, the amount that the promisor would have had to pay to obtain a release would not be an element of expectation, reliance, or restitution damages, and could be recovered only if the disgorgement interest was protected. Accordingly, the cause-​in-​fact argument concerns only how much the promisor should disgorge, not whether the promisor should disgorge. Next, there is no natural stopping point to the reasoning that the only loss caused by a breach is the amount the promisee would have required as the price for negotiating a release from the contract. If that is the promisor’s only loss in the case of disgorgement, so too it must be the promisee’s only loss in the case of expectation damages. To put this differently, if the only gain to the promisor caused in fact by a breach is the amount that the promisee would have insisted upon in exchange for a release, so too the only lost expectation caused in fact by a breach is the amount the promisee would have insisted upon in exchange for a release. Under this reasoning, therefore, expectation damages should also be measured by what the promisee would have settled for, not by what he would have gained if the contract had been performed. Nor does this problem stop with contract law. For example, suppose an agent improperly uses her principal’s property in a way that does not harm the principal. Under Farnsworth’s cause-​in-​ fact reasoning the only loss caused to the principal would be the amount he would have required the agent to pay for his consent to the agent’s use of the principal’s property. The same would be true of a trustee who improperly uses trust property without harming the beneficiary, or a corporate director who improperly uses corporate property without harming the corporation. Indeed, cause-​in-​fact reasoning could cut off damages even when a wrongdoer tortiously harmed a victim. If it can be assumed that the victim would have accepted a release from liability in exchange for an amount less than the harm—​because, for example, the victim wanted to avoid the cost of litigation or was risk-​averse—​then under the cause-​in-​fact argument the only harm that the wrongdoer has caused is the amount the victim would have accepted for a release.59 Moreover, the cause-​in-​fact argument depends on a counterfactual. Even if the promisor could have obtained a release from the promisee she did not do so. If a promisor wants to not perform her proper course of action is to renegotiate the contract to obtain a release. The cause-​in-​fact 58.  Id. at 1343–​47. 59.  Conversely, while Farnsworth’s cause-​in-​fact reasoning would improperly decrease damages in some disgorgement cases, it would improperly increase damages in others. For example, there are a number of cases, which will be considered later in this chapter and in Chapter 45, in which a promisor fails to provide promised services that will increase the value of the promisee’s property and it is clear that the cost of performing the unperformed services would be well in excess of the value of the services, and if the promisee is awarded cost-​of-​completion rather than diminished-​value damages (the difference between the value of his property as it is and the value it would have if the services were rendered), he almost certainly would not use the damage award to complete the performed services, but instead would put the damages award in the bank. In such cases the promisee should be limited to cost-​of-​completion damages. Under Farnsworth’s cause-​in-​fact reasoning, however, the promisee should be entitled to the amount he would have been able

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argument treats a breaching promisor who wrongly fails to renegotiate just as well as a promisor who properly does renegotiate and as a result does not breach. To measure the promisee’s damages as if the promisor had renegotiated when in fact she didn’t is to reward the promisor for doing the wrong thing, and to remove an incentive to doing the right thing. This problem is well brought out in a comment on Farnsworth’s article by Howard Tony Loo, which I here paraphrase: The logical structure of Farnsworth’s argument is as follows: Instead of not breaching her contract, the promisor breached to a gain from breach by selling the contracted-​for commodity to a third party (the “overbidder”), who offered a price higher than the price to be paid by the promisee. But the promisor could have negotiated with the promisee for a release that would have allowed her both to not breach and to sell the commodity to the overbidder. So instead of disgorging the profit from selling to the overbidder, the promisor should pay for not having negotiated with the promisee for a release, because what really prevented the promisor from not breaching was not having obtained a release. But who cares what the promisor could have done? The availability of negotiating for the release makes the promisor even more culpable. She had the opportunity to negotiate for the release, which would have allowed her to both not breach and to sell to the overbidder. But instead she chose to not negotiate for the release and to breach. If we think that not breaching contracts is important, we need to give incentives for doing all of not breaching, negotiating for a release, and, if the release is obtained, selling to the overbidder. Disgorgement would do this, because it takes away the incentives to just breach.60

Finally, a measure of recovery based on the cost of obtaining a release would be unadministrable, because the amount that a promisee would have required to give a release is normally not only unknown but unknowable.61

B.  JOINT CAUSE; APPORTIONMENT Farnsworth’s second causation-​based argument was that recognition of the disgorgement interest would raise a problem when the promisor’s gain from breach resulted in part from the promisor’s own skill and diligence. Farnsworth calls this the joint cause problem. For example, suppose Seller contracts to sell The Acme Hotel in Chicago to Buyer for $60 million, with closing in one month. After entering into the contract Seller continues to seek out other buyers for the Hotel and locates Overbidder. Overbidder has a strategic need for The Acme because it is putting together a hotel chain and needs a hotel in Chicago to complete the chain. Because of this need Overbidder is willing to pay $65 million for the Hotel, which is more than anyone else would pay. Seller sells The Acme to Overbidder for that price. Assume that the market value of The Acme Hotel, based on extrapolation from the sales of comparable hotels, is $61 million. If specific performance is unavailable (because, for example, Seller completes the sale of The Acme to Overbidder before Buyer can get to court), Buyer’s to extract from the promisor in exchange for a release from the contract, which would be well in excess of the promisee’s real loss. 60.  Comment by Howard Tony Loo, April 24, 2002. (Email on file with author). 61.  The cause-​in-​fact theory was presented by the plaintiff and rejected by the court in University of Colorado Foundation, Inc. v. American Cyanamid Co., 342 F.3d 1298, 1310–​11 (Fed. Cir. 2003).

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expectation damages would be $1  million, leaving Seller with a gain of $4  million from the breach. Some part of this $4 million gain, however, resulted from Seller’s skill and diligence in locating Overbidder. Farnsworth asks: How is a court to respond to the promisor’s argument that some apportionment of her gain from breach is required to compensate the seller for her skill and diligence?62 One answer is that it’s not possible to determine whether Buyer would have located the Overbidder if he had tried to do so, and therefore it’s not possible to determine what value to place on Seller’s locating the Overbidder. Furthermore as in the cause-​in-​fact argument, joint cause is not an argument against protecting the disgorgement interest in contract law. Instead, it is only an argument about how to measure disgorgement damages, because unless the disgorgement interest is protected in contract law there is nothing to apportion. Moreover, apportionment will seldom be a real issue in contract disgorgement cases, because often or usually the gain made possible by a promisor’s breach will not result from her skill and diligence. For example, in a variant of The Acme Hotel hypothetical, Overbidder may offer to buy The Acme from Seller without Seller having solicited the offer because Overbidder independently identified The Acme as a desirable purchase. In cases like this, Seller’s skill and diligence will not have contributed to her gain. Finally, even where part of the promisor’s gain from breach does result from her skill and diligence it would often be improper to give her credit for that part of the gain. If an agent wrongly uses his principal’s property to make a gain (as in the stable-​horse illustration in the Restatement Third of Agency), it would be improper to apportion part of the gain to the agent on the ground that the agent’s skill and diligence contributed to the gain. Such an apportionment would reward the agent for committing a wrong and would subvert the agent’s duty of loyalty. Similarly, even if Seller finds Overbidder through the exercise of skill and diligence, Seller’s gain from breach should not be apportioned between Seller and Buyer because it was wrongful for Seller to continue searching for an overbidder after she had contracted to sell The Acme to Buyer. There are cases in which apportionment of the gain from breach is appropriate. Suffice to say that the possibility that in some cases the promisor’s gain from breach should be apportioned between the promisor and the promisee is not a reason against protection of the disgorgement interest in all cases.

C.  REMOTE CAUSE; TRACING Farnsworth’s third causation-​based argument was founded on the question:  If a breaching promisor uses her gain from breach to make an investment and earns a profit on the investment, should the promisee recover not only the gain from breach but also the proceeds of the investment? Farnsworth argued that the proceeds from the investment should not be disgorged because they are too remote from the breach. As in the cause-​in-​fact and joint-​cause arguments, remote cause is not an argument against disgorgement, but only an issue of how disgorgement damages should be measured. Furthermore, the answer in such cases is simple: it would almost invariably be inappropriate to allow the promisee to recover the proceeds of an investment made with the 62. Farnsworth, supra note 2, at 1347.

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promisor’s gain from breach, because unless the promisor had no free cash other than her gain from breach her breach would not have made the investment possible. Correspondingly, unless the promisee had no free cash he could have made the same investment as did the breaching promisor, so that the promisee’s decision not to make the investment, not the promisor’s breach, caused the promisee to lose out on a profit from investing. Accordingly, the remote-​cause argument provides no more reason against protection of the disgorgement interest in contract law than do the cause-​in-​fact and joint-​cause arguments.63

X I I I .   W H Y D O N ’ T WE S EE MO R E D I S G O R GEM ENT I N C O N T R A CT L AW? If disgorgement should be and is an available remedy in appropriate cases in contract law, why don’t we see more of it? There are several answers to this question. To begin with, disgorgement is a fallback remedy rather than a primary one. The primary interest that should be and is protected by contract law is the expectation interest, and that interest is normally best protected by the expectation measure. The disgorgement interest should be protected only in the limited categories of cases in which disgorgement is required to provide efficient incentives to the promisor, to effectuate the contract, or to prevent unjust enrichment. Furthermore, in many cases of breach there is no gain to be disgorged. For example, there may be no gain to be disgorged where the breach is inadvertent and does not result in a gain. Even where a breach seems to result in gain to the promisor the gain may not result from, or be made possible by the breach. For example, suppose Contractor C breaches a construction contract with Owner 1 and then enters into, and makes a gain from, a contract with Owner 2. C’s gain from her contract with Owner 2 is unlikely to result from or be made possible by her breach of the contract with Owner 1, because most contractors can take on more than one job at a time, so that C could have contracted with Owner 2 even if she had not breached her contract with Owner 1. Next, protection of the disgorgement interest is unnecessary in wide classes of cases. Often a plaintiff will not seek disgorgement damages because they would be less than expectation damages—​that is, the promisee’s forgone gain will exceed the promisor’s gain from breach. In many other cases, disgorgement and expectation damages will be equal, so that after the promisor pays expectation damages she will have no gain left to disgorge. For example, many cases that potentially raise the issue of disgorgement fall into the Overbidder Paradigm, in which a seller who has contracted to sell a given commodity to a buyer breaks the contract in order to resell the commodity to an overbidder (see Chapter  6). In such cases, when the relevant 63.  Farnsworth himself called for recognizing certain exceptions to the general no-​disgorgement rule he proposed. One exception involved cases in which the promisee was entitled to specific performance of a contract to convey property; another involved what Farnsworth called “abuse of contract.” See Farnsworth, supra note 2, at 1368, 1382–​91; supra note 36 and accompanying text. It is not clear how Farnsworth reconciled these exceptions with his causation argument.

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commodity is homogeneous and not in critically short supply, disgorgement is normally unnecessary. If a commodity is homogeneous and not in critically short supply, an overbidder will not pay the seller more for the commodity than the market price. Why should he, when he can purchase the commodity on the market for that price? Accordingly, in such cases the seller’s gain on a sale to an overbidder will be the difference between the market price at the time of breach and the contract price to the original buyer. That difference is also the measure of the buyer’s expectation damages. Therefore, after the seller pays expectation damages she will have no gain remaining to be disgorged. Suppose the relevant commodity is differentiated rather than homogeneous. Since the buyer can always recover the difference between the market price and the contract price, if the overbidder pays no more than the market price the buyer would get no more from disgorgement than he would get from expectation damages.64 Disgorgement will also be unnecessary where the promisee can obtain specific performance, because that remedy will prevent the promisor from making a gain through breach. Finally, disgorgement is inappropriate in certain classes of cases for special moral or policy reasons. For example, disgorgement is inappropriate in cases involving employees who breach employment contracts and then take higher-​paying jobs, because requiring the employee to disgorge the salary differential in such cases would cut too close to the bone of involuntary servitude.65 In short, in most breach-​of-​contract cases either there is no gain to disgorge, disgorgement is unnecessary, or disgorgement is inappropriate for special moral or policy reasons. This, and not the unavailability of disgorgement under modern contract law, is the major reason we don’t see more disgorgement.

XIV.   T H E P R O B L E M OF   A PPORT I ONM ENT In some cases in which the remedy of disgorgement is appropriate a portion of the promisor’s gain is a result of her own skill and diligence. In such cases the question arises whether the amount that would otherwise be disgorged should be apportioned between the promisor and the promisee. In some of these cases apportionment would be inappropriate because it would nullify the reason for disgorgement. For example, recall that in United States v. Snepp Snepp had breached 64.  The two measures may sometimes diverge. In the case of a differentiated commodity, “market price” is normally a construct based on extrapolation from the prices paid in comparable but not identical transactions. Accordingly, the expectation and disgorgement measures may diverge because the price paid by the overbidder exceeds the constructed market price, due to the dynamics of the negotiation between the seller and the overbidder, or because the overbidder was not well informed, or had a special strategic need for the property, or was willing to pay at the top end of the range of comparable transactions while the construct falls in the midrange. And under the law of many states a seller of real estate is not liable for expectation damages if her breach is not in bad faith. See 1 Palmer, supra note 3, § 4.9 at 438–​44. 65.  Cf. S.M. Waddams, Profits Derived from Breach of Contract: Damages or Restitution, 11 J. Cont. L. 115, 119 (1997) (to permit an employer to recover disgorgement of an employee’s profit from breaking an employment contract “would be to give the employer a sort of proprietary interest in the employee’s services; this concept is unacceptable”).

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his contract by failing to obtain the CIA’s consent to publication of his book, and the Supreme Court ordered Snepp to disgorge his royalties. If the Court had ordered apportionment of the royalties, the disgorgement remedy would have been virtually nullified, because the value of Snepp’s efforts probably approached or equaled the amount of the royalties. In most of the remaining cases in which a portion of the promisor’s gain is the result of her own skill and diligence the issue of apportionment can best be approached by asking whether, if disgorgement in full was awarded, a failure to return part of the disgorged amount to the promisor would leave the promisee unjustly enriched.66 In most cases the answer to this question would be no. For example, in cases that fall within the Overbidder Paradigm the buyer would not be unjustly enriched by the seller’s efforts to find the overbidder because the efforts were wrongful, since the buyer paid the seller a premium not to engage in the efforts. In general, there should be a heavy thumb on the scale against apportionment, because usually apportionment would undercut disgorgement. However, there are some cases in which apportionment should be awarded. For example, recall that in EarthInfo, Inc. v.  Hydrosphere Resource Consultants, Inc.,67 discussed above, Hydrosphere had made a series of contracts with EarthInfo.68 Under the contracts Hydrosphere agreed to develop certain CD-​ROMs and software. EarthInfo, in turn, would prepare users’ manuals for the CD-​ROMs, package and market the CD-​ROMs and the manuals, and pay Hydrosphere certain fees and royalties. The parties became embroiled in a dispute and EarthInfo suspended payment of all royalties, including those it admittedly owed. In response Hydrosphere brought suit for rescission and restitution. The trial court held that the appropriate remedy was rescission, and fixed June 30, 1990, the date through which EarthInfo has paid royalties, as the date of recission, and ordered EarthInfo to return to Hydrosphere all tangible property that Hydrosphere developed under the contracts and to disgorge the net profits that Hydrosphere realized on sales of the CD-​ROMs after June 30. On appeal the Colorado Supreme Court held that disgorgement was appropriate but that the net profits should be apportioned in a way that reflected the parties’ relative contributions to those profits:69 The record in this case indicates that EarthInfo materially contributed effort and investment to the Hydrodata line of products. EarthInfo’s contribution included user manuals, packaging, trademarks, promotional materials, and lists of persons or entities licensed to use the products. Thus, EarthInfo should be credited for the amount of its expenses in developing and marketing the Hydrodata product line.

This result was correct, because EarthInfo’s contributions to the gain were not in themselves wrongful; on the contrary, the contributions were contractually required. Hydrosphere therefore would have been unjustly enriched if it could retain all the fruits of EarthInfo’s efforts.

66.  I am indebted to Shawn Bayern for this approach. 67.  900 P.2d 113 (Colo. 1995). 68.  More accurately, Hydrosphere had made a series of contracts with EarthInfo’s predecessor in interest. 69.  Id. at 121.

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X V.   C O NCL US I ON It was traditionally assumed by secondary authorities that the disgorgement interest is not protected by contract law, despite the availability of disgorgement in other areas of private law. This assumption is reflected in Restatement Second of Contracts Section 344, which excludes disgorgement from the interests protected by judicial remedies for breach of contract. However, the traditional assumption runs against modern case law, and has no normative support. Of course, the disgorgement interest should not be protected in all cases in which a promise is legally enforceable, any more than the reliance interest, the restitution interest, or, for that matter, the expectation interest. Rather, as in the case of those interests, the disgorgement interest should be protected where appropriate. In certain classes of cases such protection is almost always appropriate—​for example, where disgorgement has been bargained-​for, or is the best or only way to provide efficient incentives for precaution and performance, to facilitate surplus-​ enhancing reliance, to effectuate the type of contract involved, to prevent unjust enrichment. The assumption that the disgorgement interest is not protected by contract law is comparable to the view under classical contract law that the reliance interest was not protected by contract law. This view was reflected in the Restatement First of Contracts. Section 326 of that Restatement enumerated only three remedies for breach of contract:  (1) damages, which, in the parlance of Restatement First meant only expectation damages; (2)  restitution, which, in that parlance meant only benefit conferred; and (3) specific performance. Accordingly, under Restatement First the reliance interest was excluded from the interests protected by contract law.70 However, as Fuller and Perdue showed in their landmark article, “The Reliance Interest in Contract Damages,”71 that view had very little support in the case law and no normative support at all. Rather, that view, like so much of classical contract law, rested only on axiomatic grounds in Restatement Second and was discarded. Most of the axioms of classical contract law now lie in the trash-​heap of wrong ideas. The assumption that the disgorgement interest is not protected by contract law rests among the rubble of those axioms.

70.  See, e.g., 4 A.L.I. Proc. app. at 103–​04 (1926) (remarks of Mr. Williston): Either [a relied-​upon donative] promise is binding or it is not. If the promise is binding it has to be enforced as it is made [and not simply to the extent that it was relied upon]. . . . I could leave this whole thing to the subject of quasi contract so that the promisee under those circumstances shall never recover on the promise but he shall recover such an amount as will fairly compensate him for any injury incurred; but it seems to me you have to take one leg or the other. You have either to say the promise is binding or you have to go on the theory of restoring the status quo.

71.  L.L. Fuller & William R. Perdue, Jr., The Reliance Interest in Contract Damages, Part I, 46 Yale L.J. 52 (1936); Part II, 46 Yale L.J. 373 (1936).

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THE ELEMENTS OF A CONTRACT

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The Elements of a Contract expressions , implications , usages , course of dealing , course of performance , context and purpose

B e fore a c ont ract can be int erpreted i t m u st b e deter m i n ed

what are the elements of a contract. Contracts consist in large part of expressions, that is, manifestations consisting of words, acts, or both, which are either communicated by an addressor to an addressee or jointly produced by two (or occasionally more) contracting parties. It is sometimes assumed that where contractual expressions are embodied in a single writing the writing is the contract. That assumption is incorrect, because contracts almost invariably include additional elements—​in particular, the implications of the parties’ expressions and any relevant usage, course of dealing, or course of performance. So, for example, Section 1-​201(12) of the UCC defines “contract” as the “total legal obligation that results from the parties’ agreement. . . .” and Section 1-​201(3) defines “agreement” as “the bargain of the parties in fact as found in their language or inferred from other circumstances, including course of performance, course of dealing, or usage of trade. . . .”1 These elements will be considered in this chapter.

I .   E X P R ES S I ONS An expression in contract law is a manifestation consisting of words, acts, or both, which is either communicated by an addressor to an addressee or jointly produced by two or sometimes more contracting parties.

I I .   I M P L I CAT I ONS Even the simplest contract normally includes, in addition to one or more expressions, a host of implications. This is illustrated by Francis Lieber’s famous fetch-​some-​soupmeat hypothetical 1. Emphasis added.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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(which concerns an instruction rather than a contract, but whose teaching applies to all communicative language): Let us take an instance of the simplest kind, to show in what degree we are continually obliged to resort to interpretation. . . . Suppose a housekeeper says to a domestic: “fetch some soupmeat,” accompanying the act with giving some money to the latter; he will be unable to execute the order without interpretation, however easy and, consequently, rapid the performance of the process may be. Common sense and good faith tell the domestic, that the housekeeper’s meaning was this: 1. He should go immediately, or as soon as his other occupations are finished; or, if he be directed to do so in the evening, that he should go the next day at the usual hour; 2. that the money handed him by the housekeeper is intended to pay for the meat thus ordered, and not as a present to him; 3. that he should buy such meat and of such parts of the animal, as, to his knowledge, has commonly been used in the house he stays at, for making soups; 4. that he buy the best meat he can obtain, for a fair price; 5. that he go to that butcher who usually provides the family, with whom the domestic resides, with meat, or to some convenient stall, and not to any unnecessarily distant place; 6. that he return the rest of the money; 7. that he bring home the meat in good faith, neither adding any thing disagreeable nor injurious; 8. that he fetch the meat for the use of the family and not for himself. Suppose, on the other hand, the housekeeper, afraid of being misunderstood, had mentioned these eight specifications, she would not have obtained her object, if it were to exclude all possibility of misunderstanding. For, the various specifications would have required new ones. Where would be the end?2

I I I .   U S AGES Usages are an element of many contracts. Restatement Second Section 219 defines a usage as “a habitual or customary practice.” Usages fall into two categories. (1) The usages of members of a special, relatively well-​defined community, such as an ethnic or religious community or a community of those engaged in a shared endeavor, like an amateur sport or a hobby. (2) The usages of a trade. In this book, the first category will be referred to as special-​community usages and the second category will be referred to as trade usages. (Strictly speaking, trade usages are usages of a special community, but it is useful to give them special treatment because they tend to be much more important in contractual interpretation.) Restatement Second Sections 220 and 221 provide that a usage may either give particular meaning to a contract or supplement or qualify a contract.3 See Chapter 28 for more on usages. There are two reasons why usages are elements of contracts. 2.  Francis Lieber, Legal and Political Hermeneutics 17–​19 (3d ed. 1880). 3.  Under Section 220: (1) An agreement is interpreted in accordance with a relevant usage if each party knew or had reason to know of the usage and neither party knew or had reason to know that the meaning attached by the other was inconsistent with the usage. (2) When the meaning attached by one party accorded with a relevant usage and the other knew or had reason to know of the usage, the other is treated as having known or had reason to know the meaning attached by the first party.

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First, members of a special community or trade internalize the usages of the group or trade. As a result, when they use an expression that invokes a usage they mean what the usage means. If a court attached any other meaning to the expression, it would frustrate, rather than effectuate, the parties’ fair expectation. Second, it would be tedious and inefficient for parties to translate usages into ordinary language in their contracts, because the parties know what they mean. It would also be wrong-​headed, because the parties are likely to have so far internalized usages that they don’t consciously think of themselves as using the relevant terms in a special way. If in the baker’s trade the term a dozen means thirteen, a party in the trade will use the term a dozen in that way without realizing that he is using the term in a special way, just as a fluent bilingual speaker will not pause before speaking or writing words in his second language to determine what the words mean in his first language.

I V.   C O U R S E OF   DEA L I NG Section 223(1) provides that “Unless otherwise agreed, a course of dealing between the parties gives meaning to or supplements or qualifies their agreement.” The next chapter further discusses course of dealing. The reason why a course of dealing is an element of a contract is similar to the reason why special-​community and trade usages are elements of a contract. If the parties to a contract have been dealing with each other in a certain way under past comparable contracts, it is natural for both parties to assume that the course of past dealings will be continued under a new contract. To put it differently, in such cases the new contract is not an isolated event but part of a moving and related series of events.

V.   C O U R S E O F  PER F OR M A NCE Restatement Second Section 202(4) provides “Where an agreement involves repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection is given greater weight in the interpretation of the agreement.”4 UCC Section Under Section 221: An agreement is supplemented or qualified by a reasonable usage with respect to agreements of the same type if each party knows or has reason to know of the usage and neither party knows or has reason to know that the other party has an intention inconsistent with the usage.

4.  UCC Section 1-​303(a) (Am. Law Inst. & Unif. Law Comm’n 2001) (is comparable: A “course of performance” is a sequence of conduct between the parties to a particular transaction that exists if:

(1) the agreement of the parties with respect to the transaction involves repeated occasions for performance by a party; and (2) the other party, with knowledge of the nature of the performance and opportunity for objection to it, accepts the performance of acquiesces in it without objection.

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1-​303(d) is similar: “A course of performance or course of dealing between the parties or usage of trade in the vocation or trade in which they are engaged or of which they are or should be aware is relevant in ascertaining the meaning of the parties’ agreement, may give particular meaning to specific terms of the agreement, and may supplement or qualify the terms of the agreement. . . .”

V I .   C O N T E X T A ND PUR POS E A word needs to be said about the context and purpose of a contract.

A. CONTEXT The context in which a contractual expression is used, although critical in interpreting the expression, is not an element of a contract. Tigers can only be fully understood in the context of their habitat, but this habitat is not an element of tigers.

B. PURPOSE A contract must be interpreted in light of its purpose—​that is, the shared objectives of the parties as embodied in their contract. Once that purpose is determined it heavily informs the interpretation of the contract. However, those objectives are not part of a contract. Instead, they are derived from an interpretation of the elements of the contract. The determination of the purpose of a contract is part of a feedback loop. Such a determination follows from an interpretation of the elements of a contract, taken together to achieve the best fit, but the determination is then fed back into the contract to ascertain its meaning. As stated in Comment c to Restatement Second Section 202: The purposes of the parties to a contract are not always identical; particularly in business transactions, the parties often have divergent or even conflicting interests. But up to a point they commonly join in a common purpose of attaining a specific factual or legal result which each regards as necessary to the attainment of his ultimate purposes. . . . Determination that the parties have a principal purpose in common requires interpretation, but if such a purpose is disclosed further interpretation is guided by it. Even language which is otherwise explicit may be read with a modification needed to make it consistent with such a purpose.

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INTERPRETATION IN CONTRACT LAW This Part considers the issue: What principles should govern interpretation in contract law? Two preliminary points:

1. An underlying question in determining those principles is: What should be the aim of interpretation? Under the basic contract-​law standard, if appropriate conditions are satisfied, and subject to appropriate limitations and constraints based on policy, morality, and experience, contract law should aim to effectuate the objectives of parties to a promissory transaction as manifested in their contract. Correspondingly, the aim of interpretation should be to determine those objectives. 2. What is conventionally referred to as interpretation often consists of a selection between two parties’ competing meanings based on fault. In such cases the issue is not what is the best interpretation of the contract, but whether one contracting party is at fault in attaching a certain meaning to an expression. Furthermore, in some cases both contracting parties subjectively attach the same meaning to an expression, and in such cases that mutually held meaning should prevail, and questions of interpretation are moot. Accordingly, determining the meaning of a contract would sometimes better describe what is encompassed in the process conventionally described as interpretation.

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The General Principles of Contract Interpretation This c hap ter discu sses principl es of c on tr act i n terpretati on . * Theories of contract interpretation generally fall into two broad schools. Theories in one school hold that a contract cannot be sensibly interpreted without regard to the context in which the contract was made. Theories in the other school hold that if a contract is embodied in a relatively comprehensive writing it should be interpreted solely on the basis of the writing. The two schools go under various names. In this book they will be referred to as contextualism and literalism.

I .   C O N T E XT UA L I S M The principle of contextualism set out in Restatement Second Section 212 and Comment b: § 212(1) Interpretation of Integrated Agreement. The interpretation of an integrated agreement is directed to the meaning of the terms of the writing or writings in the light of the circumstances. . . . Comment b. Any determination of meaning . . . should only be made in the light of the relevant evidence of the situation and relations of the parties, the subject matter of the transaction, . . . usages of trade, and the course of dealing between the parties.1

*  Shawn Bayern reviewed a draft of this chapter, and made superb comments, all of which have been incorporated into the final version of the chapter. 1.  The term integrated agreement, as used here, means a written apparently complete contract. The term is discussed in more detail in Chapter 38.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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The argument for contextualism is compellingly made by Stanley Fish in his paper, “Normal Circumstances, Literal Language, Direct Speech Acts, The Ordinary, The Everyday, The Obvious, What Goes Without Saying, and Other Special Cases”:2 A sentence is never not in a context. We are never not in a situation. . . . A  set of interpretive assumptions is always in force. A  sentence that seems to need no interpretation is already the product of one. . . . [Suppose student X says to student Y, “Let’s go to the movies tonight,” and student Y replies, “I have to study for an exam.” The statement by student X seems to be a proposal, and the statement by student Y seems to be rejection of the proposal. Now suppose student Y replies instead, “I have to eat popcorn tonight” or “I have to tie my shoes.” In most circumstances, those statements would not be regarded as a rejection of the proposal. But] is it possible to imagine a set of circumstances in which “I have to eat popcorn tonight” would immediately and without any chain of inference be heard as a rejection of X’s proposal? It is not only possible; it is easy. Let us suppose that student Y is passionately fond of popcorn and that it is not available in any of the local movie theaters. If student X knows these facts (if he and student Y mutually share background information), then he will hear “I have to eat popcorn tonight” as a rejection of his proposal. Or, let us suppose that student Y is by profession a popcorn taster; that is, he works in a popcorn manufacturing plant and is responsible for quality control. Again if student X knows this, he will hear “I have to eat popcorn tonight” as a rejection of his proposal because it will mean “Sorry, I have to work.” Or, let us suppose that student Y owns seventy-​five pairs of shoes and that he has been ordered by a dormitory housemother to retrieve them from various corners, arrange them neatly in one place, and tie them together in pairs so that they will not again be separated and scattered. In such a situation “I have to tie my shoes” will constitute a rejection of student X’s proposal and will be so heard. Moreover it is not just “I have to eat popcorn” and “I have to tie my shoes” that could be heard as a rejection of the proposal; given the appropriate circumstances any sentence (“The Russians are coming,” “My pen is blue,” “Why do you behave like that?”) could be so heard. . . . The argument will also hold for “Let’s go to the movies tonight.” . . . Thus if speakers X and Y are trapped in some wilderness, and one says to the other, “Let’s go to the movies tonight,” it will be heard not as a proposal, but as a joke; or if student X is confined to his bed or otherwise immobilized, and student Y says, “Let’s go to the movies tonight,” it will be heard not as a proposal, but as a dare. . . . It is important to realize what my argument does not mean. It does not mean that [a]‌sentence can mean anything at all. . . . A sentence . . . is never in the abstract; it is always in a situation, and the situation will already have determined the purpose for which it can be used. So it is not that any sentence can be used as a request to open the window, but that given any sentence, there are circumstances under which it would be heard as a request to open the window. A sentence neither means anything at all, nor does it always mean the same thing; it always has the meaning that has been conferred on it by the situation in which it is uttered.

To the same effect, Richard Posner: . . . [O]‌ne can never be completely confident of being able to determine the meaning of a document from the document alone. [C]larity in a contract is a property of the correspondence between the 2. 4 Critical Inquiry 625–​44 (1978).

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contract and the things or activities that it regulates, and not just of the semantic surface. The contract’s words point out to the real world, and the real world may contain features that make seemingly clear words, sentences, and even entire documents ambiguous.3

Similarly, Corbin: Sometimes it is said that “the courts will not disregard the plain language of a contract or interpolate something not contained in it”; also “the courts will not write contracts for the parties to them nor construe them other than in accordance with the plain and literal meaning of the language used.” It is true that when a judge reads the words of a contract he may jump to the instant and confident opinion that they have but one reasonable meaning and that he knows what it is. A  greater familiarity with dictionaries and the usages of words, a better understanding of the uncertainties of language, and a comparative study of more cases in the field of interpretation, will make one beware of holding such an opinion so recklessly arrived at.4  . . .  All through the history of the common law, and of other systems of law also, there is found a very common assumption of the existence of antecedent rules and principles, beginning no man knows when, coming from no man knows where, seemingly universal and unchangeable. And yet, at almost all periods, there have been a few jurists who took thought to the matter and who knew better. Nowhere is the truth of this more obvious than in the immense quantity of juristic writing about the rules of interpretation and the admissibility of evidence to aid in interpretation. Specific rules have been dogmatically laid down by judges of great repute. These have been repeated innumerable times, sometimes to apply them though justice weeps at her own blindness, sometime to avoid them by making fine and specious distinctions, sometimes merely to state them with respect while disregarding them, and sometime to voice criticism and disapproval. Among such rules are those indicating that words must have one, and only one, true and correct meaning, that this meaning must be sought only by pouring over the words within the four corners of the paper, that extrinsic evidence of intention will not be heard, or that evidence of surrounding circumstances will be admissible only in cases of latent ambiguity. In view of all this, it can hardly be insisted on too often or too vigorously that language at its best is always a defective and uncertain instrument, that words to not define themselves, that terms and sentences in a contract, a deed or a will do not apply themselves to external objects and performances, that the meaning of such terms and sentences consists of the ideas that they induce in the mind of some individual person who uses or hears or reads them, and that seldom in a litigated case do the words of a contract convey one identical meaning to the two contracting parties or to third persons. Therefore, it is invariably necessary, before a court can give any meaning to the words of a contract and can select one meaning rather than other possible ones as the basis for the determination of rights and other legal effects, that extrinsic evidence shall be heard to make the court aware of the “surrounding circumstances,” including

3.  Richard A. Posner, The Law and Economics of Contract Interpretation, 83 Tex. L.  Rev. 1581, 1597 (2005). 4.  Arthur Linton Corbin, Corbin on Contracts § 535 (1960).

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the other persons, objects, and events to which the words can be applied and which caused the words to be used.5

The iconic embodiment of contextualism in the case law is Pacific Gas & Electric Co. v. G.W. Thomas Drayage & Rigging Co.6 G.W. Thomas Drayage & Rigging (Thomas) contracted with Pacific Gas & Electric (PG&E) to remove and replace the upper metal cover of a PG&E steam turbine. Thomas agreed to perform the work “at [its] own risk and expense” and to “indemnify [PG&E] against all loss, damage, expense and liability resulting from . . . injury to property, arising out of or in any way connected with the performance of this contract.” In the course of Thomas’s work the turbine cover fell and injured the exposed turbine rotor. PG&E sued Thomas, both in negligence and under the indemnification provision, to recover the amount it spent on repairs. During the trial PG&E dropped its claim for negligence, so that the only issue was the application of the indemnification provision. That issue turned on whether Thomas’s promise to indemnify PG&E for loss, risk, damage, expense, and liability caused by Thomas’s work was limited to PG&E’s liability to third parties or also applied to injuries to PG&E’s own property. Thomas attempted to show that the indemnification provision should be interpreted in the former, more limited way (so that Thomas would not be liable for the damage it caused to PG&E’s rotor), and to that end it sought to introduce into evidence admissions of PG&E’s agents and the course of dealing under similar contracts between Thomas & PG&E. In the view of the trial court the question was whether the indemnification provision was ambiguous as to whether it covered injuries to PG&E’s property, in which case Thomas’s evidence was admissible, or unambiguous, in which case the evidence was inadmissible. The trial court held that the indemnification provision unambiguously covered injury to PG&E’s own property, so that evidence outside the four corners of the agreement—​“extrinsic evidence”—​such as that presented by Thomas, was inadmissible, and gave judgment for PG&E. The California Supreme Court, in an opinion by Chief Justice Roger Traynor, one of the greatest judges of modern times, reversed and remanded: When a court interprets a contract on [the basis employed by the trial court]: it determines the meaning of the instrument in accordance with the “. . . extrinsic evidence of the judge’s own linguistic education and experience.” The exclusion of testimony that might contradict the linguistic background of the judge reflects a judicial belief in the possibility of perfect verbal expression. This belief is a remnant of a primitive faith in the inherent potency and inherent meaning of words. The test of admissibility of extrinsic evidence to explain the meaning of a written instrument is not whether [the instrument] appears to the court to be plain and unambiguous on its face, but whether the offered evidence is relevant to prove a meaning to which the language of the instrument is reasonably susceptible. . . . A rule that would limit the determination of the meaning of a written instrument to its four-​ corners merely because it seems to the court to be clear and unambiguous, would either deny the relevance of the intention of the parties or presuppose a degree of verbal precision and stability our language has not attained. 5.  Id. at § 536. 6.  442 P.2d 641 (Cal. 1968).

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The General Principles of Contract Interpretation Some courts have expressed the opinion that contractual obligations are created by the mere use of certain words, whether or not there was any intention to incur such obligations. Under this view, contractual obligations flow, not from the intention of the parties but from the fact that they used certain magic words. Evidence of the parties’ intention therefore becomes irrelevant. In this state, however, the intention of the parties as expressed in the contract is the source of contractual rights and duties. A court must ascertain and give effect to this intention by determining what the parties meant by the words they used. Accordingly, the exclusion of relevant, extrinsic evidence to explain the meaning of a written instrument could be justified only if it were feasible to determine the meaning the parties gave to the words from the instrument alone. If words had absolute and constant referents, it might be possible to discover contractual intention in the words themselves and in the manner in which they were arranged. Words, however, do not have absolute and constant referents. “A word is a symbol of thought but has no arbitrary and fixed meaning like a symbol of algebra or chemistry . . .” The meaning of particular words or groups of words varies with the “. . . verbal context and surrounding circumstances and purposes in view of the linguistic education and experience of their users and their hearers or readers (not excluding judges). . . . A word has no meaning apart from these factors; much less does it have an objective meaning, one true meaning.” Accordingly, the meaning of a writing “. . . can only be found by interpretation in the light of all the circumstances that reveal the sense in which the writer used the words. . . .” Accordingly, rational interpretation requires at least a preliminary consideration of all credible evidence offered to prove the intention of the parties. . . . Such evidence includes testimony as to the “circumstances surrounding the making of the agreement . . . including the object, nature and subject matter of the writing . . .” so that the court can “place itself in the same situation in which the parties found themselves at the time of contracting.” If the court decides, after considering this evidence, that the language of a contract, in the light of all the circumstances, is “fairly susceptible of either one of the two interpretations contended for . . .” extrinsic evidence relevant to prove either of such meanings is admissible.7

Similarly, in Garden State Plaza Corp. v. S.S. Kresge Co.,8 the court said: [I]‌n the process of interpretation and construction of [an] integrated agreement all relevant evidence pointing to meaning is admissible because experience teaches that language is so poor an instrument for communication or expression of intent that ordinarily all surrounding circumstances and conditions must be examined before there is any trustworthy assurance of derivation of contractual intent, even by reasonable judges of ordinary intelligence, from any given set of words which the parties have committed to paper as their contract.

Or as stated in Berg v. Hudesman:9 Words, written or oral, cannot apply themselves to the subject matter. The expressions and gen­ eral tenor of speech used in negotiations are admissible to show the conditions existing when the 7.  Id. at 643–​46. 8.  189 A.2d 448, 454 (N.J. Super. Ct. App. Div. 1963). 9.  801 P.2d 222 (Wash. 1990).

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writing was made, the application of the words, and the meaning or meanings of the parties. Even though words seem on their face to have only a single possible meaning, other meanings often appear when the circumstances are disclosed. In cases of misunderstanding, there must be inquiry into the meaning attached to the words by each party and into what each knew or had reason to know.10

In short, interpretation of a text is never easy solely on the ground that the text is unambiguous on its face. This does not mean that there are no easy cases in interpreting contractual texts. It does mean that interpretation will be easy only where the text in context is easy to interpret. As the name implies the most important element of contextualism is the context in which a contract was made. However, there are four other elements to contextualism: special-​community usages, trade usages, course of dealing, and course of performance. Special-​community usage. A usage is a habitual or customary practice.11 A special-​community usage is a usage followed by the member of a well-​defined social community. A contract should and will be interpreted in accordance with a special-​community usage if each party knew or had reason to know of the usage.12 Here is an example of a special-​community usage, from Restatement Second Section 221, which illustrates why any sound theory of interpretation includes usages: A, an ordained rabbi, is employed by B, an orthodox Jewish congregation, to officiate as cantor at specified religious services. At the time the contract is made, it is the practice of such congregations to seat men and women separately at services, and a contrary practice would violate A’s religious beliefs. At a time when it is too late for A to obtain substitute employment, B adopts a contrary practice. A refuses to officiate. The practice is part of the contract, and A is entitled to the agreed compensation.13

Trade usage. A trade usage is a usage having such regularity in a trade as to justify an expectation that it will be observed with respect to a particular contract.14 Here are three illustrations of trade usages, from Restatement Second Section 222, which indicate why any sound theory of interpretation should include the principle that a contract is interpreted in accordance with relevant trade usages:



1. A contracts to sell B 10,000 shingles. By usage of the lumber trade, in which both are engaged, two packs of a certain size constitute 1,000, though not containing that exact number. Unless otherwise agreed, 1,000 in the contract means two packs. 2. A contracts to sell B 1,000 feet of San Domingo mahogany. By usage of dealers in mahogany, known to A and B, good figured mahogany of a certain density is known as San

10.  Id. at 229 (quoting Restatement (Second) of Contracts § 214 cmt b (Am. Law Inst. 1981) [hereinafter Restatement Second]. 11.  Restatement Second § 221. 12.  Restatement Second § 220. 13.  Supra note 9. 14.  Restatement Second § 221(1).

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Domingo mahogany, though it does not come from San Domingo. Unless otherwise agreed, the usage is part of the contract. 3. A and B enter into a contract for the purchase and sale of “No. 1 heavy book paper guaranteed free from ground wood.” Usage in the paper trade may show that this means paper not containing over 3% ground wood.15 Hurst v. W.J. Lake16 is a further illustration of why under any sound theory of interpretation contracts should be interpreted in accordance with any relevant trade usage. In this case Buyer and Seller made a contract for the sale of 350 tons of horsemeat scraps, “minimum 50% protein,” for $50 per ton. Under the contract, if any of the scraps tested at “less than 50% of protein” Buyer was to receive a discount of $5.00 per ton. About 170 tons contained less than 50 percent protein; of these, 140 tons contained 49.53 to 49.96 percent protein. Buyer took a $5.00 discount on the entire 170 tons. Seller claimed that Buyer was entitled to a discount on only 30 tons, because under a usage of trade the terms “minimum 50% protein” and “less than 50% protein,” when used in a contract for the sale of horsemeat scraps, meant that a protein content of not less than 49.5 percent was equal to a content of 50 percent protein. The trial court granted Buyer’s motion for judgment on the pleadings. The Oregon Supreme Court reversed: The flexibility of or multiplicity in the meaning of words is the principal source of difficulty in the interpretation of language. Words are the conduits by which thoughts are communicated, yet scarcely any of them have such a fixed and single meaning that they are incapable of denoting more than one thought. In addition to the multiplicity in meaning of words set forth in the dictionaries there are the meanings imparted to them by trade customs, local uses, dialects, telegraphic codes, etc. One meaning crowds a word full of significance, while another almost empties the utterance of any import. The various groups above indicated are constantly amplifying our language; in fact, they are developing what may be called languages of their own. Thus one is justified in saying that the language of the dictionaries is not the only language spoken in America.17

Course of dealing. A course of dealing is a sequence of previous conduct between the parties to a contract that is fairly to be regarded as establishing a common basis for interpreting their contract.18 A course of dealing has obvious relevance to interpretation. For example, if a contractor has been regularly building homes for a developer and has always used a certain grade of wood in building those homes, the developer had knowingly accepted the contractor’s use of that grade of wood, and the contractor and the developer enter into a new contract that is comparable to the previous contracts and nothing is said about the grade of wood the contractor will use, then the contractor acts reasonably in interpreting the new contract to allow him to use the same grade of wood, and the developer acts reasonably in interpreting the contract to require the contractor to use the same grade of wood.

15.  Restatement Second § 222. 16.  16 P.2d 627 (Or. 1932). 17.  Id. 18.  See Restatement Second § 223.

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Course of performance. As referenced in the previous chapter, a course of performance is a continued performance under a contract in a certain way that is known by and not objected to by either party. In such a case the contract should be interpreted to mean that the parties interpret the contract to permit and require continued performance in the same way, and that interpretation should be given by the courts. There is one exception. In some cases a course of performance may be a modification rather than an interpretation of a contract. In such cases the modification will be enforceable as an implied-​in-​fact contract unless the underlying contract requires modifications to be in writing and the course of performance is not in writing (although it may be enforceable in some cases even then, on the ground of waiver).

II. LITERALISM Literalism holds that contracts should be interpreted only on the basis of the words used in a contract, without regard to the context in which those words were used, special-​community usages, usages of trade, the course of dealing between the contracting parties, or the course of performance.

A.  THE PLAIN-​MEANING RULE Literalism comes in various forms. The most prominent form is the plain-​meaning or four-​ corners rule. Under that rule if there exists a more or less complete writing that reflects the existence of a contract, and the court determines, by looking only at the writing, that the writing is unambiguous, the parties are not allowed to consider evidence outside the writing—​“extrinsic evidence”—​concerning the meaning of the writing, except a dictionary. Furthermore, if the court deems the expression to be unambiguous on its face, even evidence intended to show that the writing is ambiguous will not be admissible. As Thayer observed, sardonically, under this rule: The [judge can] . . . retir[e]‌into that lawyer’s Paradise where all words have a fixed, precisely ascertained meaning; where men may express their purposes, not only with accuracy, but with fullness; and where, if the writer has been careful, a lawyer, having a document referred to him, may sit in his chair, inspect the text, and answer all questions without raising his eyes.19

The plain-​meaning rule is fatally defective in two ways. First, as shown in Section I, a writing cannot be sensibly interpreted without regard to the context in which it was written, usages, especially trade usages, and any relevant course of dealing between the parties. Second, the plain-​meaning rule is applicable only when a contract is unambiguous, and disputed contract language is almost never unambiguous.

19.  James Bradley Thayer, A  Preliminary Treatise on Evidence at the Common Law 428–​29 (1898).

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A good illustration is provided by Steuart v. McChesney.20 On June 8, 1968, Lepha and James Steuart executed an agreement granting to William and Joyce McChesney a “Right of First Refusal” on a parcel of farmland. This right provided that: “During the lifetime of said Steuarts, should said Steuarts obtain a Bona Fide Purchaser of Value, the said McChesneys may exercise their right to purchase said premises at a value equivalent to the market value of the premises according to the assessment rolls as maintained by the County of Warren and Commonwealth of Pennsylvania for the levying and assessing of real estate taxes. . . .” In July 1977 the premises were appraised by a real estate broker at a market value of $50,000. James Steuart died sometime before October 1977. On October 10 and 13, 1977, Lepha received offers of $35,000 and $30,000 for the premises. Upon receiving notice of these offers the McChesneys sought to exercise the Right of First Refusal by tendering $7,820 to Lepha. This amount was twice the assessed value of the premises as listed on the tax rolls maintained in Warren County, apparently because the practice in the County was to value real estate for tax-​assessment purposes at 50  percent of market value. Lepha refused the tender and the McChesneys sought a decree conveying the property to them for $7,820. After hearing testimony, a Pennsylvania trial court held that the exercise price in the Right of First Refusal was intended to serve as “a mutual protective minimum price for the premises rather than to be the controlling price without regard to a market third party offer.” The court therefore construed the agreement as granting the McChesneys a preemptive right to purchase the land for $35,000, the amount of the first bona fide offer. The Superior Court reversed, holding that the plain meaning of the Right of First Refusal was that the value shown on the assessment rolls alone determined the exercise price. That decision was affirmed by the Pennsylvania Supreme Court: In the instant case, the language of the Right of First Refusal, viewed in context, is express and clear and is, therefore, not in need of interpretation by reference to extrinsic evidence. The plain meaning of the agreement in question is that if, during the lifetime of the appellant, a bona fide purchaser for value should be obtained, the appellees may purchase the property “at a value equivalent to the market value of the premises according to the assessment rolls as maintained by the County of Warren and Commonwealth of Pennsylvania for the levying and assessing of real estate taxes.” Indeed, a more clear and unambiguous expression of the Right of First Refusal’s exercise price would be onerous to conceive. By conditioning exercise of the Right of First Refusal upon occurrence of the triggering event of there being obtained a bona fide offer, protection was afforded against a sham offer, made not in good faith, precipitating exercise of the preemptive right. The clear language of the agreement, however, in no manner links determination of the exercise price to the magnitude of the bona fide offer received through that triggering mechanism.21

As in many or most plain-​meaning cases the court here erred twice: first in endorsing the plain-​meaning rule, and second in concluding that the language of the writing was unambiguous. In reality, the Right of First Refusal was ambiguous in at least eight respects:

1. The normal meaning of a right of first refusal in an agreement between A and B on property owned by A is that A cannot sell the property to a third party who has made an offer to

20.  444 A.2d 659 (Pa. 1982). 21.  Id. at 663.

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2.



3.



4.



5.



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purchase the property without first offering to sell the property to B at the price offered by the third party. (This is exactly the interpretation of the contract given by the trial judge after hearing testimony.) The title of the instrument in dispute therefore was inconsistent with the Supreme Court’s interpretation, because although Lepha Steuart had received offers on the property there is no indication that she had attempted to sell the property. The Right of First Refusal stated that it could be exercised “should said Steuarts obtain a Bona Fide Purchaser of Value.” A purchaser is a person who makes a purchase. The McChesneys attempted to exercise their right of first refusal after two offers were made, but before a purchase was attempted or an offer was accepted. In other words, at the time of the alleged exercise of the Right of First Refusal there was no purchaser. The Right of First Refusal applied “only should said Steuarts obtain a bona fide purchase for value.” There was no evidence that Lepha had obtained the two offers. For all that appears, the offers came in over the transom. The court held that if the Right of First Refusal was triggered the McChesneys would have the right to purchase the property for the amount at which it was listed on the County assessment roles—​$3,910. But the McChesneys did not offer that amount. Instead, they offered $7,820. If the agreement was unambiguous, why didn’t the McChesneys offer $3,910? The Right of First Refusal could be exercised only “[d]‌uring the lifetime of said Steuarts.” Did this mean the lifetimes of both Steuarts, in which case the Right could no longer be exercised since James had died, or the lifetime of either Steuart, in which case the Right could be exercised despite James’s death? It is worth nothing that the Right refers to the “lifetime” (singular) of the Steuarts. The Right of First Refusal did not state that the exercise price was the value listed on the County assessment roles. Instead it stated that the exercise price was the market value listed on the assessment roles. Why should the exercise price be the value on the assessment roles if the those roles did not state the market value, as required under the Right? The Pennsylvania statute provided that: “It shall be the duty of the chief assessor to assess, rate and value all subjects and objects of local taxation . . . according to the actual value thereof.”22 However, the Steuarts’ property had not been reassessed for five years, and in any event based on the two offers made to Lepha it is clear that the property had not been valued “according to the actual value thereof.” At least arguably, it was an implied term of the exercise price that the amounts stated in the assessment roles would be determined lawfully. They weren’t. No reason was given, either in the Supreme Court’s opinion or in the Right of First Refusal itself, why the Steuarts gave the McChesneys the Right. Was it a gift? Was it given in exchange for a reduction in the price of the property? Was there some other form of consideration? Surely the reason that the Steuarts gave the Right to the McChesneys bears on the meaning of the Right, and omission of this reason creates one more ambiguity.

22.  72 P.S. § 5453.602(a) (1964).

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Stewart v. McChesney illustrates a truth about literalism: literalist judges are brutally insensitive to the English language. Another illustration of this insensitivity is provided by Reading Law, a book on interpretation by Justice Scalia (a literalist) and Bryan A. Gainer. The book was reviewed, and eviscerated, by Judge Posner, who said:23 . . . [Scalia and Gainer] applaud White City Shopping Center, L.P. v. P.R. Restaurants, LLC, a decision that held that the word “sandwiches” in a lease did not include burritos, tacos, or quesadillas, because Merriam-​Webster’s dictionary defines “sandwich” as “two thin pieces of bread, usually buttered, with a thin layer (as of meat, cheese, or savory mixture) spread between them. . . .” [A]‌s is often the case, the court got the definition wrong. . . . A sandwich does not have to have two slices of bread; it can have more than two (a club sandwich) and it can have just one (an open-​ faced sandwich). The slices of bread do not have to be thin, and the layer between them does not have to be thin either. The slices do not have to be slices of bread: a hamburger is regarded as a sandwich, and also a hot dog—​and some people regard tacos and burritos as sandwiches, and a quesadilla is even more sandwich-​like. Dictionaries are mazes in which judges are soon lost. A dictionary-​centered textualism is hopeless.

Literalist opinions, even by very smart judges, sometimes verge on risibility. For example, after PG&E was decided, Alex Kozinski, a very smart judge, writing for a panel of the Ninth Circuit, opined that: [Pacific Gas] chips away at the foundation of our legal system. By giving credence to the idea that words are inadequate to express concepts, Pacific Gas undermines the basic principle that language provides a meaningful constraint on public and private conduct. If we are unwilling to say that parties, dealing face to face, can come up with language that binds them, how can we send anyone to jail for violating statutes consisting of mere words lacking “absolute and constant referents”? How can courts ever enforce decrees, not written in language understandable to all, but encoded in a dialect reflecting only the “linguistic background of the judge”? Can lower courts ever be faulted for failing to carry out the mandate of higher courts when “perfect verbal expression” is impossible? . . . 24

In other words, Kozinski opined that under PG&E all California prisoners would be freed and lower courts in California would not be bound by the decisions of higher courts. Many years have now gone by and none of Kozinski’s nightmares have occurred. Prisoners have not been freed and lower courts have not turned their backs on higher courts. Stanley Fish scathingly critiqued Kozinski’s opinion: . . . Kozinski’s assertion of ready made formal constraints is belied by his efforts to stabilize what he supposedly relies on, the plain meaning of absolutely clear language. The act of construction for which he says there is no room is one he is continually performing. Moreover, he performs it in a way no different from the performance he castigates. Trident, he complains, is attempting “to obtain judicial sterilization of its intended default,” and the reading its lawyers propose is

23.  The Spirit Killeth but the Letter Giveth Life, New Republic, Sept. 13, 2012, at 18, 20. 24.  Trident Ctr. v. Conn. Gen. Life Ins. Co., 847 F.2d 564 (9th Cir. 1998).

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Interpretation in Contract Law an extension of that attempt rather than a faithful rendering of what the document says. The implication is that his reading is the extension of nothing, proceeds from no purpose except the purpose to be scrupulously literal. But his very next words reveal another, less disinterested purpose: “But defaults are messy things and they are supposed to be . . . Fear of repercussion is [the] strong medicine that keeps debtors from shirking their obligations.” And he is, of course, now administering that strong medicine through his reading, a reading that is produced not by the agreement, but by his antecedent determination to enforce contracts whenever he can. The contrast then is not (as he attempts to draw it) between a respect for what “the contract clearly does . . . provide” and the bending of the words to an antecedently held purpose, but between two bendings. . . .25

In short, even taking the plain-​meaning rule on its own terms, anyone with any sensitivity to English would understand the lack-​of-​ambiguity predicate almost invariably fails because texts that literalist judges regard as unambiguous are in fact almost always ambiguous. Judges who apply a literalist approach on the ground that a contract is unambiguous on its face almost invariably lack sensitivity to the principles of real, living English, so that contracts that literalist judges think are unambiguous are almost always ambiguous. (This is not surprising, because literalist judges seldom studied English; the number of literalist judges who have read four novels by Jane Austin is probably short of ten.) Even more important, the concept that a contract can be interpreted without regard to its contect is absurd. Purposeful words, like those in a contract, have no intelligible meaning outside of the contect in which they were used. Purposeful words out of context are like fish out of water—​dead or dying. More to the point, the plain-​meaning rule cannot sensibly be taken on its own terms because expressions can seldom be understood without regard to their contexts. As Learned Hand famously said, “There is no surer way to misread any document than to read it literally.”26 Of course, it’s true that we make ourselves understood almost all of the time, but that’s not because everyone means the same thing by certain words regardless of context, but because language is always in context and language in context is almost always easy to understand. For example, suppose A says to B, “I want a hot dog.” That sentence might seem to be unambiguous, but it certainly isn’t, because the sentence can only be understood in context. For example, if B is a friend who is taking a walk with A, “I want a hot dog” means “Let’s find a place that serves hot dogs, so I can eat one.” If B is a checker in a supermarket, “I want a hot dog” means “What section are hot dogs in?” If B operates a hot dog stand, “I want a hot dog” means “I want to order a hot dog from you.” If A is a race-​car owner who is interviewing B as a driver, “I want a hot dog” means “I want to hire a show-​off type of driver.” If A is shopping for a dog and B owns a pet store, “I want a hot dog” means “I want to buy a dog of a breed that is extremely popular right now.” All of these meanings are easy to understand in context and virtually impossible to understand without context.

25.  Stanley Fish, The Law Wishes to Have a Formal Existence (1992). 26.  Giuseppi v. Walling, 144 F.2d 608 (2d Cir. 1944).

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I I I .   E X T R E M E L I T ER A L I S M In two related articles, “Contract Theory and the Limits of Contract Law” (hereafter “Contract Theory”)27 and “Contract Interpretation Redux,”28 (hereafter “Redux”), Alan Schwartz and Robert Scott formulated a unique approach to the interpretation of contracts. Schwartz and Scott begin by establishing the domain of their approach, which is not the interpretation of all contracts, but the only interpretation of contracts between business firms. Having set out their domain, Schwartz and Scott locate their school of thought. Traditionally there are two competing schools of interpretation—​contextualism and literalism. Schwartz and Scott enroll in a third school—​formalism. Indeed, they claim that “Contract Theory” “has become the iconic formalist statement.” They do not support this claim, but it is probably correct. As shown in Chapter 2, formalism is dead and for good reason. Schwartz and Scott exhume the corpse but they cannot revive it. Accordingly, there are very few living formalists other than Schwartz and Scott. That being the case, “Contract Theory” is the iconic formalist statement of interpretation by default—​hardly anyone else is making formalist statements. Because formalism is a corpse, not a school, a better description of Schwartz and Scott’s approach to interpretation is extreme literalism—​extreme because Schwartz and Scott exclude from the principles of interpretation not only context but such almost-​universally recognized principles as trade usage and course of dealing.29 Schwartz and Scott’s extreme literalism consists of a cluster of assertions—​theories, claims, and arguments. It would be beyond the scope of this chapter to consider all of these assertions. Instead, this chapter considers their central assertions. (i) Schwartz and Scott incorrectly argue that accuracy is not the primary goal of interpretation. Schwartz and Scott begin by pointing out that “There is a consensus among courts and commentators that the appropriate goal of contract interpretation is to have the enforcing court find the correct answer. The correct answer is the solution to a contracting problem that the contracting parties intended to enact.”30 This point can be reformulated as follows: there is a consensus among courts and commentators that the appropriate goal of interpretation is to accurately determine the contracting parties’ intention. To put this differently, accuracy is the primary goal of interpretation, and whether a given principle of interpretation lends to accuracy in interpretation is the lodestar by which the principle is judged.

27.  Contract Theory and the Limits of Contract Law, 113 Yale L.J. 568, 569 (2003). 28.  Contract Interpretation Redux, 119 Yale L.J. 926, 965 (2010). 29.  Schwartz and Scott deny that they reject contextualism. “A minimum evidentiary basis,” they say, “ordinarily will convey sufficient contextual information. For example, the pleadings and supporting briefs, evidence as to what the seller delivered, the contract, a recent 10-​K SEC filing by the buyer (if any) and the life experience of the judge, together are likely to permit a court to decide that an agreement between a professional constriction company and a chemical company is likely to be satisfied by the delivery of a gazebo.” Redux, supra note 28, at 952–​53. This may be sufficient contextual evidence for a literalist, but it is not sufficient evidence for a contextualist. To begin with, none of these elements bears on interpretation (except of course the contract) or would even be admissible on an issue of interpretation. Next, and more important, this list omits every contextual element that is relevant to interpretation, such as the setting in which the contract was made, the parties’ relationship, the parties’ objectives, trade usage, and course of dealing. 30.  Contract Theory, supra note 27, at 568–​69.

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Who could possibly disagree with that? The answer is, Schwartz and Scott. After stating that there is a consensus among courts and commentators that the appropriate goal of contract interpretation is to have the enforcing court find the correct answer—​or in the parlance of this chapter, to accurately determine the parties’ intention—​Schwartz and Scott go on to state that “In our view the current consensus asks the wrong question. A  commitment to party sovereignty regarding the contract’s substantive terms implies a further commitment to party sovereignty regarding the interpretive style an adjudicator should use to find the substantive terms.” In other words, Schwartz and Scott argue that contracting parties should have the power to determine the principles of interpretation that will be applied to their contract, but claim that under present law the principles of interpretation are mandatory.31 “Courts in general,” they say, “treat interpretation as mandatory.”32 This is not the case and this is not the law. Under contract law as it stands contracting parties do have the power to determine what principles of interpretation should be applied to their contracts, just as much as they have the power to determine what they will buy and sell and at what price. There are no cases to the contrary. Not only were Schwartz and Scott unable to find any cases to support their claim that under present contract law the principles of interpretation are mandatory, they were unable to find any commentators who support that claim. Schwartz and Scott contend that “other commentators believe that the principles of interpretation are mandatory.”33 They can name only one commentator who takes that position, Omri Ben-​Shahar, in “The Tentative Case against Flexibility in Contract Law,”34—​however, Ben-​Shahar does not say that. In short, Schwartz and Scott offer no support whatever, either in the case law or the commentary, for their central claim that the principles of interpretation are mandatory. They don’t offer any such support because there is no support. Schwartz and Scott claim that David Snyder, in “Language and Formalities in Commercial Contracts: A Defense of Custom and Conduct”35 refers to the UCC’s rules of interpretation as quasi-​mandatory. Schwartz and Scott comment that “[b]‌ecause contracting has positive costs, a quasi-​mandatory rule will be mandatory in practice for many parties, who will be unwilling to bear the additional costs of specifying alternative regimes.”36 But quasi-​mandatory means not mandatory. Furthermore, the UCC is only a fragment of contract law so that even if Schwartz and Scott were right about Snyder’s position, that leaves open interpretation in contract law generally. More important, however, Snyder actually takes a position diametrically opposed to that of Schwartz and Scott: The use of custom and conduct in the construction of contracts has lately come under increasing challenge. Perceptive and careful scholarship raises important questions. Some of these questions can be answered, though, in favor of continuing the role of usage of trade, course of dealing, and course of performance in the revision of the UCC. They are an integral part of the parties’ agreement. Like the words the parties use in a written contract, usage of trade and course of dealing 31.  See, e.g., id. at 547, 583. 32.  Id. at 583. 33.  Id. at 569 n.52. 34. 66 U. Chi. L. Rev. 781 (1999). 35. 54 SMU L. Rev. 617 (2001). 36.  Contract Theory, supra note 27, at 569 n.52.

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constitute a part of the parties’ language. Courts ignore that language, verbal and nonverbal, at the risk of ignoring the parties’ manifested assent. Although course of performance presents a weaker linguistic case, it is important, particularly in a legal context, because it partakes of the cautionary, evidentiary, and channeling functions of a natural legal formality. The Code does well to retain custom and conduct as constituents of the parties’ agreement. To do otherwise would be to reject or subordinate assent as a basis for contractual liability.37

To summarize: Schwartz and Scott say that contracting parties should be able to choose their own interpretive regime. That’s true, but it’s also true that no argument is needed to establish this point—​it’s obviously correct and already the law. The real issue is what regime contracting parties should be deemed to prefer when they have not specified a regime. The answer, which is also obvious but which Schwartz and Scott reject, is that where contracting parties have not specified an interpretive regime they should be deemed to prefer a regime that will accurately determine their intention. Schwartz and Scott’s theory of interpretation does not serve that purpose. In fact, it rejects that purpose. (ii) Schwartz and Scott don’t directly face the fact that few firms adopt the interpretative regime that Schwartz and Scott claim, with no evidence, that firms prefer. Instead, they attempt to deal with that fact indirectly, by arguing that the reason contracts don’t provide for a literalist, non-​contextual regime is that contract law doesn’t allow them to do so.38 In fact, Schwartz and Scott claim that a major contribution of “Contract Theory” is to establish that, contrary to existing law, contracting parties should be able to choose the interpretive regime that will govern their contract. That claim misses the mark. As shown above, there is nothing in contract law that prevents parties from providing the interpretive principles that are applied to their contract. Schwartz and Scott cite no cases to support their claim. Judge Posner concludes to the contrary: “Contracting parties,” he points out, “can provide in their contract that the court should base its interpretation solely on the words of the contract, although I have not found a case in which such a provision was mentioned.”39 (iii) Schwartz and Scott base their arguments in part on the claim that “the UCC strongly urges a contextualist interpretation style,” and support this proposition by citing comments to UCC Sections 2-​205 and 2-​202.40 There would be nothing wrong with that since contextualism is the only way that contracts should be interpreted. But to begin with, the UCC covers only contracts for the sale of goods. Furthermore, “strongly urges” is not the same as “requires.” And most fundamentally, UCC § 1-​302(a) provides that “Except as otherwise provided in subsection (b)  or elsewhere in [the UCC], the effect of provisions of [the UCC] may be varied by agreement.”41 (iv) Schwartz and Scott incorrectly claim that the rules of interpretation are difficult to escape. Schwartz and Scott state that “there is a consensus that the rules of interpretation are difficult for 37. Snyder, supra note 35, at 653–​54. 38.  Contract Theory, supra note 27, at 583. 39.  See Posner, supra note 3; Contract Theory, supra note 27, at 583 n.79, 584–​85. 40.  U.C.C. §§ 1-​201, cmt 1, 2-​201, cmt. 2 (Am. Law Inst. & Unif. Law Comm’n 2017). 41.  Section 1-​302(b) provides that “The obligations of good faith, diligence, reasonableness, and care prescribed by [the Uniform Commercial Code] may not be disclaimed by agreement. The parties, by agreement, may determine the standards by which the performance of those obligations is to be measured if those standards are not manifestly unreasonable.”

38

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the parties to escape.”42 There is no such consensus. Schwartz and Scott provide no case citations to support their claim. They cannot; there are no such citations. The rules of interpretation should be and are very easy to escape. (v) Schwartz and Scott assert a linguistic hypothesis, as follows: that there are two sets of linguistic communities. One set consists of a single linguistic community, composed of judges, lawyers, business persons, and potential jurors, who read and write in a language Schwartz and Scott call “majority talk,” or M. The other set consists of many linguistic communities, each of which reads and writes in a language that Schwartz and Scott call “party talk,” or P. This hypothesis is not persuasive. Schwartz and Scott admit that linguists would say that when everyone reads and writes English, “majority talk” and “party talk” are not two different languages but only different dialects of English. The linguists are right: not surprisingly, they know more about linguistics than lawyers. Recall too that the domain of Schwartz and Scott’s approach to interpretation involves business firms, not individuals. In the case of business firms located in English-​speaking countries there is clearly no majority talk, no party talk, no M and no P: there is only English. Therefore, to the extent that Schwartz and Scott’s theories, claims, and arguments depend on the existence of M and P they are incorrect on that ground too. (vi) Schwartz and Scott incorrectly argue that the issue is interpretation is what principles of interpretation typical parties want courts to use when attempting to find the correct answer.43 That is not the issue. The issue is what principles of interpretation the contracting parties want a court to use in interpreting their contract. If the contracting parties specify the principles of interpretation they want the court to use, that is the end of the matter. If they don’t so specify, it should be assumed that they want the court to apply the standard principles of interpretation. After all, Schwartz and Scott’s domain consists of contracts between business firms. Contracts between business firms are drafted by lawyers who are knowledgeable about the law that will govern their contracts. Lawyers are well aware of the rules of interpretation. Since they could vary those rules if they wanted to, if they don’t vary those rules it must be assumed that they didn’t want to. In other words, contracting parties are free to select the principles of interpretation that will be applied to their contracts, and when they don’t specify any contrary principles they have effectively adopted the principles of interpretation under contract law. (vii) A centerpiece of Schwartz and Scott’s approach to interpretation is their claim that it is Willistonian. Contrary to Schwartz and Scott’s claim, it isn’t: Williston was a contextualist. In the first edition of Williston’s treatise (the only edition that can be confidently regarded as expressing his thinking, because later editions are either coauthored or posthumous) Williston distinguished between the “local standard” for the meaning of a word or term and the “normal standard.” Williston defined the local standard as “the natural meaning of [a word or term] to parties of the kind who contracted at the time and place where the contract was made, and with such circumstances as surrounded its making.”44 Williston did not define his normal standard as crisply, but pretty clearly he used the term to mean “the common and normal sense of the words—something close to Schwartz and Scott’s M.”45 42.  Contract Theory, supra note 27, at 569. 43.  Id. at 569. 44. 2 Samuel Williston, Williston on Contracts 1167 (1920) (emphasis added). 45.  Id. at 1162.

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He continued, According to the weight of authority and on principle, where the parties have assented to a writing as an expression of their agreement . . . the standard of interpretation is the local standard. [That is, the natural meaning of words to the parties with such circumstances as surrounded their making.] . . .46 [A]‌reasonable degree of certainty is attained if words are construed according to a standard not peculiar to the parties, but customary among persons of their kind under the existing circumstances. The certainty obtained by enforcing always the normal standard would be but little greater, and would be obtained at the expense of a rigidity which would frequently do violence to the actual intention of the parties. That the local standard would be applied unless at any rate under the normal standard the words were extremely clear seems to have been early settled. Even though the local standard led to a construction opposed to the literal meaning of the language this was true . . . .47 . . . The circumstances under which a writing was made may always be shown. The question the court is seeking to answer is the meaning of the writing at the time and place when the contract was made; and all the surrounding circumstances at that time necessarily throw light upon the meaning of the contract. . . .48

In a footnote, Williston cited some of the cases that supported his contextualist position: In Myers v. Sarl [1860] . . . , Blackburn, J. said: “ . . . I take to be the true rule of law upon the subject that when it is shown that a term or phrase in a written contract bears a peculiar meaning in the trade or business to which the instrument relates, that meaning is prima facie to be attributed to it; unless upon the construction of the whole contract enough appears, either from express words or by necessary implication, to show that the parties did not intend that meaning to prevail. . . . In the well-​known case of Smith v. Wilson [1832] . . . in an action on a covenant in a lease to “leave in the warren ten thousand rabbits,” proof was allowed that the customary meaning of thousand as applied to rabbits in that vicinity was one hundred dozen, and Coloridge, J., said: “Evidence will not be excluded because the words are in their ordinary meaning unambiguous” (emphasis added). In Grant v, Maddox [1846] . . . years was interpreted as meaning the period of the year less a long vacation. In Mitchell v. Henry [1880] . . . the words “white salvage” were interpreted as covering a dark gray border on a piece of goods, on proof that such was the trade name. In Walls v. Bailey [1871] . . . , Folger, J., said: “The meaning of words may be controlled and varied by usage, even when they are words of numbers, length or space, usually the most definite in language”. See also Commonwealth v. Hobbs [1886] . . . (arsenic colored with lamp black was held under the evidence to be “white arsenic”) . . .49 Though the expressions in the cases are numerous that where language used in a contract is clear and unambiguous there is no opportunity for interpretation or construction, yet these expressions themselves need interpretation. As has been seen, in a strict sense, every contract needs interpretation; and, therefore, the expressions in question are literally inexact; moreover, if the local standard

46.  Id. at 1167. 47.  Id. at 1171–​72 (emphasis added). 48.  Id. at 1198 (emphasis added). 49.  Id. at 1172–​73.

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Interpretation in Contract Law is adopted, contracts apparently clear in their meaning may be shown by usage or the surrounding circumstances to be ambiguous or perhaps clearly to mean something different from the normal or ordinary meaning of their language. . . .50

Restatement First of Contracts, widely acknowledged to have been principally authored by Williston, is to the same effect as his treatise: § 235. Rules Aiding Application of Standards of Interpretation. . . . (a)  The ordinary meaning of language throughout the country is given to words unless circumstances show that a different meaning is applicable. . . . (d)  All circumstances accompanying the transaction may be taken into consideration, subject in case of integrations to the qualifications stated in § 230 . . . . [Emphasis added.] § 236. Secondary Rules Aiding Application of Standards of Interpretation. (b) The principal apparent purpose of the parties is given great weight in determining the meaning to be given to manifestations of intention or to any part thereof. . . . § 246. Effect of Operative Usages. Operative usages have the effect of (a)  defining the meaning of the words of the agreement or the meaning of other manifestations of intention, and (b) adding to the agreement or manifestations of intention provisions in accordance with the usage, and not inconsistent with the agreement or manifestations of intention. Comment on Clause (a): a. The rule stated in the Clause is not confined to unfamiliar words or to words often used ambiguously. Familiar words may have different meanings in different places. A usage may show that the meaning of a written contract is different from an apparently clear meaning which the writing would otherwise bear. . . .(emphasis added). Illustrations of Clause (a): 1.  A contracts to sell and B contracts to buy ten bushels of oats. By an operative usage 32 pounds constitutes a bushel. Ten bushels in the contract means 320 pounds. 2. A contracts to sell B ten thousand shingles. By an operative usage, two packs constitute a thousand, though not containing that exact number. One thousand in the contract means two packs. 3. A contracts to sell B a thousand feet of San Domingo mahogany. By an operative usage, good figured mahogany of a certain density is known as San Domingo mahogany, though it does not come from San Domingo. San Domingo mahogany in the contract means good figured mahogany of proper density. 4. A  and B enter into a contract for the purchase and sale of “No. 1 heavy book paper guaranteed free from ground wood.” An operative usage may show that this means paper not containing over three per cent ground wood. . . . 5. A and B enter into a contract for a year’s employment of B by A. By an operative usage such a contract may be terminated by a month’s notice. That provision is part of the contract.

50.  Id. at 1173 (emphasis added).

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6. A sends goods to B by C, a railroad company, receiving a bill of lading from C. B rejects the consignment. The usage of carriers operative as to both A and C is to notify the consignor on rejection of a shipment by the consignee. C fails to give such notification. The requirement of notification is added to those stated in the bill of lading. . . .

(viii) Schwartz and Scott incorrectly argue that the aim of interpretation is not find the most accurate interpretation of the parties’ contract, but to determine the mean or the distribution of possible interpretations. Another argument that Schwartz and Scott make against the primacy of accuracy in determining the principles of interpretation is that the correct answer (as they call it) is not the most accurate answer, but the mean of the distribution of possible interpretations.51 This argument is not proven, and mistaken, because . . . it is out of touch with the reality of interpretation cases, which almost invariably involve a choice between two competing interpretations, not the determination of a mean. Take Lawson v. Martin Timber Co.:52 Lawson and Timber Company entered into an agreement on October 14, 1948, which provided that Timber Company had two years to cut and remove timber from Lawson’s land, and that “in event of high water after this time [i.e., during the two–​year period], . . . Timber Co. is to get additional one year’s time.” Timber Company cut and removed certain timber from Lawson’s land after the original two-​year period had expired. Lawson brought an action to recover the value of that timber. The evidence indicated that there was high water during approximately half of the two-​year period, but that all the lumber on Lawson’s land could have easily been cut and removed during the other half. The issue was whether the one-​year extension was or was not applicable under these circumstances.53 Here there was no mean of interpretation:  only two interpretations were possible (or at least, presented to the court), and either one or the other had to be selected; and this is almost invariably the case. Parties to an interpretive dispute do not present the court with three, four, five, seven, or more interpretations. Each party presents one interpretation, for a total of two. Accordingly, there is almost never a mean of possible judicial interpretations—​only a choice between two interpretations. Or suppose a seller and a buyer have a dispute concerning when the seller was required to deliver a machine. The buyer argues that delivery was due six months after the contract was made. The seller argues that delivery was due twelve months after the contract was made. Under Schwartz and Scott’s argument the seller would be required to make delivery nine months after the contract was made, a result neither party wants. A related argument that Schwartz and Scott make against the primacy of accuracy in determining the interpretation of a contract is that firms are content with interpretations that are right on average, not right every time. This argument too lacks support and is mistaken. Of course, firms realize that courts will not be right every time, just as a baseball hitter realizes an umpire will not be right every time. But to realize is one thing; to be satisfied is another. If all a firm wants is that courts be right on average, why spend large amounts on litigation instead of flipping a coin, which will produce results that are right on average, for a near-​infinitely cheaper price? Or imagine a court saying to the parties, “I know you are content with results that are

51.  Redux, supra note 28, at 931. 52.  115 So. 2d 821 (La. 1959). 53.  Lon Fuller & Melvin A. Eisenberg, Basic Contract Law 404–​05 (8th ed. 2006).

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right on average, so I’m just going to put two pieces of paper in a hat, one that says plaintiff and one that says defendant, and then draw out the winner.” Contrary to Schwartz and Scott, no firm would say that all it wants from a court is to be right on average. Litigants who don’t settle think they are right and want courts to so hold. To put it differently, litigating firms want courts to be right all the time. (ix) Schwartz and Scott’s arguments have little or no empirical support. The argument in “Contract Theory” is not only mistaken: it lacks almost any empirical support. At the end of “Redux,” Schwartz and Scott do make two empirical arguments in support of their extreme literalism, but these arguments do not stand up. First, Schwartz and Scott adduce evidence that parties do explicitly attempt to alter common judicial interpretive practices. To this end, they cite “[a]‌common provision found in alliance agreements,” which they draw from an alliance agreement between DuPont and EarthShell: The Parties’ legal obligations under this Alliance Agreement are to be determined from the precise and literal language of this Alliance Agreement and not from the imposition of state laws attempting to impose additional duties of good faith, fair dealing or fiduciary obligations that were not the express basis of the bargain at the time this Agreement was made. The Parties are sophisticated business entities with legal counsel that have been retained to review the terms of this Alliance Agreement and the Parties represent that they have fully read this Alliance Agreement, and understand and accept its terms.54

Although Schwartz and Scott claim that provisions such as this are common in alliance agreements, they provide no evidence to support this claim. Moreover, it seems likely that fewer than 1 percentof all commercial contracts are alliance agreements. But no matter, because the important point here is that Schwartz and Scott’s argument concerning alliance agreements completely undermines their assertion that the principles of interpretation are mandatory. Next, Schwartz and Scott discuss data developed by Ted Eisenberg and Geoffrey Miller on contractual choice-​of-​law provisions. In “The Flight to New  York”55 Eisenberg and Miller analyzed the choice of law in 2,865 contracts, and found that in 46 percent of the contracts the parties chose to have their contracts governed by New York law. In contrast, California law was chosen in less than 8 percent of the contracts although the commercial activity of California and New York are roughly equivalent. In “Bargains Bicoastal: New Light on Contract Theory,” Geoffrey Miller claims his evidence shows that “formalistic rules offer superior value for the interpretation. . . . of commercial contracts.” 56 This claim is incorrect. Miller’s evidence does not prove or even suggest that large companies prefer New York law because New York courts interpret contracts literalistically rather than contextually while California courts interpret contract contextually rather than literalistically. There is a lot of valuable empirical material in Miller’s article, but none of it supports his claim that the preference for New York law is based on interpretive styles. Indeed, the

54.  Redux, supra note 28, at 955. 55.  Theodore Eisenberg & Geoffrey P. Miller, The Flight to New York: An Empirical Study of Choice of Law and Choice of Forum Clauses in Publicly-​Held Companies’ Contracts, 30 Cardozo L. Rev. 1475 (2009). 56.  Geoffrey P. Miller, Bargains Bicoastal: New Light on Contract Theory, 31 Cardozo L. Rev. 1475 (2010).

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empirical data that Miller adduces completely fails to support his claim. There are at least eleven reasons adduced by Miller himself, none concerning New  York’s principles of interpretation why firms may prefer their contracts to be governed by New York rather than California law:







(1) New York provides accelerated consideration of actions based upon instruments for the payment of money.57 (2) Although both New York and California recognize freedom of contract as an important value, New York gives more weight to that value than California, and almost never upsets contracts, however inequitable they may appear.58 (3) Unlike New York, California does not sharply distinguish between consumer and commercial contracts, so that in California even business-​to-​business contracts can be reviewed for unfairness, inequity, or substantial injustice.59 (4) New York is less receptive than California to claims of duress, and California recognizes some duress-​like defenses that are not found in New York law.60 (5) New  York’s standards for unconscionability are more demanding than that of California.61 (6) Unlike California, New York rarely upsets contracts on public policy grounds.62 (7) California looks with disfavor at contractual provisions that would undermine the sense of security for individual rights.63 (8) New York is more permissive than California in allowing parties to limit their liability by contract.64 (9) New  York courts are more ready than California to enforce waivers of liability for negligence.65 (10) New  York established a Commercial Division of its Supreme Court in 1995, which is staffed by judges and court personnel experienced in business law, uses new case-​ management techniques, and offers enhanced opportunities for court-​ annexed adjudicatory dispute-​resolution. (11) New York limits lender liability.

Moreover, in “The Flight to New York” Miller and Eisenberg concluded that New York’s success in being named in choice-​of-​law provisions appears to be a combination of a decades-​long effort to attract contracting parties with possible lender insistence of New York law governing

57.  Id. at 1485–​86. 58.  Id. at 1479–​80. 59.  Id. at 1480. 60.  Id. at 1487–​88. 61.  Id. at 1489–​92. 62.  Id. at 1493–​96. 63.  Id. at 1495. 64.  Id. at 1496. 65.  Id. at 1496–​97.

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credit arrangements.66 In short, it is impossible to conclude, on the basis of Eisenberg and Miller’s data, that New York’s literalist approach to interpretation, or any other single feature of New York law, is the reason why firms so frequently choose New York law to govern their contracts. Accordingly, there is nothing in “The Flight to New York” to show that firms prefer literal, non-​contextual contract interpretation.67 (ix) Schwartz and Scott’s major argument against the primacy of accuracy in determining the principles of interpretation is that the cost of applying a given principle of interpretation is more significant than the accuracy to which the principle leads. This argument is incorrect because Schwartz and Scott don’t recognize that inaccuracy is a cost—​always significant, and often vastly greater than any other cost of interpretation. The reason for this is simple. Parties write the most efficient contract they can. Therefore, if a court interprets parties’ contract to be a different contract than what they intended to write, the court will inflict upon the parties the difference between the value of the efficient contract they intended to write and the value of the less efficient contract the court imposes upon them. This difference will always be substantial, and at the extreme the difference can be the entire value of the contract to one or both parties. The out-​of-​pocket cost of drafting a contract and the expected cost of litigating the interpretation of a contract are a vanishingly small fraction of the cost of an inaccurate interpretation. (x) Schwartz and Scott also argue that it is less costly to write a contract than to try a case. However, that is not true from an ex ante perspective, which is the relevant perspective in determining the principles of interpretation. The ex ante cost of writing a contract is an actual out-​ of-​pocket cost. In contrast, the cost of trying a case is a contingent expected cost, which is likely to be vanishingly small because most disputes are settled, not tried.68 Accordingly, from an ex

66.  Supra note 55, at 1511. 67.  See also Shawn Bayern, Contract Meta-​Interpretation, 49 U.C. Davis L. Rev. 1097, 1122 (2016): There are several further problems with the inference from this study that firms prefer textualism. One is that Professors Eisenberg and Miller have studied only public companies, not all the firms to which Schwartz and Scott intend to apply their analysis. Another, perhaps more significant, problem is that there is a wide variety in the choices of law that even large public firms have made. New York’s law, recall, was chosen in fewer than half the cases that Eisenberg and Miller studied, and for particular types of contracts, the choice is even less evident. Thus, public firms chose New York law in only about 25% of cases involving the purchasing of assets, only about 20% in licensing agreements, only 17% in mergers, and, perhaps of special note, in only 18% of cases involving legal settlements, where regularity of administration is presumably of special importance to at least one of the parties. Indeed, in settlement contracts, parties chose California law—​Schwartz’s and Scott’s paradigmatic contextualist regime—​about as often as they chose New York. The picture that the limited empirical data paints is one of variety, not one of consistency.

68.  Cf. Shawn Bayern, supra note 67, at 1120–​1121: Although evidence is not comprehensive, it appears that a typical contract case costs between $70,000 and $100,000 if litigated to trial. In 2005, state courts in the United States decided 8,917 contracts cases, implying that cases that led to resolution in court cost less than $900 million. In 2005, the gross domestic product (“GDP”) of the United States was $14.37 trillion. Of course, $900 million is a significant amount; as the old joke goes, add $900 million here and $900 million there, and eventually you’re dealing with real money. Nonetheless, $900  million is .006% (or one in about 16,000) of the GDP. Of course, most cases settle, perhaps before being counted in these statistics. The effect of the default interpretive regime on settlement rates is complicated and contested, but even Schwartz and Scott seem to admit that their textualist

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ante perspective, efficiency is maximized if more weight is given to the cost of drafting than to the cost of trying a case. Therefore, in determining the principles of interpretation the emphasis should be on which principles entail the lowest drafting costs. The answer is contextualism, because extreme literalism forces the parties to spell out every trade usage, course of dealing, and implication.

proposal would not increase settlement rates. As a result, the only question at stake seems to be: to what extent can we reduce the 0.006% drain on the economy that contract litigation represents? If the litigation were solely a loss, this might be a productive question for a very small administrative agency to consider; the problem, however, is that the economy receives something substantial for that $900 million: it receives a reliable adjudicatory system that backs up the commercial deals of American businesses. How much is it appropriate to risk in order to reduce that cost? Moreover, how much would textualism reduce it; would it even make a significant difference in the total amount, keeping in mind that the typical difference between textualism and contextualism involves only the production of such evidence as trade usage and evidence of course of dealing? Despite general popular rhetoric suggesting the waste associated with litigation, I am aware of no empirical evidence suggesting that the economic savings in reducing the evidentiary base for commercial litigation would be significant.

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Objective and Subjective Elements of Interpretation A de ep diff erence bet ween cl assi ca l a n d modern c on tr act l aw

is that the standards of classical contract law were entirely or almost entirely objective and abstract whereas the standards of modern contract law include important subjective elements. This difference is particularly striking in the area of interpretation. Classical contract law adopted a standard of interpretation that was almost purely objective. So, for example, in Woburn National Bank v. Woods1 the court said: A contract involves what is called a meeting of the minds of the parties. But this does not mean that they must have arrived at a common mental state touching the matter in hand. The standard by which their conduct is judged and their rights are limited is not internal, but external. In the absence of fraud or incapacity, the question is: What did the party say and do? “The making of a contract does not depend upon the state of the parties’ minds; it depends upon their overt acts.”2

Similarly, in Hotchkiss v. National City Bank3 Learned Hand stated: A contract has, strictly speaking, nothing to do with the personal, or individual, intent of the parties. A contract is an obligation attached by the mere force of law to certain acts of the parties, usually words, which ordinarily accompany and represent a known intent. If, however, it were proved by twenty bishops that either party, when he used the words, intended something else than the usual meaning which the law imposes upon them, he would still be held, unless there were some mutual mistake, or something else of the sort. Of course, if it appear by other words, or acts, of the parties, that they attribute a peculiar meaning to such words as they use in the contract, that meaning will prevail, but only by virtue of the other words, and not because of their unexpressed intent.

1.  89 A. 491 (N.H. 1914). 2.  Id. at 492 (quoting Oliver W. Holmes, The Common Law 307 (1881)). 3.  200 F. 287 (S.D.N.Y. 1911), aff ’d, 201 F. 664 (2d Cir. 1912), aff ’d, 231 U.S. 50 (1913).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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. . . [W]‌hatever was the understanding in fact of the banks [in this case] . . . of the legal effect of this practice between them, it is of not the slightest consequence, unless it took form in some acts or words, which, being reasonably interpreted, would have such meaning to ordinary men.4

And Williston: It is even conceivable that a contract shall be formed which is in accordance with the intention of neither party. If a written contract is entered into, the meaning and effect of the contract depends on the construction given the written language by the court, and the court will give that language its natural and appropriate meaning; and, if it is unambiguous, will not even admit evidence of what the parties may have thought the meaning to be.5

Classical contract law got it wrong. Just as the aim of contract law should be to effectuate the objectives of contracting parties, subject to applicable conditions and constraints, so the aim of interpretation should be to ascertain those objectives, subject to those constraints. Subjective understandings often play a crucial role in the ascertainment process. This point is illustrated by four basic principles of interpretation, each of which incorporates both objective and subjective elements. Principle I. If in a contractual context the parties attached different meanings to an expression, neither party knew or had reason to know that the other attached a different meaning than he attached, and the two meanings were not equally reasonable, the more reasonable meaning should prevail. Principle I is adopted in Restatement Second Section 201 (2) (b): “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 agreement was made . . . that party had no reason to know of any different meaning attached by the other, and the other had reason to know the meaning attached by the first party.” The principle is exemplified by the following paradigm: Paradigm 1. A  and B enter into a contract that includes Term T.  A  attaches meaning Alpha to Term T and B attaches meaning Beta. Under the circumstances meaning Beta is a more reasonable meaning than meaning Alpha. A does not know that B attaches meaning Beta to Term T and B does not know that A attaches meaning Alpha.

Under Principle I, meaning Beta should prevail. Under the basic aim of interpretation, ascertainment of the parties’ objectives is subject to constraints based on policy, morality, and experience, and two such constraints underlie Principle I. To begin with, Principle I is based in significant part on fault. In Paradigm 1 A is at fault—​is negligent—​in using an expression she should realize would lead a reasonable person in B’s position to believe that A attaches meaning Beta to the expression, when in fact A attaches meaning Alpha. If B attaches meaning Beta, and thereby suffers wasted reliance or the defeat of a legitimate expectation when A insists on meaning Alpha, A should be liable. Principle I is

4.  Id. at 293–​94 (emphasis added). 5. 1 Samuel Williston, The Law of Contracts 181–​82 (1920) (emphasis added).

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also supported by the policy of security of transactions. If an actual but less reasonable meaning attached by A could trump a more reasonable meaning attached by B, then A could attempt to avoid liability under a losing contract simply by claiming that he attached the less reasonable meaning. A potential for such claims might make contracts unduly insecure. Although Principle I is primarily objective it has a subjective component as well, because the more reasonable meaning of an expression should prevail only if the party who asserts that meaning subjectively attached the meaning to the expression at the time she used it. As stated in Restatement Second Section 201(2)(b), “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 agreement was made . . . that party had no reason to know of any different meaning attached by the other, and the other had reason to know the meaning attached by the first party” [emphasis added]. For example, in Embry v. Hargadine, McKittrick Dry Goods Co.6 Embry sued Hargadine, McKittrick (Hargadine) for breach of an employment contract. Embry testified as follows: He had a written employment contract with Hargadine for one year, ending December 15, 1903, at a salary of $2,000 per year. His duties were to be in charge of Hargadine’s sample department. Several times prior to the termination of his contract he had endeavored to reach an understanding with Hargadine’s president, McKittrick, renewing the contract for another year, but he had been put off. On December 23, he called on McKittrick and said that there were only a few days until January 1 in which to seek employment with other firms. Therefore, if Hargadine wished to retain his services, he must be given a contract for another year or he would quit then and there; he had been put off twice before and wanted an understanding or contract at once so that he could go ahead without worry. McKittrick asked him how he was getting along in the sample department, and Embry said that he was very busy as they were in the height of the season getting men out—​had about 110 salesmen on the line and others in preparation. McKittrick responded, “Go ahead, you’re all right. Get your men out, and don’t let that worry you.” Embry understood this statement to mean that McKittrick assented to rehiring Embry for another year and he worked until February 15, when he was discharged. McKittrick, in his testimony, denied that the conversation as related by Embry took place. Instead, McKittrick testified that, when Embry came to McKittrick’s office McKittrick was working on his books to get out a report for a stockholder’s meeting. When Embry said that if he did not get a contract he would leave, McKittrick said, “Mr. Embry, I am just getting ready for this stockholder’s meeting tomorrow. I have no time to take it up now. I have told you before I would not take it up until I had these matters out of the way. You will have to see me at a later time. I said: ‘Go back upstairs and get your men out on the road,’ I may have asked him one or two other questions relative to the department, I don’t remember. The whole conversation did not take more than a minute.” At the trial the court gave the jury an instruction embodying in substance Embry’s version of the conversation, and stating that the parties’ conversation constituted a contract “if you [the jury] find both parties thereby intended and did contract with each other for Embry’s employment for one year . . . at a salary of $2,000.” The jury found for Hargadine. The appellate court reversed on the ground that if Embry’s version of his conversation was

6.  105 S.W. 777 (Mo. Ct. App. 1907).

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true and Embry subjectively understood the conversation to constitute a contract then a contract was formed, because Embry’s interpretation of the conversation was reasonable and McKittrick’s was not: In Smith v. Hughes, L.R. 6 Q.B. 597, 607, it was said: “If, whatever a man’s real intention may be, he so conducts himself that a reasonable man would believe that he was assenting to the terms proposed by the other party, and that other party upon that belief enters into the contract with him, the man thus conducting himself would be equally bound as if he had intended to agree to the other party’s terms.” . . . In view of [the] authorities, we hold that, though . . . McKittrick may not have intended to employ Embry by what transpired between them according to the latter’s testimony, yet if what McKittrick said would have been taken by a reasonable man to be an employment, and Embry so understood it, it constituted a valid contract of employment for the ensuing year. . . . [W]‌e rule that if the conversation was according to [Embry’s] version, and he understood he was employed, it constituted in law a valid contract of re-​employment. . . .7

Embry v. McKittrick brings out another issue in contractual interpretation. In choosing between contested meanings, courts often treat interpretation like an on-​off switch, under which one possible meaning is reasonable and all others are unreasonable. In real life, however, interpretation is often like a rheostat, because several interpretations of an expression may be reasonable, although some are better than others and one is best of all. In such cases the issue under Principle I is not which interpretation is reasonable but which interpretation is more or most reasonable, that is, best. A nice illustration is provided by Lawson v.  Martin Timber Co.8 Lawson owned timber-​ bearing land. On October 14, 1948, he entered into a contract with Martin Timber Co. under which Martin had two years to cut and remove as much timber from Lawson’s land as Martin wanted (the basic period). However, in the event of high water during the basic period, Martin was to get a one-​year extension of the right to cut and remove Lawson’s timber (the extension period). As it turned out there was high water on Lawson’s land during half of the basic period but Martin could easily have cut and removed the remaining timber during the other half. Instead, Martin cut and removed timber from Lawson’s land after the basic period had expired but within the extension period. Lawson sued to recover the value of that timber on the ground that under the circumstances the extension period was inapplicable. In its initial opinion the Louisiana court held that the extension period was applicable because there had been high water on Lawson’s land during the basic period. Justice Simon dissented on the ground that: . . . [T]‌he words in the clause standing alone are meaningless. But when taken in context with the preceding language of the contract wherein it is stated that the defendant is given two years in which to cut and remove all of said timber, this clause can have but one objective meaning. . . . It is manifest that, taking the clause as written with the language preceding, it can only mean that if there existed any overflow or high water during the period of two years which would have

7.  Id. at 779 (emphasis added). 8.  115 So.2d 821 (La. 1959).

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prevented the cutting and removal of this timber within the stated primary term, then the defendant enjoyed the right of so doing during the period of one additional year. . . . 9

On rehearing, the court adopted Justice Simon’s position.10 The meaning the court attached to the contract on rehearing may well have been better—​ may well have been more reasonable—​than the meaning the court attached in its initial opinion. However, Justice Simon’s statement that the expression used by the parties could “have but one objective meaning” is belied by both the ambiguous language of the expression and the fact that most of the judges of a state supreme court originally interpreted the expression in exactly the opposite way. There was not one and only one reasonable meaning of the contract; there was a more and a less reasonable meaning. The more reasonable meaning should prevail, but not because it was the only reasonable meaning. Principle II. If in a contractual context the parties subjectively attached the same meaning to an expression that meaning should prevail even though it is less reasonable than other possible meanings. Principle II is adopted in Restatement Second Section 201(1):  “[W]‌here the parties have attached the same meaning to a promise or agreement or a term thereof, it is interpreted in accordance with that meaning.” Under Section 201(1), objective interpretation comes into play only where a mutual subjective interpretation is lacking. As stated in the Comment to Restatement Second, “the primary search [for meaning] is for a common meaning of the parties, not a meaning imposed on them by the law. . . . The objective of interpretation in the general law of contracts is to carry out the understanding of the parties rather than to impose obligations on them contrary to their understanding: ‘the courts do not make a contract for the parties.’ ”11 Accordingly, Principle II and Restatement Second stand the classical school’s position on its head by giving primacy to a mutually held subjective meaning and resorting to an objective or reasonable meaning only in the absence of a mutually held subjective meaning. As the court put it in Berke Moore Co. v Phoenix Bridge Co.12: The rule which precludes the use of the understanding of one party alone is designed to prevent imposition of his private understanding upon the other party to a bilateral transaction. . . . But when it appears that the understanding of one is the understanding of both, no violation of the rule results from determination of the mutual understanding according to that of one alone. Where the understanding is mutual, it ceases to be the “private” understanding of one party. Having thus determined the mutual understanding of the parties, the Court properly interpreted the contract accordingly. . . .

Principle II is exemplified by the following paradigm: Paradigm 2.  A and B jointly agree on Term U as part of a contract between them. Under the circumstances, the most reasonable meaning of Term U is Alpha, but both A and B subjectively 9.  Id. at 824 (Simon, J., dissenting). 10.  See id. at 826–​28. 11.  Restatement (Second) of Contracts § 201 (Am. Law Inst. 1981)  [hereinafter Restatement Second]. 12.  98 A.2d 150 (N.H. 1953).

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Interpretation in Contract Law attach meaning Beta to the term. Later, there is a controversy between A and B concerning the meaning of their contract. A claims that the most reasonable meaning, Alpha, should prevail. B claims that the shared meaning, Beta, should prevail.

Under Principle II A is wrong: the shared meaning, Beta, should prevail. Principle II is largely based on the basic aim of contract law, which is to effectuate the contracting parties’ objectives. In Paradigm 2 the parties’ objective concerning Term U is meaning Beta. Classical contract law would nevertheless attach meaning Alpha to Term U. Recall, for example, Williston’s assertion that “it is even conceivable that a contract shall be formed which is in accordance with the intention of neither party. If a written contract is entered into [and is unambiguous, the court] will not even admit evidence of what the parties may have thought the meaning to be.”13 This is a perversion of both the aim of contract law and the aim of contract interpretation. Principle II may seem inconsistent with the concept of fault, because if both parties have the same unreasonable meaning, both were at fault in their use of language. However, the fault caused no injury. Indeed, a party would be at fault if he pressed an interpretation that he himself did not attach to the expression. For example, in Paradigm 2 where B, like A, attached meaning Beta to Term U, B is at fault for later trying to force meaning Alpha down A’s throat. Nor does applying a mutually held subjective interpretation undermine the security of transactions, because a party will prevail under Principle II only if he can shoulder the difficult burden of proving not only his state of mind but that of the other party. In any event, the security of legitimate expectations is equally or more important than the security of transactions per se. In cases covered by Principle II, B’s legitimate expectation would be defeated if a strictly objectivist view were applied. Having said all this, it must be recognized that although in theory Principle II trumps Principle I, in practice Principle I is the workhorse of interpretation. Here is the reason: A party, A, can prevail under Principle II only if he shows in court that both he and the other party, B, attached the same meaning to the relevant expression. Normally, however, a case comes to court precisely because one party, B, denies that he attached the same meaning to the expression as the other, A. Despite this denial, A may be able to prove that B subjectively attached the same meaning as A. For example, B may have told someone that she attached that meaning14 or B’s denial may be implausible. Nevertheless, because it is difficult to prove the subjective intentions of others, A is much more likely to prevail by showing that the meaning he attached was more reasonable than the meaning B attached than by showing that he and B attached the same meaning and B is now lying. Principle III. If, in a contractual context the parties subjectively attached different meanings to an expression, the two meanings were equally reasonable, and neither party knew that the other attached a different meaning, neither meaning prevails. Principle III is adopted in Restatement Second Section 20(1):  “There is no manifestation of mutual assent to an exchange if the parties attach materially different meanings to their manifestations and . . . neither party knows or has reason to know the meaning attached by the other. . . .” 13.  Williston, supra note 6, at 181–​82. 14.  See, e.g., MCC-​Marble Ceramic Ctr., Inc. v. Ceramica Nuova d’Agostino, S.p.A, 144 F.3d 1384 (11th Cir. 1998).

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Principle III is embodied in a line of cases beginning with Raffles v. Wichelhaus, the famous Peerless case.15 Seller agreed to sell to Buyer 125 bales of Surat cotton to arrive at Liverpool “ex [ship] ‘Peerless’ from Bombay.”16 However, there were two ships named Peerless that sailed from Bombay: one sailed in October and one in December. Seller meant the December Peerless and shipped Surat cotton to Buyer on that ship. Buyer meant the October Peerless and refused to accept the cotton shipped on the December Peerless.17 Seller sued for breach of contract. The court held for Buyer on the ground that no contract had been formed.18 There are a number of cases like Peerless. For example, in Oswald v. Allen,19 Oswald, a coin collector, was interested in purchasing Swiss coins from Mrs. Allen. Dr.  Oswald went to the Newburgh Savings Bank, where two of Mrs. Allen’s coin collections were located: a Swiss Coin Collection and a Rarity Coin Collection. The Rarity collection contained several valuable Swiss coins. Dr. Oswald was shown both collections and took notes on each. On returning from the bank, Dr.  Oswald and Mrs. Allen agreed to a price of $50,000 for Mrs. Allen’s collection of Swiss coins. However, Dr. Oswald thought he was buying all of Mrs. Allen’s Swiss coins, while Mrs. Allen thought she was selling only the Swiss Coin Collection and not the Swiss coins in the Rarity Coin Collection. The evidence showed that each collection had its own key number and was housed in a labeled cigar box. Dr.  Oswald, however, testified that he did not know that some of the Swiss coins he examined were in a separate collection. Held, no contract was formed. “Even though the mental assent of the parties is not requisite for the formation of a contract . . . the facts . . . clearly place this case within the small group of exceptional cases in which there is ‘no sensible basis for choosing between conflicting understandings.’ . . . The rule of Raffles v. Wichelhaus is applicable here.”20 Principle III is exemplified by the following paradigm: Paradigm 3. A and B enter into a bargain that includes Term V. A subjectively attaches meaning Alpha to Term V, while B subjectively attaches meaning Beta. Under the circumstances, Alpha and Beta are equally reasonable meanings. A does not know that B attaches the meaning Beta to Term V and B does not know that A attaches the meaning Alpha.

In cases such as Paradigm 3 each party mistakenly believes that a relevant expression is unambiguous, so that the meaning he attaches to the expression is the only meaning that could reasonably be attached. In fact, however, the expression is ambiguous, not unambiguous, and the meanings attached by each party are equally reasonable. Since both parties are equally at fault—​or, rarely, neither is at fault—​in believing that the relevant expression is unambiguous, neither party’s meaning should prevail. Principle III is partly objective, since it applies only if the relevant expression is objectively ambiguous. However, the heart of Principle III is subjective: if

15.  (1864) 159 Eng. Rep. 375; 2 H. & C. 906. 16.  Id. 17.  The facts are as stated in Buyer’s answer, to which Seller demurred. Id. 18.  Id. at 376; 2 H. & C. at 907–​08. See also Frigaliment Imp. Co. v. B.N.S. Int’l Sales Co., 190 F. Supp. 116 (S.D.N.Y. 1960) (Friendly, J.), re-​rationalized, Dadourian Exp. Co. v. United States, 291 F.2d 178, 187 n. 4 (2d Cir. 1961) (dissenting opinion) (Friendly, J.). 19.  417 F.2d 43 (2d Cir. 1969). 20.  Id. at 45.

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both parties attached the same meaning, that meaning should prevail. So, for example, if both parties in Peerless had the October Peerless in mind their contract should be interpreted to require Seller to deliver the cotton on that ship. Why not? In The Common Law Holmes argued that the result in Peerless was explained by objective theory. “The true ground of the decision was not that each party meant a different thing from the other,” he said, but that each said a different thing. “The plaintiff offered one thing, the defendant expressed his assent to another.”21 But if both parties subjectively meant the December Peerless Buyer should have been held to be in breach, and if both parties subjectively meant the October Peerless Seller should have been held in breach. Holmes had it backward: the result in Peerless is correct not because the parties said different things but because they meant different things. And although Principle III is largely subjective it does not undermine the security of transactions, because its application rests on the existence of two meanings of an expression that are equally reasonable, a condition that is objective. This leaves the question of liability. The traditional rule, established in Peerless, is that no contract is formed in cases that fall within Principle III, and therefore neither party is liable to the other. However, the no-​liability conclusion does not follow from the no-​contract premise. Contract is a ground of liability, but it is not the only ground. The real issue is not whether a contract is formed but whether liability should be imposed on a party. In cases that fall within Principle III, characteristically both parties are at fault, and equally at fault, in believing that the expression they used was unambiguous. This characteristic is illustrated by the Peerless case itself. Both parties thought that the term Peerless was unambiguous; both were at fault in so thinking. A.W. Brian Simpson has shown that at the time of the case, ships commonly shared the same name, and there were reports of at least eleven ships called Peerless.22 Ships bearing the same name could be differentiated by using their registration numbers or, more commonly, the names of their captains,23 but it was not alleged that the parties in Peerless used either device. On these facts the buyer and the seller in Peerless were equally at fault in assuming that the term Peerless was unambiguous. Where both parties are at fault and equally at fault, the parties should pool their out-​of-​pocket expenses and then share them equally. The question of liability is more difficult where neither party is at fault, but the outcome should be the same. As Dan Dobbs says, “[I]‌f equally innocent parties have set out to sail the same boat, to require them to share the chore of bailing water when it begins to sink is not necessarily all bad.”24 Principle IV. If, in a contractual context, the parties, A and B, attached different meanings, Alpha and Beta, to an expression, and A knew that B attached meaning Beta, while B did not know that A  attached meaning Alpha, meaning Beta should prevail even if it is less reasonable than meaning Alpha. Principle IV is adopted in Restatement Second Section 201 (2)(a): “Where the parties have attached different meanings to a promise or agreement or a term thereof, it is interpreted

21.  Oliver W. Holmes, The Common Law 309 (1881). 22.  A.W. Brian Simpson, Contracts for Cotton to Arrive: The Case of the Two Ships Peerless, 11 Cardozo L. Rev. 287, 295 (1989). 23.  Id. 24. 2 Dan B. Dobbs, Law of Remedies 742 (2d ed. 1993); see also Melvin Aron Eisenberg, The Responsive Model of Contract Law, 36 Stan. L. Rev. 1107, 1124 (1984) (making a comparable analysis).

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in accordance with the meaning attached by one of them if at the time the agreement was made . . . that party did not know of any different meaning attached by the other, and the other knew the meaning attached by the first party. . . .” Principle IV is exemplified by the following paradigm: Paradigm 4. A and B enter into a contract that includes Term W. A subjectively attaches meaning Alpha to Term W while B subjectively attaches meaning Beta. Under the circumstances Beta is a more reasonable meaning than Alpha. However, B knows that A attaches meaning Alpha to Term W whereas A does not know that B attaches the meaning Beta.

Under Principle IV, meaning Alpha should prevail. Although Principle IV allows a less reasonable meaning to prevail over a more reasonable meaning, the principle is supported by a fault analysis: in cases that fall under Principle IV B is attempting to unfairly exploit A’s ignorance. As Judge Posner stated in a different but related context, “[to] take deliberate advantage of an oversight by your contract partner concerning his rights under the contract . . . is not the exploitation of superior knowledge . . .; it is sharp dealing. Like theft, it has no social product.”25 It is true that in Paradigm 4 A was at fault in attaching meaning Alpha to Term W.  However, B was not injured by A’s fault, because B knew of A’s mistake before purporting to conclude the contract. Furthermore, B too was at fault, by knowingly allowing A to proceed on the basis of his mistaken interpretation, and on a moral scale B’s fault exceeded that of A. Finally, Principle IV does not undermine the security of transactions because A will prevail only if he can shoulder the difficult burden of proving B’s state of mind. It might be argued that the law should permit a party like B to knowingly take advantage of A’s mistake because doing so would promote efficiency by giving actors an incentive to improve their interpretive skills. Even if this argument had some weight, which is questionable, the likely efficiency gain would be too slight to outweigh the exploitive character of B’s conduct in such cases. In any event, the argument is not convincing. Actors who engage in contracting already have great incentives to do their best in interpreting the contractual expressions they employ, partly because of the costs of litigation if the interpretation turns out to be problematic and partly because if the case does not fall within Principle IV, under Principle I a more reasonable interpretation will trump an interpretation that is less reasonable. As stated in S.T.S. Transport Service, Inc. v. Volvo White Truck Corp., in a different but related context, “No incentives exist to make such mistakes; all the existing incentives work, in fact, in the opposite direction.”26 Therefore, it is highly unlikely that attaching the meaning of parties like B in cases that fall within Principle IV would lead actors to learn to interpret better. Finally, the rule that A’s interpretation will prevail where B knows the meaning that A attaches and A does not know the meaning that B attaches has favorable information-​forcing qualities. As Howard Loo has stated: Because B cannot take advantage of A’s interpretive mistake if B is aware of the mistake, A has an incentive to communicate information to B regarding any interpretations that A makes that are not straightforward. For example, A has an incentive to tell B, “This Expression, F, is unclear.

25.  Mkt. St. Assocs. v. Frey, 941 F.2d 588, 594 (7th Cir. 1991). 26.  766 F.2d 1089, 1093 (7th Cir. 1985).

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Interpretation in Contract Law I wanted to let you know that I’m assigning the meaning Alpha to it.” A has an incentive to do this because, by letting B know, Alpha will attach if B does not clarify. In this way, the rule is information forcing. So, even if actors already use their best interpretive skills, the rule (allowing Alpha to attach if B knows that A attaches Alpha, even though Alpha is less reasonable than Beta) nevertheless encourages clarifications prior to formation.27

The information-​forcing quality also gives B an incentive to communicate that she attaches the meaning Beta to the relevant expression, because if she does so a court will give the expression that meaning, since by hypothesis it is the more reasonable meaning.

27.  Comments by Howard Tony Loo (Feb. 19, 2002; email on file with author).

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Expression Rules I .   B A C K G R O U N D CONS I DER AT I ONS Many types of expressions that are employed in a contractual context are addressed by one party to another rather than jointly agreed upon. Such expressions are most notably found in the offer-​and-​acceptance area:  examples include offers, counteroffers, and revocations. Often the meaning of such an expression is determined under special rules of interpretation that are applicable to a given type of expression, rather than under the general principles of interpretation. In this book such rules will be referred to as expression rules. This chapter considers expression rules as a class. Subsequent chapters will consider specific expression rules. Since most expression rules concern the offer-​and-​acceptance process this chapter forms a bridge between Chapter 28, on the general principles of interpretation, and Chapters 31 and 32, on offer and acceptance. Since expression rules differ from the general principles of interpretation, the use of expression rules is in need of justification. If the general principles of interpretation are unsound they should be revised. If those principles are sound, however, then they reflect a considered judgment concerning the manner in which to best interpret contractual expressions, and an expression rule that displaces those principles needs a strong justification. Of course, if the meaning attributed to an expression by an expression rule is identical to the meaning that would be attributed under the general principles of interpretation, no difficulty is presented. Often, however, the application of an expression rule will produce a different result than the application of the general principles of interpretation. Accordingly, the application of an expression rule is likely to involve a certain rate of error as compared to a perfect application of the general principles of interpretation. Given this rate of error, what would justify the adoption of an expression rule? The problem of justifying specific rules that apply to conduct that would otherwise be governed by a general principle is not unique to law. For example, the general utilitarian principle is that in any given situation one should act in the manner that maximizes social welfare. However, utilitarians often agree that certain types of conduct should be governed by special moral rules. Utilitarians then face the problem of why this is so. John Rawls’s analysis of this issue provides a useful starting point for investigating the parallel problem in interpretation.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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In his essay “Two Concepts of Rules”1 Rawls develops three types of specific rules of conduct. He calls the first type rules of thumb. Rules of thumb are nonbinding summaries of past decisions.2 Take, for example, a rule of thumb that covers the way an actor should conduct himself in Situation S. Before the rule is developed, under utilitarian theory every actor should decide how to conduct himself in Situation S by applying the general utilitarian principle. However, if over time application of the general utilitarian principle to a recurring specific type of situation leads to the same decision by many different persons, a rule of thumb is formulated: In Situation S, a guide to conduct, based on past experience, is as follows. . . . If knowledge was complete and rationality was perfect, rules of thumb would serve no purpose, because every individual could directly, smoothly, and correctly apply the general utilitarian principle to every situation. However, in the real world, which is marked by incomplete knowledge and imperfect rationality, actors often use rules of thumb as guides that have been tested by experience. Nevertheless, every actor is morally entitled either to reconsider the correctness of a rule of thumb or to question whether it is proper to follow the rule in a particular case. Rawls calls a second type of specific moral rules general rules: One is pictured as estimating on what percentage of the cases likely to arise a given rule may be relied upon to express the correct decision, that is, the decision that would be arrived at if one were to correctly apply the utilitarian principle case by case. If one estimates that by and large the rule will give the correct decision, or if one estimates that the likelihood of making a mistake by applying the utilitarian principle directly on one’s own is greater than the likelihood of making a mistake by following the rule, and if these considerations held of persons generally, then one would be justified in urging its adoption as a general rule.3

In contrast to rules of thumb, Rawls’s general rules have a real although not definitive bite. On the one hand, they are not merely guides to action but instead normally should be followed. On the other hand, a general rule may give way to a direct application of the general utilitarian principle “in extraordinary cases where there is no assurance that the generalization will hold and the case must therefore be treated on its merits. Thus there goes with this conception the notion of a particular exception which renders a [general] rule suspect on a particular occasion.”4 This feature apparently explains why Rawls calls these rules general rules—​they need to be followed generally, but not invariably. A third class of specific moral rules identified by Rawls consists of rules that define and constitute a practice, that is, a social institution that is defined and constituted by rules.5 In this book rules that constitute practices will be referred to as constitutive rules. Practices are constituted for various reasons. One important reason is that many areas of life require coordination among actors. Coordination ordinarily cannot be achieved simply by each actor’s trying to foresee how

1.  John Rawls, Two Concepts of Rules, 64 Phil. Rev. 3 (1955). Except as otherwise indicated the passages in text accompanying notes 2–​10, infra, paraphrase or follow that essay. 2.  Id. at 23. 3.  Id. 4.  Id. at 24. 5.  Id.

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other actors will conduct themselves. Therefore, a practice is adopted, which allows those who engage in the practice to coordinate their actions. Unlike rules of thumb and general rules, constitutive rules are logically prior to particular cases that fall under the rules, because “there cannot be a particular case of an action falling under a rule of a practice unless there is the practice.”6 One may illustrate this point from the game of baseball. Many of the actions one performs in a game of baseball one can do by oneself or with others whether there is the game or not. For example, one can throw a ball, run, or swing a peculiarly shaped piece of wood. But one cannot steal a base, or strike out, or draw a walk, or make an error, or balk; although one can do certain things which appear to resemble these actions such as sliding into a bag, missing a grounder and so on. Striking out, stealing a base, balking, etc., are all actions which can only happen in a game. No matter what a person did, what he did would not be described as stealing a base or striking out or drawing a walk unless he could also be described as playing baseball, and for him to be doing this presupposes the rule-​like practice which constitutes the game.7

Constitutive rules differ from rules of thumb and general rules in another important respect. Once constitutive rules are adopted they are definitive; action under such rules is never a proper subject for application of the general utilitarian principle. Rather, it is essential to a practice that the rules that constitute the practice must always be followed: If one wants to do an action which a certain practice specifies then there is no way to do it except to follow the rules which define it. Therefore, it doesn’t make sense for a person to raise the question whether or not a rule of a practice correctly applies to his case. . . . If someone were to raise such a question, he would simply show that he didn’t understand the situation in which he was acting.8 This point is illustrated by the behavior expected of a player in games. If one wants to play a game, one doesn’t treat the rules of the game as guides as to what is best in particular cases. In a game of baseball if a batter were to ask, “Can I have four strikes?” it would be assumed that he was asking what the rule was; and if, when told what the rule was, he were to say that he meant that on this occasion he thought it would be best on the whole for him to have four strikes rather than three, this would be most kindly taken as a joke. One might contend that baseball would be a better game if four strikes were allowed instead of three; but . . . [the rules of baseball cannot be pictured] as guides to what is best on the whole in particular cases. . . .9

Legal rules take a variety of forms that do not fall within Rawls’s three categories. Indeed, Rawls states that his analysis is not intended to be comprehensive: “there are further distinctions that can be made in classifying rules, [and] which should be made if one were considering other questions.”10 Nevertheless, Rawls’s analysis is useful in considering expression rules because it is suggestive as to both taxonomy and justification. 6.  Id. at 25. 7.  Id. 8.  Id. at 26. 9.  Id. 10.  Id. at 29.

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II.   TH E F O R MS O F   E X PR ES S I ON  R UL ES With this background we can turn to the forms of expression rules in contract law. One form of expression rule is a maxim. A maxim is a legal standard that sums experience and guides decisions but does not compel a specific meaning to be given to a specific type of expression. Maxims are the legal equivalent of Rawls’s rule of thumb. Like Rawls’s rules of thumb a maxim conveys the accumulated wisdom concerning the meaning of an expression while leaving the court free to find that the accumulated wisdom is not a good guide in any given case. A maxim therefore makes dispute settlement at least somewhat more expeditious while posing only a minimal threat to the protection of fair expectations as reflected in the general principles of interpretation. Another form of expression rule is a presumption. When an expression rule takes the form of a presumption a given type of expression is interpreted to have a certain meaning unless the party who is adversely affected by that meaning meets the burden of proving, by a preponderance of the evidence, that under the circumstances the expression should be given a different meaning. Alternatively, an adversely affected party may be required to establish a different meaning by more than a preponderance of the evidence—​for example, by clear and convincing evidence. In either case, presumptions represent a compromise between employing the general principles of interpretation and formulating an expression rule. A presumption allows the courts to apply the general principles of interpretation in any given case by determining that the presumption has been overcome, but nevertheless makes the resolution of disputes somewhat easier than do the general principles of interpretation alone. The desirability of a presumption therefore depends on whether the presumption is a useful accommodation between a case-​by-​case application of the general principles and an expression rule because the presumption has some of the benefits of each approach, or is an undesirable accommodation because the presumption has some of the costs of each approach. Unfortunately, the courts and the commentators have seldom analyzed expression rules in these prudential terms. An expression rule may also take the form of a categorical rule. When an expression rule takes this form, a certain type of expression is always given a certain meaning. Categorical rules are similar to, but different from, Rawls’s general rules. Like Rawls’s general rules a categorical rule has a wide sweep. Unlike Rawls’s general rules, however, a categorical rule cannot be departed from unless the court modifies or overthrows the rule.

I I I .   T H E JU S T I F I CAT I ONS O F   E X P R E S S I ON  R UL ES The extent of justification that an expression rule requires depends in significant part on the form of the rule. A maxim needs relatively little justification, because it is only a nonbinding guide and therefore will not introduce error if properly utilized. A presumption needs more justification, because unless overcome it is outcome-​determinative. A categorical rule needs particularly strong justification. The strongest justification of an expression rule is that results under the rule are completely congruent with results under general principles of interpretation. In such cases the expression

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rule is simply a shorthand, easy-​to-​apply version of the general principles. Suppose, however, that the results under an expression rule are significantly but not completely congruent with the results under the general principles of interpretation. For example, suppose that Expression Rule R assigns meaning m to Type E expressions, and that if the general principles of interpretation were perfectly applied to Type E expressions on a case-​by-​case basis those expressions would usually but not always be determined to mean m. Adoption of Expression Rule R would then involve a certain rate of error as compared with perfect application of the general principles of interpretation. Given that rate of error some justification other than a complete congruence of results under the expression rule and the general principles of interpretation is required. Rawls’s justification for rules of thumb and general rules provides one possible justification. Error may result from the application of an expression rule, but error may also result from application of the general principles of interpretation, because those principles may not be perfectly applied in every case, and it may be more difficult to apply general principles than special rules. Adoption of an expression rule would then be justified on the ground that it reduces the rate of error.11 Call this the accuracy justification. Another possible justification of an expression rule is that because such a rule is much more specific than the general principles of interpretation it will be easier to administer. Call this the administrative justification. This justification has limited force, because disputes must be settled not only easily but properly. Accordingly, an expression rule can appropriately be justified on administrative grounds only if it produces results that are substantially even though not perfectly congruent with the results that would be produced by the general principles of interpretation. Consider, for example, the problem of determining the duration of an offer that states no time for acceptance. Under the general principles of interpretation such an offer is open for a reasonable time, and what is a reasonable time depends on the circumstances of the individual case. The law might alternatively adopt an expression rule that such an offer lapses after ten days. That rule would be extremely easy to administer, but it would be undesirable because in most cases it would not be the best interpretation of the offer. Still another possible justification of an expression rule is that the rule is supported by a noninterpretive policy. Call this the policy justification. For example, if a contract states no duration, the general rule is that the contract will be deemed to extend for a reasonable time. In contrast, if an employment contract fails to state or clearly imply a duration either party normally may terminate the contract at will.12 One justification of this rule has been that as a matter of policy an employee should not be forced to continue an employment relationship, and for reasons of mutuality if an employee is not bound to continue a relationship neither should an employer be bound.13 This justification is very weak, and in general a policy justification of an expression rule should be given only limited weight unless the policy is very strong, because any noninterpretive justification of an expression rule will conflict with the objective of effectuating the intent of the contracting parties, since by hypothesis the expression rule does not rest on that objective.

11.  Id. at 23–​24. 12.  See, e.g., Clyde W. Summers, Individual Protection against Unjust Dismissal: Time for a Statute, 62 Va. L. Rev. 481, 484–​85 (1976). 13.  See, e.g., Pitcher v. United Oil & Gas Syndicate, Inc., 139 So. 760, 761 (La. 1932).

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Another possible justification of an expression rule is that the rule is constitutive of the contracting process. That approach, however, will not justify an expression rule. Although an act under a constitutive rule can be justified by reference to the rule, any given constitutive rule can be justified only on the ground that it is normatively desirable. Furthermore, the rules of contract law are seldom if ever constitutive rules, because promising and contracting are social acts that are supported and governed by law, not practices that are constituted by law. For example, the rules of consideration are not constitutive of the social act of promising, and the legal principles that govern the interpretation of expressions are not constitutive of the social act of interpreting expressions. You cannot steal a base unless you play baseball, but you can conclude a bargain even if the law will not enforce it, and you can interpret an agreement even if contract law included no principles of interpretation. Moreover, unlike constitutive rules, contract-​law rules can be changed retroactively. A ballplayer who has just taken a third strike cannot meaningfully say to the umpire that he should be allowed a fourth strike on the ground that all things considered requiring four strikes would make a better game than requiring three strikes.14 In contrast, an offeree against whom an expression rule is invoked in court may meaningfully respond that all things considered, the rule is unjustified and should no longer be followed.15 Although expression rules are not constitutive rules they might be justified on the ground that they facilitate coordination in the same way as rules of the road, and that the point of rules of the road is that they exist, not that they are right. The force of that argument depends in part on the extent to which actors can reasonably be expected to know the relevant rules, because unknown rules will not facilitate coordination. Traffic lights facilitate coordination because and only because everyone knows the meaning of red and green. Similarly, players in a game normally know most rules of the game; if they do not, they cannot play the game in any meaningful sense. In contrast, contracting actors can contract if they know the social rules of contracting even if their knowledge of the law is scant. The evidence strongly suggests that private actors often do just that: countless cases involve parties who apparently did not know contract law. For example, promises are often deemed unenforceable on the ground that while the promisor made a real promise the promisee made only an illusory promise. If actors knew the law such results could easily be avoided by making a slight change in the expression that is deemed to be an illusory promise. Similarly, most oral promises that are unenforceable under the Statute of Frauds could easily have been made enforceable, if actors knew the law, by putting the promise in a writing or other record. The fact that lawyers must attend graduate school for three years, then serve a de facto apprenticeship of several more years, and thereafter take continuing-​legal-​education courses, is evidence that knowing the law takes a whole lot of work. Because private actors normally cannot be taken to know contract law, if by virtue of expression rules the expressions of such actors were given a meaning that differed in a significant number of cases from the meaning that would result from the application of the general principles of interpretation, the result would be to frustrate, not coordinate, legitimate expectations. Furthermore, even if private actors did know contract law, if the meaning that an expression rule assigned to a given type of expression diverged in a significant number of cases from the

14.  See Rawls, supra note 1, at 26. 15.  See infra text on counteroffers in Chapter 33 Section G.

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meaning of the expression under the general principles of interpretation private actors would have to incur transaction costs to maneuver around the rule. Accordingly, a coordination justification of an expression rule is normally supportable only if there is a high degree of congruence between the result under the expression rule and the result under the general principles of interpretation. Given the various possible justifications of expression rules, both the desirability of any given expression rule and the form that such a rule should take depend on prudential judgments concerning the degree of congruence between the results under the general principles of interpretation and under the expression rule, the comparative rate of error entailed by application of the general principles of interpretation and the expression rule, and the strength of a noninterpretive policy that is thought to support the expression rule. Normally, an expression rule will be justified only if it is highly congruent with the general principles of interpretation. In the absence of such congruence administrative considerations are unlikely to support the rule, coordination is more likely to be frustrated than promoted, and noninterpretive policies are unlikely to outweigh the goal of facilitating the power of capable and informed parties to further their objectives through contracting. Where, as often occurs, an expression rule is justified, but only weakly, it should be put in the form of a maxim.

I V.   C O N CL US I ON Some expression rules in contract law can be justified on prudential grounds; others cannot. The latter rules appear to be survivals of classical contract law and owe their continued existence to the time required for the principles of modern contract law to work their way through the legal system. However, even the most soundly based expression rules, such as the rule that a rejection terminates a power of acceptance, reflect prudential choices, not axiomatic truths. Unfortunately, most expression rules have not come under searching analysis. Moreover, little if any attention has been directed to the question whether, if an expression rule is desirable, it should take the form of a maxim, a categorical rule, or a presumption, and, if the last, of what type and how strong the presumption should be. As a first step, therefore, it is necessary to recognize expression rules as a legal category—​ that is, to recognize that many rules of contract law fly under the flag of interpretation but in fact supplant the general principles of interpretation. Next, it must be recognized that a number of expression rules often yield results that are different from the results that would be reached under the general principles of interpretation. Once the air is cleared in this way, the justification of any expression rule that is not completely congruent with the general principles of interpretation should be examined to determine if it outweighs the rate of error that results from the rule. If the justification is insufficient the rule should be dropped. Even if the justification is sufficient the form of the rule should be examined. Generally speaking, only an exceptionally high degree of congruence will justify a categorical expression rule. For the most part, therefore, expression rules that are justified should be cast as either weak presumptions or maxims. If we look past the black-​letter rules to the case law, that is just the direction in which contract law is moving.

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offer and acceptance. Indeed, classical contract law placed the offer-​and-​acceptance sequence on center stage. Under the teachings of that school a contract was virtually identical to a bargain, and a bargain was formed by an offer and an acceptance. A.W.B. Simpson has shown that the central role that classical contract law gave to the offer-​and-​acceptance sequence was in fact only a nineteenth-​century development.1 Modern contract law, like pre-​nineteenth-​ century contract law, recognizes that contract is not coextensive with bargain, and that even in a bargain context contractual liability can attach without an offer-​and-​acceptance sequence. Nevertheless, that process is extremely significant. The instant an offer is accepted a contract is formed, and the instant a contract is formed each party becomes liable for expectation damages if she fails to perform the contract, even if she changes her mind only a nanosecond after the contract is formed. Because the acceptance of an offer has such potent consequences much can ride on the web of rules that govern offer and acceptance. At the center of this web is the rule that an offer creates a power of acceptance—​that is, a power in the offeree to conclude a bargain, and therefore a contract, by assenting to the offer. Other rules in this web concern the nature of an offer, how various kinds of offers can be accepted, and how an offeree’s power of acceptance can be terminated. This chapter will consider the nature of an offer. The latter two topics will be considered in Chapters 32 and 33.

1.  A.W.B. Simpson, Innovation in Nineteenth Century Contract Law, 91 L.Q. Rev. 247, 258 (1975). Simpson adds, “The new doctrine of offer and acceptance reached its most flamboyant statement in Sir Walter Anson’s Principles of the English Law of Contract. . . . To Anson the doctrine reached the status of an analytical universal truth about life.” Thus Anson stated: Every expression of a common intention arrived at by two parties is ultimately reducible to question and answer. In speculative matters this would take the form: “Do you think so and so?” “I do.” In practical matters and for the purpose of creating obligations it may be represent[ed] as, “Will you do so and so?” “I will.”

Id.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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I .   T H E P R O M I S SORY NAT UR E O F   A N   O F F ER There are various ways to define an offer. Preliminarily, an offer may be defined as a proposal by an addressor to make a bargain that gives the addressee the power to conclude the bargain by assenting to the proposal.2 The explanation of why an offer should create this power begins with the promissory nature of an offer. An offer is a promise to enter into and perform a bargain if a given condition, acceptance, occurs. For example, suppose that A says to B, “I will sell you my 2014 Camry for $20,000.” Here A has promised B that if B accepts A’s offer A will transfer her Camry to B in exchange for $20,000. Some scholars reject the proposition that an offer is a promise. Peter Tiersma, for example, contends that an offer is not a promise because a promise is a commitment and an offer is not:3 A promise is a speech act by which the speaker places herself under an obligation to carry out a particular future course of action. . . . [A]‌promise commits the speaker when made. As soon as I promise a friend to go hiking tomorrow by saying “I promise to go hiking with you tomorrow,” I am under an obligation to do so. I cannot change my mind later without breaking my promise. . . . A promise can, of course, be conditional. If so, the promisor does not need to perform until the condition occurs. Nonetheless, he is obliged at the time he makes the promise to perform the promised act if and when the condition has been fulfilled. Suppose, for instance, that I promise my friend to go hiking tomorrow if it is a nice day. I am under an obligation today to go hiking if the condition is met tomorrow. Surely I cannot renege before the condition has been fulfilled without breaking my promise. Even if the condition does not occur, I have promised. If it rains tomorrow, I cannot say that we are not going hiking because I never promised anything. Rather, I must say that although I promised to go hiking, it was subject to the condition that it had to be a nice day. Because it rained, my duty to carry out the promised act never matured. . . . . . . . In contrast, [in the case of an offer,] there is a condition to the commitment itself, that is, a condition that determines whether or not a person becomes committed in the first place. I refer to this as conditional commitment. Conditional commitment is one of the critical features that distinguishes an offer from a promise. The obligation created by an offer is inherently subject to acceptance. . . . Until an offer is accepted, the proposal binds no one and can be withdrawn unilaterally. On the other hand, the commitment of a promise, by its very nature, cannot be conditional.4

2.  Cf. Restatement (Second) of Contracts § 24 (Am. Law Inst. 1981)  [hereinafter Restatement Second]. An offer is a “manifestation of willingness to enter into a bargain, so made as to justify [the addressee] in understanding that his assent to the bargain is invited and will conclude it.” 3.  Peter Meijes Tiersma, Reassessing Unilateral Contracts: The Role of Offer, Acceptance and Promise, 26 U.C. Davis L. Rev. 1 (1992). 4.  Id. at 20–​23; see also John P. Dawson, Gifts and Promises:  Continental and American Law Compared 211–​13 (1980); Margaret N. Kniffin, Innovation or Aberration:  Recovery for Reliance on a Contract Offer, as Permitted by the New Restatement (Second) of Contracts, 62 U. Det. L. Rev. 23, 26 (1984).

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This position conflicts with conventional legal usage. As stated in the Comment to Restatement Second Section 24, in the normal case an “offer itself is a promise.”5 Similarly, contracts are conventionally classified as either bilateral or unilateral. A  bilateral contract is defined as a bargain formed by an exchange of promises. One of these promises consists of an offer. A unilateral contract is defined as a bargain formed by the exchange of a promise for an act. Again, the requisite promise consists of an offer. The position that an offer is not a promise is also inconsistent with the concept that a bargain is concluded by an offer and an acceptance. If an offer is not a promise, then an offeror makes no promise. If an offeror makes no promise, not even a conditional one, then an offeree cannot transmute the offer into a promise by his unilateral act of acceptance. Instead, an offeror would be free to respond to an acceptance as follows: “Your ‘acceptance’ is an interesting phenomenon, which I duly note. However, in making my offer I made no promise. Since I made no promise, I am not committed to treating your would-​be acceptance as concluding a bargain. And in fact, I choose not to treat it that way. Have a nice day.” In contrast, when an offer is understood as a promise there is no need to explain why the offeror cannot walk away if her offer is accepted. She cannot walk away because by making her offer she promised to enter into and perform a bargain if her offer was accepted, and it is desirable to enforce that promise. It is true that the obligation to perform the promise that is embedded in an offer is conditional on acceptance by the offeree. However, promises are often conditional, as Tiersma recognizes.6 Tiersma argues that an offer differs from a straightforward conditional promise because an offer normally can be revoked any time after it is made,7 and therefore an offeror makes no commitment unless and until acceptance occurs. This line of argument ignores an important fact: if a would-​be offer was made and revoked in the same breath, it would not constitute an offer. Accordingly, there is always a period of time during which an offer is on the table and the offeror is obliged to honor his promise if the offer is accepted. To put this differently, there is always an interval during which the offeror has made a commitment, albeit a conditional one. The length of that interval is irrelevant to the legal obligations arising from the interaction between parties. This characteristic of offers was the basis of the decision in Gurfein v. Werbelovsky.8 Seller and Buyer made a contract for the sale of five cases of plate glass. The glass was “to be shipped within three months” of the contract date but Buyer had an option to cancel the order before shipment. Seller argued that by virtue of the cancellation clause Buyer made no promise (or more accurately, made only an illusory promise) and therefore gave no consideration for Seller’s promise. The Connecticut Supreme Court held that Buyer did make a promise, because Seller had one clear opportunity to enforce the contract by shipping the glass as soon as he received the order. “This is all that is necessary to constitute a legal consideration and to bring the contract into existence. If [Seller] voluntarily limited his absolute opportunity of enforcing the contract to the shortest possible time, the contract may have been improvident, but it was not void for want of consideration.”9 5.  Restatement Second § 24 cmt. a; see also 1 Samuel Williston, The Law of Contracts § 25 (1920). 6. Tiersma, supra note 3, at 21–​24. 7.  Id. at 23. 8.  118 A. 32 (Conn. 1922). 9.  Id. at 33.

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In short, an offer is a promise by the offeror to enter into and perform a bargain if the offeree accepts.10 Such a promise should be and is enforceable because it is ancillary to and promotes bargains, bargains serve important social-​welfare purposes, and enforcing promises that are ancillary to and promote bargains furthers those purposes.

II.   WH AT C O N S T I T UT ES A N  OF F ER ? Let us turn now to the question: How is it to be determined whether a given expression is an offer? Offers are commonly contrasted with invitations to deal, such as “I would be interested in buying your Camry for $20,000.” Like an offer, an invitation to deal is an expression that looks toward the formation of a bargain. Unlike an offer, which has the effect of creating a power of acceptance in the offeree, an invitation to deal has no immediate legal effect, because the addressee cannot conclude a bargain by saying “Yes.”11 Suppose that whether a given expression is an offer or an invitation to deal was decided under the general principles of interpretation. The issue then would be, given the language of the expression interpreted in light of all relevant circumstances—​and assuming that no relevant subjective considerations are involved—​would a reasonable person in the addressee’s position believe that he had the power to conclude a bargain by saying yes or the equivalent? In many cases that is just the way courts approach the question. In some important classes of cases, however, the question whether an expression is an offer is governed by an expression rule, that is, a rule that attaches a predetermined meaning or effect to any expression that falls into a given category (such as advertisements), rather than allowing the meaning or effect of such an expression to be determined under the general principles of interpretation.12 Among these categories are advertisements and auctions.

A. ADVERTISEMENTS Suppose a store advertises “17 Sony TVs, Model 5072Q—​price $350.” A  customer comes into the store and says that he will buy the TV at that price. Applying the general principles of interpretation the advertisement would constitute an offer, because a reasonable person reading the advertisement would believe that he could conclude a bargain by telling a salesman that he wanted one of the advertised Sonys at the advertised price. This point is exemplified in Fisher v. Bell.13 A statute made it unlawful to “offer for sale” a switchblade knife. 10.  See Restatement Second § 24 & cmt. a. 11.  However, an invitation to deal may affect the interpretation of subsequent expressions by the bargaining parties. For example, suppose A says to B, “I’m considering selling my Camry for $20,000. Are you interested?” A’s statement is an invitation to deal, not an offer, because B cannot conclude a bargain by saying “Yes.” If B responds, “Yes, I’ll buy the car at that price,” B’s response is an offer. Although B’s response does not explicitly state what car he is willing to buy or what price he is willing to pay, both of those elements are implied in B’s offer on the basis of A’s earlier invitation to deal. 12.  The concept of expression rules is developed and discussed more fully in supra Chapter 30. 13.  [1961] 1 QB 394 (Eng.).

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Bell, a shopowner, was prosecuted for having displayed such a knife in his shop window with a tag reading “Ejector knife—​4 [shillings].” The court said, “I confess that I think most lay people and, indeed, I myself . . . would be inclined to the view that to say that if a knife was displayed in a window like that with a price attached to it was not offering it for sale was just nonsense.”14 (However, the court held for Bell on the ground that “according to the . . . law of contract the display of an article with a price on it in a shop window is merely an invitation to treat.”) Under classical contract law, however, the rule was that advertisements were normally deemed to be only invitations to deal.15 Call this the advertisement rule. For example, Williston, in the first edition of his treatise, stated that “if goods are advertised for sale at a certain price, it is not an offer, and [therefore] no contract is formed by the statement of an intending purchaser that he will take a specified quantity of the goods at that price.”16 Similarly, the Comment to Restatement Second Section 26 states that “Advertisements . . . are not ordinarily intended or understood as offers to sell.”17 Since the classical-​contract-​law rule departed so widely from the result that would be reached under the general principles of interpretation it is not easy to understand why the rule was adopted. One possibility is that the courts were worried about the problem of overacceptance. Here is an illustration of that problem: Suppose A makes separate offers to B and C to sell her Camry for $20,000. Neither B nor C knows that A has offered the Camry to the other, and each accepts the offer. A is now bound to both B and C. If A doesn’t deliver the Camry to either B or C, he must pay expectation damages to both. If A delivers the Camry to B, he must pay expectation damages to C, and vice versa. Accordingly, classical-​contract-​law-​courts may have been concerned that if an advertisement for a commodity that specified description and price was deemed to be an offer, advertisers would constantly be faced with an overacceptance problem, because often the number of consumers seeking to accept an advertisement would exceed the advertiser’s supply. In fact, however, treating advertisements as offers would not create an overacceptance problem. It is implied in an advertisement that the advertiser has a reasonable quantity of the advertised merchandise on hand and will sell the merchandise on a first-​come, first-​served basis, subject to constraints of customer creditworthiness and the like.18 An advertiser who satisfies those conditions will not be liable to disappointed shoppers, because it will have honored its offer even if some shoppers who wanted to accept were unable to do so. Moreover, not all advertisements would be offers even in the absence of the advertisement rule. Rather, the meaning of an advertisement, like the meaning of other expressions looking toward the formation of bargains, would be decided by applying the general principles of interpretation to the particular advertisement. Under these principles some advertisements would be offers and some would not.

14.  Id. at 399. 15.  The same rule was applied to “offering circulars,” that is, flyers with price quotations circulated to the trade. See, e.g., Neb. Seed Co. v. Harsh, 152 N.W.310 (1915). 16. 1 Williston, supra note 5 § 27, at 33. 17.  Restatement Second § 26 cmt. b. 18.  See Joseph M. Perillo, Calamari & Perillo on Contracts § 2.6, at 32 (6th ed. 2009).

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Even under classical contract law there were significant exceptions to the advertisement rule. Under one major exception, the rule was inapplicable to advertisements of prizes or rewards. (Perhaps this exception was made because usually a only a very limited number of persons—​ typically, only one—​can claim a prize or reward, so there is no prospect of overacceptance. Where more than one person had a justified claim to a prize or reward, as where more than one person participated in apprehending a criminal for whose capture a reward had been advertised, the courts normally would divide up the reward in an equitable way.19) In addition, the advertisement rule was often stated as only a presumption, or as subject to a broad and virtually indeterminate exception. For example, Corbin stated that “It is quite possible to make a definite and operative offer to buy or sell goods by advertisement . . . [but] the presumption is the other way.”20 Similarly, Williston stated that “there is no doubt that a positive offer may be made even by an advertisement. . . . The only general test which can be submitted as a guide is the inquiry whether the facts show that some performance was promised in positive terms in return for something requested.”21 And the Comment to Restatement Second Section 26 provides that the advertisement rule does not apply when the advertisement includes “some language of commitment or some invitation to take action without further communication.” When the rule is stated this way any advertisement of specified items for specified prices could fit within either the rule or the exception, depending on the circumstances and the language. The status of the advertisement rule under modern contract law is not completely clear. Some modern cases follow the rule;22 some reject it. The best-​known modern case is Lefkowitz v. Great Minneapolis Surplus Store, Inc.23 Great Minneapolis had published the following advertisement in a local newspaper: Saturday 9 A.M. 2 Brand New Pastel Mink 3 -​Skin Scarfs Selling for $89.50 Out they go Saturday. Each. . . . $1.00 1 Black Lapin Stole Beautiful, worth $139.50. . . . $1.00 First Come First Served.

On the appointed day Lefkowitz was first in line and tendered $1 for the stole. Great Minneapolis refused to sell him the stole. Lefkowitz sued for breach of contract, and Great

19.  See, e.g., Chambers v. Ogle, 174 S.W. 532, 536 (Ark. 1915). 20. 1 Arthur Linton Corbin, Corbin on Contracts § 25, at 74–​75 (1963). 21. 1 Williston on Contracts § 4:10, at 484, 486 (Richard A. Lord ed., 4th ed. 1990). 22.  See, e.g., Craft v. Elder & Johnston Co., 38 N.E.2d 416, 417 (Ohio Ct. App. 1941) (an advertisement for the sale of a sewing machine at a specified price on a certain day was a “unilateral offer,” which, “not being supported by any consideration could be withdrawn at will and without notice”). 23.  86 N.W.2d 689 (Minn. 1957).

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Minneapolis responded that an advertisement is not an offer, so that no contract was formed by Lefkowitz’s would-​be acceptance. The court held for Lefkowitz: The test of whether a binding obligation may originate in advertisements addressed to the general public is “whether the facts show that some performance was promised in positive terms in return for something requested.” The authorities . . . emphasize that, where the offer is clear, definite, and explicit, and leaves nothing open for negotiation, it constitutes an offer. . . . . . . We are of the view on the facts before us that the offer by the defendant of the sale of the Lapin fur was clear, definite, and explicit, and left nothing open for negotiation.24

Lefkowitz is open to several interpretations. It might be said that the advertisement there was unusual because it involved foreseeable reliance—​but so does any advertisement whose primary purpose is to induce a customer to visit a store. Or, it might be said that the advertisement was unusual because it stated the available quantity and the method of allocating the quantity, that is, on a first-​come, first-​served basis. However, it is or should be implied in every advertisement that a reasonable quantity is available and that the quantity will be allocated first-​come, first-​ served. Accordingly, the best explanation for Lefkowitz and cases like it is that the advertisement rule is unjustified and modern courts therefore should not apply it.25

24.  Id. at 691. A week earlier, Great Minneapolis had run the following newspaper advertisement: Saturday 9 A.M. Sharp 3 Brand New Fur Coats Worth to $100.00 First Come First Served $1 Each

  Lefkowitz was the first to present himself, and demanded one of the fur coats. Great Minneapolis refused to sell. As to this advertisement, the court held for Great Minneapolis, but only on damages grounds. For a trenchant critique of this branch of the case, see Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 Yale L.J. 87, 105–​06 (1989). 25.  See, e.g., Izadi v. Machado (Gus) Ford, Inc., 550 So. 2d 1135, 1139 (Fla. Dist. Ct. App. 1989) (an advertisement proffering a $3,000 minimum-​trade-​in value toward the purchase of a new car could be objectively interpreted as an offer); Oliver v. Henley, 21 S.W.2d 576, 578 (Tex. Civ. App. 1929) (an advertisement for the sale of cottonseed that was “clear, definite, and explicit, [and which] left nothing open for negotiation,” was an offer); Chang v. First Colonial Sav. Bank, 410 S.E.2d 928, 930 (Va. 1991) (a bank’s newspaper advertisement promising $20,136.12 upon maturity of a $14,000 savings certificate was “clear, definite, and explicit and left nothing open for negotiation,” and therefore constituted an offer).   In Donovan v. RRL Corp., 27 P.3d 702 (Cal. 2001), an automobile dealer had advertised a specific used car at a specific price. Plaintiff came to the dealership and agreed to buy the car at that price. The dealership refused to sell the car at that price, partly on the ground that an advertisement is not an offer. The court said: This court has not previously applied . . . the rule that advertisements generally constitute invitations to negotiate rather than offers. Plaintiff observes that such rules governing the construction of advertisements have been criticized on the ground that they are inconsistent with the reasonable expectations of consumers and lead to haphazard results. . . . Plaintiff urges this court to reject the black-​letter advertising rule.

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B. AUCTIONS Suppose that an auction takes place and the auctioneer puts a lot up on the auction block—​that is, puts a commodity up for bids. Does that act constitute an offer to sell the lot to the highest bidder? If the general principles of interpretation were applied to the auctioneer’s act it might seem that it does. For example, Williston, in the first edition of his treatise, stated: As an original question it seems fairly open to argument whether an auctioneer by putting up goods for sale makes an offer which ripens into a contract or sale when the highest bidder accepts the offer; or whether putting up the goods for sale is merely an invitation to those present to make offers which they do by making bids, one of which is ultimately accepted by the fall of the hammer.26

However, auctions are governed by a cluster of expression rules, not by the general principles of interpretation. The basic default rule that governs auctions is the with-​reserve rule. A reserve price is the price below which the owner of a commodity to be auctioned will not sell it. A reserve price may be publicly announced but usually is not. If the auction is with reserve and the highest bid does not equal the reserve price the auctioneer may either state that the reserve price has not been met or may purport to recognize a fictitious bid equal to the reserve price and pronounce that the auction of the relevant lot is complete.27 Auctions are deemed to be with reserve unless the auctioneer states that the auction is without reserve. 28 Under the with-​reserve rule the act of an auctioneer in putting a lot up on the auction block is not an offer, so the auctioneer is free to not sell the lot to the highest bidder. If, however, an auction is announced to be without reserve, once the auctioneer puts a lot on the block he is bound to sell it. (Online auctions, such as those conducted on eBay, follow many of the same rules. The option to put up a commodity with reserve is available, and it functions in an identical fashion. In other words, putting up an item for auction on eBay is in itself no more an offer than putting up a lot for auction at Sotheby’s. As a matter of practice, however, online auctions like eBay’s are typically conducted without reserve.)

In the present case, however, we need not consider the viability of the black-​letter rule regarding the interpretation of advertisements in general. Vehicle Code section 11713.1(e), provides that it is a violation of the Vehicle Code for the holder of any dealer’s license to “[fail to sell a vehicle to any person at the advertised total price . . . while the vehicle remains unsold, unless the advertisement states the advertised total price is good only for a specified time and the time has elapsed. We] conclude that a licensed automobile dealer’s advertisement for the sale of a particular vehicle at a specific price—​when construed in light of Vehicle Code section 11713.1, subdivision (e)—​reasonably justifies a consumer’s understanding that the dealer intends the advertisement to constitute an offer and that the consumer’s assent to the bargain is invited and will conclude it. (Emphasis in original.) Id. at 710–​711.

26. 1 Williston, supra note 5 § 29, at 39. Williston concluded that “The latter view . . . seems more in accordance with the facts.” Id. 27.  See Ralph Cassady, Jr., Auctions and Auctioneering 227–​ 28 (1967); Charles W. Smith, Auctions 100 (1989). 28.  For example, Sotheby’s auction catalog contains the following language regarding reserves: All lots in this catalogue are offered subject to a reserve, which is the confidential minimum hammer price at which a lot will be sold. No reserve will exceed the low presale estimate stated in the catalogue, or as amended by oral or posted notices.

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Although the with-​reserve default rule—​that putting a lot on the auction block is not an offer—​seems to depart from the basic principles of interpretation, the rule is justified. Outside the auction context most actors are unlikely to know the legal rules that govern offer and acceptance. In contrast, most bidders at auctions are likely to know the rules that govern auctions. This is most obviously true of auctions to the trade, such as auctions of tobacco or freshly landed fish.29 Even auctions that are open to all comers will often involve knowledgeable repeat players, as in the case of high-​priced art auctions or regular local antique auctions dominated by neighboring dealers and collectors. As a result the with-​reserve rule is unlikely to frustrate the expectations of most bidders. Furthermore, the with-​reserve rule cannot be taken in isolation, because it is only part of a web of interrelated rules and practices that define and constitute any given auction. A seller at auction may set a reserve price for a number of reasons. Principal among these is a concern that the highest bid may be unduly low, either because not enough interested buyers will show up or because the bidding will be held down by collusion among members of an auction ring.30 (An auction ring is a group of potential buyers at an auction who collude beforehand not to bid against one another on a lot, in order to minimize the price at which the lot is sold. The lot is then bought, at an artificially low price, by a member of the ring. Subsequently, the ring holds a surreptitious private auction, called a knockout auction, that is attended only by members of the ring. The difference between the artificially low price paid in the original auction and the higher real-​value price paid by the winning bidder in the knockout auction is then shared among the members of the ring. For example, assume A, B, C, D, and E are art dealers and are all interested in purchasing, for eventual resale, a Rembrandt that is coming up for auction. They form a ring and agree that only A will bid on the Rembrandt. A makes the highest bid at the auction, $15 million, and acquires the painting. The ring then holds a knockout auction among themselves for the painting, at which C makes the highest bid, $17.5 million. As a result, C gets the painting and pays A, B, D, and E $500,000 each, their pro rata shares of the ring’s profit—​that is, the difference between the $17.5 million value of the painting and the $15 million that C paid. A, B, D, and E end up with $500,000 each, C gets a $17.5 million painting for $15 million, and the original owner of the painting gets $2.5 million less than he would have received if the ring had not been formed. (It is a criminal offense to participate in an auction ring, and the original owner has the right to annul the sale made to a member of a ring, if she learns of the ring.) The problems faced by auction sellers are accentuated where buyers, rather than sellers, control an institutionalized auction—​as where buyers organize and run the auction, or where a group of buyers participates in the auction on a regular basis while any given seller participates on only an episodic basis.31 Accordingly, the auction rules are part of a complex system through which the relative needs and power of the members of various auction communities can be accommodated. Of course, not everyone who attends every auction knows all the rules, because some auctions are attended by nonrepeat players. This might be true, for example, of tourists who drop in on an antiques auction in New England, or persons who attend an auction at Sotheby’s

29.  See Cassady, supra note 27, at 15–​19 & passim; Smith, supra note 27, at 1–​19 & passim. 30.  See Cassady, supra note 27, at 228–​29; Smith, supra note 27, at 99–​102. 31.  See Smith, supra note 27, at 96–​97.

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for the first time. In such cases the auction rules may frustrate the reasonable expectations of at least some bidders. However, administrative and substantive problems would be presented if the auction rules were applied to experienced players but not to naive players. Undoubtedly, the best approach for an auction house would be to announce its rules in advance. Probably many auction houses do so. (The fact that online auctions such as eBay are more accessible, and therefore more likely to attract one-​time bidders, may explain why these auctions tend to be without reserve unless explicitly labeled as with reserve.) Even where that is not done, however, the auction rules are justified. __________________ In sum, an offer is a conditional promise that gives the offeree the power to conclude a bargain by assenting. Whether or not an expression is an offer normally should be determined by the general principles of interpretation. Often, however, the issue is determined by expression rules. In some cases, such as auctions, the relevant expression rule is justified. In other cases, such as advertisements, it is not.

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Modes of Acceptance Assume that an offer has been made and is still ou tstanding,

and the offeree attempts to accept. The next question is whether the would-​be acceptance is effective, so that a contract is formed and the offeror is bound. There are various modes of offers and correspondingly various modes of acceptance. Frequently, determining whether a would-​be acceptance is effective depends on an interpretation of the offer. For example, if an offer specifies a certain mode of acceptance, such as a promise, and the offeree attempts to accept by some other mode, such as an act, the would-​be acceptance is normally ineffective. The ineffectiveness of a would-​be acceptance can have significant consequences. For example, if an offer is revocable and the offeree uses the wrong mode of acceptance the offeror remains free to revoke the offer unless and until the offer is properly accepted. If an offer states a definite period in which acceptance must be made and within that period the offeree uses the wrong mode of acceptance, the would-​ be acceptance will be ineffective and the offer may lapse before the offeree makes a timely acceptance. These and other issues concerning various modes of acceptance will be discussed below.

I .   A C C E P TA N CE BY  PR OM I S E O R B Y  A CT ? Most offers require acceptance by either a promise (offers for a bilateral contract) or an act (offers for a unilateral contract). In some cases an offer is ambiguous as to what mode of acceptance is required. Sometimes this ambiguity turns out not to matter because the offeree performs an act that doubles as a promise. In such cases a contract will be formed by doing a certain act, whichever mode of acceptance is deemed to be required. For example, suppose A is standing in front of his fence with a can of paint and a paintbrush. B comes along, and A says, “I will pay you $200 to paint my fence.” B immediately picks up the brush and starts painting. B’s act can be interpreted either as a promise, like nodding one’s head up and down to signify “yes,” or as an act, consisting of the beginning of performance. If A’s offer is best interpreted as an offer for a bilateral contract, A will be bound because B’s act constitutes a promise. If A’s offer is best interpreted as an offer for a unilateral contract, A will be bound because an offer for a unilateral contract cannot be revoked once the offeree has begun to perform.1 1.  See Chapter 33 Section III, infra. Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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Often, however, cases in which it is ambiguous whether an offer is to be accepted by a promise or an act cannot be resolved this way—​because, for example, the offeree knows that his beginning of performance will not seasonably come to the offeror’s attention, so that it cannot double as a promise. One approach to these cases would be to apply the general principles of interpretation to the offer to determine which mode of acceptance the offer requires. Under this approach if one interpretation is even slightly better than the other, the better interpretation governs. A much different rule is stated in many cases and embodied in Restatement Second Section 32: “In case of doubt an offer is interpreted as inviting the offeree to accept either by promising to perform what the offer requests or by rendering the performance, as the offeree chooses.”2 Section 32 is itself ambiguous. Does the rule it embodies apply if there is any doubt concerning the meaning of the offer, or only if there is a significant doubt? If the rule applies whenever there is any doubt, the offeror could be bound even though the offeree attached a very unreasonable meaning to the offer, as long as his interpretation was at least plausible. Since that result would be unsound, presumably the rule requires at least a significant doubt. This approach is exemplified in Illustration 3 to Section 32: A publishes the following offer: “I will pay $50 for the return of my diamond bracelet lost yesterday on State Street.” B sees this advertisement and at once sends a letter to A, saying, “I accept your offer and will search for this bracelet.” There is no acceptance.3

The Comment to Section 32 rationalizes the rule embodied in the Section on interpretive grounds: “The offeror is often indifferent as to whether acceptance takes the form of a promise to perform or performance, and his words literally referring to one mode are often intended and understood to refer to either.”4 However, the fact that offerors are often indifferent as to the mode of acceptance hardly justifies a rule that treats offerors as though they were always indifferent. Although the rule embodied in Section 32 cannot readily be justified on interpretive grounds it might be justified on policy grounds. Suppose an offeree attempts to accept an ambiguous offer by performance, when under the best interpretation of the offer he should have accepted by promise. If his acceptance is for that reason deemed ineffective the offeree stands to suffer a considerable loss, because if the offeror rightfully revokes after the offeree has begun to perform the offeree may forfeit the cost of the performance he rendered before the revocation. In contrast, if in such a case the acceptance is deemed effective the offeror’s 2.  Restatement (Second) of Contracts§ 32 (Am. Law Inst. 1979)  (emphasis added) [hereinafter Restatement Second]. U.C.C. § 2-​206(1)(b) (Am. Law Inst. & Unif. Law Comm’n 2002) [hereinafter U.C.C.] takes a comparable approach to contracts for the sale of goods: [A]‌n order or other offer to buy goods for prompt or current shipment shall be construed as inviting acceptance either by a prompt promise to ship or by the prompt or current shipment of conforming or nonconforming goods, but such a shipment of non-​conforming goods does not constitute an acceptance if the seller reasonably notifies the buyer that the shipment is offered only as an accommodation to the buyer.

3.  Restatement Second § 32, illus. 3. 4.  Restatement Second § 32 cmt. a. The Comment also states, “The rule of this Section is a particular application of the rule stated in § 30(2).” Id. Section 30(2) provides: “Unless otherwise indicated by the language or the circumstances, an offer invites acceptance in any manner and by any medium reasonable in the circumstances.” Id. § 30(2).

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loss is likely to be minimal. Conversely, suppose an offeree attempts to accept by promise when under the best interpretation of the offer he should have accepted by performance. If the would-​be acceptance is for that reason ineffective and the offeror revokes, the offeree may lose any investment he made in preparing for performance and also the value of any opportunities he let pass by because he believed that a contract had been formed. It is true that if the offeree’s attempt to accept by promise is effective in such a case the offeror might conceivably suffer a loss of some sort, but that is not very likely because the offeree is bound to render performance under his promise. In short, where an offer is ambiguous as to whether acceptance should be by promise or by act the offeree’s interpretation should prevail even if it is slightly inferior to the most reasonable interpretation, because if the acceptance is deemed ineffective the consequences to the offeree are likely to be more severe than the consequences to the offeror if the acceptance is deemed effective. Accordingly, in such cases it seems fair to vary the general principles of interpretation and put the burden on the offeror to phrase her offer so that it is clear whether she wants acceptance by promise or by act, and to make her take the consequences of significant ambiguity if she does not make her intention clear.

I I .   A C C E P TA NCE OF   OF F ER S F O R   U N I L AT E RA L CONT R A CT S This Section considers offers for unilateral contracts as follows: (1) The background. (2) The law concerning employment manuals, which at least for a while became the most important type of unilateral contract. (3)  The significance of the offeree’s motivation, specifically, whether a person who knows of an offer for a unilateral contract and performs the act invited by the offer must have been motivated by the offer. (4) The significance of the offeree’s knowledge, and more specifically whether a person who performs an invited act must have known of the offer when he performed the act. (5) Whether a person who performs an invited act is required to give notice of his performance to the offeror where the performance would not reasonably come to the offeror’s attention.

A.  THE BACKGROUND A unilateral contract is comprised of the exchange of a promise for an act. Correspondingly, an offer for a unilateral contract is a promise to perform in a designated way—​almost invariably, by making a designated payment—​if the offeree performs a designated act. Unilateral contracts are much less common than bilateral contracts, because it is not usual for an offeror to state that she wants acceptance by performance only and that a promise won’t do. At one time, perhaps the most common types of unilateral contracts were offers of prizes and rewards. It is easy to see why those offers normally take the unilateral form. If A advertises a reward for finding her lost dog, Red Rover, A doesn’t want people to promise to find Red Rover; A wants Red Rover. Similarly, if A advertises a prize for the solution to a famous mathematical conjecture, A doesn’t want mathematicians to promise to solve the conjecture; she wants the solution.

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Until the first part of the twentieth century the distinction between unilateral and bilateral contracts was regarded as a fundamental concept in contract law, and indeed was an important feature of Restatement First. In the late 1930s, however, Karl Llewellyn, a great contracts scholar, argued that unilateral contracts were neither theoretically important nor often found in real life, and therefore should be treated as unusual beasts and relegated to the freak tent.5 Other scholars joined in this critique,6 and later Restatement Second dropped the terminology bilateral and unilateral in favor of the terminology acceptance by promise and acceptance by performance.7 However, few courts or scholars have switched to this terminology, and in an important article Mark Pettit showed that the tide has come back in because unilateral contracts are now doing very significant work that could not easily be done by bilateral contracts: [An] important reason for the continued use of unilateral contract analysis in contemporary litigation is that it has proved adaptable to the needs of judges and lawyers in areas unforeseen by Llewellyn and apparently by the drafters of the Second Restatement. Relatively few of the modern unilateral contracts cases involve traditional commercial exchanges (sales of goods), and it was primarily the traditional commercial context that Llewellyn had in mind when he unleashed his attack on the unilateral contract idea. Llewellyn did not foresee the usefulness in a highly organized society of a concept that allows a plaintiff to assert the defendant’s promissory obligation and at the same time preempt the argument that he himself did not undertake any obligation. Many of the modern unilateral contracts cases involve claims by an individual offeree against an organizational offeror—​the little guy against the big organization. In this context courts often are quite willing to conclude that the organization made a promise even though the individual did not. . . . [L]‌awyers and judges recently have been choosing unilateral contract analysis with remarkable and increasing frequency. In assessing this trend toward the unilateral contract, however, it is important to recognize an important change in the way that unilateral contract is being used. In Llewellyn’s time, unilateral contract was predominantly a defendant’s theory; the plaintiff pressed a bilateral contract argument and the defendant claimed to have made an offer for a unilateral contract which he revoked before the plaintiff ’s acceptance by performance. In modern times, unilateral contract is predominantly a plaintiff ’s theory. With some exceptions, courts employ unilateral contract analysis when they find liability and reject it when they deny liability. The crucial, difficult question facing the courts in the modern cases is not whether to choose unilateral or bilateral contract analysis, but whether to employ any contractual analysis at all. Judges and lawyers have been expanding contract analysis into new areas and situations. It is no coincidence that they have resorted to unilateral contract in this process. The need to find an enforceable return promise provides some limitation on the use of bilateral contract theory to impose liability. Plaintiffs pursuing a bilateral theory have to prove, and sometimes subject themselves to,

5. K.N. Llewellyn, On Our Case-​Law of Contract:  Offer and Acceptance, I, 48 Yale L.J. 1, 36 (1938) (“[U]‌nilaterals, at large, for purposes of studying formation, are not usefully conceived as one of two coordinate bodies of Contracts cases, . . . but belong[] in the freak tent as an interesting and often instructive curiosity.”). 6.  See, e.g., Samuel Stoljar, The False Distinction between Bilateral and Unilateral Contracts, 64 Yale L.J. 515 (1955). The relevant intellectual history is fully developed in Mark Pettit’s article, Modern Unilateral Contracts, 63 B.U. L. Rev. 551 (1983), on which the above passage significantly draws. 7.  Restatement Second § 1 cmt. f (stating that “the terms unilateral and bilateral are generally avoided in this Restatement.”) See also id. §§ 45, 50, 61.

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their own promissory obligation. Plaintiffs using the unilateral contract device, like tort plaintiffs, have to prove only the defendant’s obligation.8

The leading exemplification of Pettit’s analysis involve employment manuals, which will be considered in the next Section.

B.  EMPLOYMENT MANUALS AND THE AT-​WILL RULE 1.  In General There is a general rule of interpretation that if a contract does not explicitly or implicitly specify its duration the duration is a reasonable time. However, this rule is not applied to certain kinds of contracts. In particular, in the absence of a specified duration, employment contracts are deemed to be terminable at any time without cause and without notice at the will of either the employer or the employee.9 The at-​will rule probably fails to reflect the reasonable expectations of many employees. Many, perhaps most employees who work without contracts that specify a duration do not expect that they can be fired at will without cause and without notice. A better rule would at least require reasonable notice or severance pay. Perhaps the at-​will rule reflects an idea of mutuality: that because an employee should be able to depart at will if he has not agreed otherwise, so as to prevent involuntary servitude, an employer should be able to discharge at will. But nothing requires mutuality of obligation as a matter of interpretation. Alternatively, perhaps the at-​will rule reflects a policy idea that allowing employers maximum freedom of action in discharging employees enhances social welfare. However, although policy can legitimately enter into interpretation it normally should not control over fair contrary implications, and in any event there are social-​welfare interests, such as the welfare gain from reasonable security of employment, that cut the other way. In short, the at-​will rule lacks a firm foundation. Perhaps for this reason, the rule has been gradually eroded through the adoption of statutory and judicially created exceptions. For example, federal statutes provide that an employee cannot be discharged on the basis of race, religion, gender, age, or disability10 and prohibit a public company from discharging an employee because he assisted or testified in a proceeding concerning conduct that he reasonably believed violated the securities laws.11 Apart from statutes, many courts have held that an employee cannot be discharged in bad faith12 or for a reason that is against public policy, such as

8.  Mark Pettit, Jr., Modern Unilateral Contracts, 63 B.U. L. REV. 551, 574–​76 (1983). 9.  See, e.g., Schneider v. TRW, Inc., 938 F2d 986, 990 (9th Cir. 1991) (applying Cal. law); Mann v. Ben Tire Distribs., Ltd. 411 N.E.2d 1235, 1236 (Ill. App. Ct. 1980). 10.  See, e.g., Age Discrimination in Employment Act of 1967 § 4(a), 29 U.S.C. § 623(a)(l) (2015); Civil Rights Act of 1964 § 703(a), 42 U.S.C. § 2000e-​2(a)(1) (2015); Americans with Disabilities Act, 42 U.S.C. § 12112 (2015). 11.  18 U.S.C. § 1514A (2015). 12.  These courts generally base these holdings on a finding that the employment contract contains an implied covenant of good faith and fair dealing that is violated by a bad-​faith discharge. See, e.g., Fortune v. Nat’l Cash Register Co., 364 N.E.2d 1251, 1255–​56 (Mass. 1977) (an employee was fired because the employer sought to avoid paying an otherwise-​due bonus). Some courts have refused to find the implied

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testifying truthfully against the employer in a judicial or legislative hearing.13 Moreover, even where an employee has no explicit contract the context of the particular employment relationship may give rise to an implied promise by the employer not to discharge the employee without cause and without notice.14 A more recent exception to the at-​will rule is that an employment manual that is distributed to employees constitutes an offer for a unilateral contract, and the employee’s act of working constitutes an acceptance of that offer. Accordingly, if the employment manual puts limits on the employer’s rights to discharge employees at will, those limits are part of the employee’s contract. For example, in Pine River State Bank v. Mettille,15 the court said: [The employer-​defendant argues that the job-​security provisions in its personnel handbook] lack enforceability because mutuality of obligation is lacking. Since under a contract of indefinite duration the employee remains free to go elsewhere, why should the employer be bound to its promise not to terminate unless for cause or unless certain procedures are followed? The demand for mutuality of obligation, although appealing in its symmetry, is simply a species of the forbidden inquiry into the adequacy of consideration, an inquiry in which this court has, by and large, refused to engage. ‘If the requirement of consideration is met, there is no additional requirement of . . . equivalence in the values exchanged; or . . . “mutuality of obligation.” ’ Restatement Second of Contracts § 79 (1981). We see no merit in the lack of mutuality argument . . . the concept of mutuality in contract law has been widely discredited and the right of one party to terminate a contract at will does not invalidate the contract.

Although Pine River State Bank represents the dominant view on the contractual status of employee handbooks, courts in some jurisdictions have declined to give employee manuals that status.16

covenant applicable to contract law, holding that it is too radical a departure from common law and precedent and must be mandated by either the state’s highest court or the legislature. Schwartz v. Mich. Sugar Co., 308 N.W.2d 459, 463 (Mich. Ct. App. 1981); see Whittaker v. Care-​More, Inc., 621 S.W.2d 395, 396 (Tenn. Ct. App. 1981). 13.  See, e.g., Tameny v. Atl. Richfield Co., 610 P.2d 1330, 1335 (Cal. 1980) (“[A]‌n employer’s obligation to refrain from discharging an employee who refuses to commit a criminal act . . . reflects a duty imposed by law upon all employers in order to implement the fundamental public policies embodied in the state’s penal statutes.”); Petermann v. Int’l Bhd. of Teamsters, Local 396, 344 P.2d 25, 27 (Cal. Ct. App. 1959) (to allow an employer to fire an employee because the employee would not commit perjury would violate public policy). 14. Such an implied promise has been recognized—​though not consistently so—​when the employee gave up an existing position to accept new employment, see Scott v.  Lane, 409 So. 2d 791, 795 (Ala. 1982); Rabago-​Alvarez v. Dart Indus., Inc., 127 Cal. Rptr. 222, 225 (Ct. App. 1976), passed up other job opportunities, see Wagner v. Sperry Univac, Div. of Sperry Rand Corp., 458 F. Supp. 505, 520–​21 (E.D. Pa. 1978), aff ’d, 624 F.2d 1092 (3d Cir. 1980) (applying Pennsylvania law); McInerney v. Charter Golf, Inc., 680 N.E.2d 1347, 1350–​51 (Ill. 1997); Grouse v. Grp. Health Plan, Inc., 306 N.W.2d 114, 116 (Minn. 1981); or served an employes for a long time or particularly well, see, Luck v. S. Pac. Transp. Co., 267 Cal. Rptr. 618, 633–​34 (Ct. App. 1990). 15.  333 N.W.2d 622, 629 (Minn. 1983). 16.  See, e.g., Heideck v. Kent Gen. Hosp., 446 A.2d 1095, 1096 (De1. 1982); Johnson v. Nat’l Beef Packing Co., 551 P.2d 779, 781–​82 (Kan. 1976).

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Some states, most notably Michigan, enforce commitments in employee handbooks under a noncontractual theory, first set forth in Toussaint v. Blue Cross & Blue Shield:17 While an employer need not establish personnel policies or practices, where an employer chooses to establish such policies and practices and makes them known to its employees, the employment relationship is presumably enhanced. The employer secures an orderly, cooperative and loyal work force, and the employee the peace of mind associated with job security and the conviction that he will be treated fairly. No pre-​employment negotiations need take place and the parties’ minds need not meet on the subject; nor does it matter that the employee knows nothing of the particulars of the employer’s policies and practices or that the employer may change them unilaterally. It is enough that the employer chooses, presumably in its own interest, to create an environment in which the employee believes that, whatever the personnel policies and practices, they are established and official at any given time, purport to be fair, and are applied consistently and uniformly to each employee. The employer has then created a situation “instinct with an obligation.”

In Rood v. Gen. Dynamics Corp.,18 the court added: [T]‌he legitimate expectations theory of Toussaint is not based on traditional contract analysis. The rationale for judicial enforcement of employer policies and procedures relating to employee discharge is simply the intuitive recognition that such policies and procedures tend to enhance the employment relationship and encourage an “orderly, cooperative and loyal work force” for the ultimate benefit of the employer. In short, in addition to the traditional grounds for enforcing promises, this perceived employer benefit is recognized under Toussaint as a sufficient, and independent, basis for enforcing promises of job security contained in employer policy statements that are disseminated either “to the work force in general or to specific classifications of the work force, rather than to an individual employee.”19

2. Disclaimers After the employment-​manual exception was widely adopted, employers began limiting its force by including in employment manuals disclaimers providing that the manual is not a binding contract. Some cases have been relatively quick to give effect to such a disclaimer,20 but others have held that such a disclaimer will be effective only if it satisfies very demanding conditions of clarity and notice. For example, in Sanchez v.  Life Care Centers of America, Inc.,21 an employee handbook contained the following disclaimer: “The executive director and supervisors

17.  292 N.W.2d 880, 892 (Mich. 1980). 18.  507 N.W.2d 591, 606 (Mich. 1993). 19.  See also In re Certified Question, 443 N.W.2d 112, 119–​21 (Mich. 1989); LeDuc v. Liquid Air Corp., 826 P.2d 664, 670 (Wash. 1992); Thompson v. St. Regis Paper Co., 685 P.2d 1081, 1087 (Wash. 1984). 20.  See, e.g., Abney v. Baptist Med. Ctrs., 597 So. 2d 682, 683 (Ala. 1992); Lobosco v. N.Y. Tel. Co./​NYNEX, 751 N.E. 2d 462, 465 (N.Y. 2001). 21.  855 P.2d 1256, 1257 (Wyo. 1993).

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must therefore reserve all the customary rights of management, including the right to . . . terminate . . . or otherwise manage associates. . . . This handbook is not a contract and contains no promises . . . upon which any prospective, current or prior associates of this nursing center can reasonably maintain or create any expectations of such.” The court held that the disclaimer was ineffective because it was not sufficiently explicit and conspicuous: The language of the disclaimer speaks in terms of “mutual benefit,” management “enhancement” and the right to supervise. It does not say that the employer retains the right to deviate from the terms of the handbook at its own caprice. It does not say that the employer remains free to change wages and all other working conditions without consulting the employee or obtaining his agreement, nor that the employer retains absolute power to fire anyone with or without good cause. Instead, there is an inference in the disclaimer that it is a guide for “mutual benefit,” that certain procedures contained therein would be “implemented” to “enhance the management of a successful nursing center,” and that the “customary rights” of the employer were set forth in the handbook. The operative language in the disclaimer is not bold lettered; it is buried in introductory paragraphs. It is not designed to attract attention and is stated in language which does not tell the employee what he needs to know.22

3. Modification Where an employee handbook or the like has contractual force and does not include a disclaimer, the cases have differed on the employer’s right to unilaterally modify the handbook’s provisions. On the one hand, if an employee handbook constitutes a contract when the employee begins working, then under normal contract doctrine the handbook/​contract can be modified only if both parties consent. This position was taken in Demasse v. ITT Corp.:23 ITT [the employer] argues that it had the legal power to unilaterally modify the contract by simply publishing a new [I989] handbook. But as with other contracts, an implied-​in-​fact contract term cannot be modified unilaterally. . . . Once an employment contract is formed—​whether the method of formation was unilateral, bilateral, express, or implied—​a party may no longer unilaterally modify the terms of that relationship. . . . Continued employment after issuance of a new [modified] handbook does not constitute acceptance, otherwise the “illusion (and the irony) is apparent: to preserve their right under the [existing contract] . . . plaintiffs would be forced to quit.” . . . It is “too much to require an employee to preserve his or her rights under the original employment contract by quitting working.” . . . Thus, the employee does not manifest consent to an offer modifying an existing contract without taking affirmative steps, beyond continued performance, to accept.24

22.  Id. at 1259. See also, e.g., Nicosia v. Wakefern Food Corp., 643 A.2d 554, 560–​61 (N.J. 1994); Liquid Air Corp., 826 P.2d at 671–​72 (Wash. 1992); McDonald v. Mobil Coal Producing, Inc., 820 P.2d 986, 988 (Wyo. 1991). 23.  984 P.2d 1138 (Ariz. 1999). 24.  Id. at 1144–​45.

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This approach, however, leads to a counterintuitive result, because if an employee works for only one day, the handbook cannot be modified as to him as long as he lives. A seemingly contrary position was taken in Asmus v.  Pacific Bell.25 Pacific Bell had issued a Management Employment Security Policy (MESP) in 1986. The MESP stated that “[i]‌t will be Pacific Bell’s policy to offer all management employees who continue to meet our changing business expectations employment security through reassignment to and retraining for other management positions, even if their present jobs are eliminated. This policy will be maintained so long as there is no change that will materially affect Pacific Bell’s business plan achievement.” In October 1991, Pacific Bell announced it would terminate the MESP on April 1, 1992, for the purpose of achieving more flexibility and competing more successfully in the marketplace, and instead would adopt a new layoff policy called the Management Force Adjustment Program (MFAP). Employees who chose to continue working for Pacific Bell would receive enhanced pension benefits, and employees who retired in late 1991 would receive additional enhanced benefits. Pacific Bell did not claim there had been a change that would materially affect the achievement of its business plan. Former Pacific Bell managers who were adversely affected by cancellation of the MESP brought suit. The managers had remained with Pacific Bell for several years after the cancellation and had received increased pension benefits for their continued employment while working under the MFAP. The court held for Pacific Bell on the ground that when Pacific Bell terminated the MESP, and offered continuing employment to employees who received notice and signed an acknowledgment to that effect, “the employees accepted the new terms, and the subsequent modified contract, by continuing to work. Continuing to work after termination and subsequent modification constituted acceptance of the new employment terms.”26 Taken in isolation, this language suggests that despite the rule that handbooks are enforceable, they really aren’t, because the employer can unilaterally cut off the employees’ rights by the simple expedient of “modifying” the manual to destroy these rights. If an employee keeps working after the manual is modified he loses his right to object to the modification. If an employee quits after the modification he also loses his rights to object because he is no longer an employee. Catch-​22. However, other elements of Asmus point in a very different direction. The best rule in these cases would be to allow an employer to modify a handbook, but only on reasonable notice and on reasonable terms. In Asmus that is just what happened: Pacific Bell gave the employees six months’ notice of the modification and gave special benefits to employees who chose to resign because of the modification. Furthermore, the court effectively stated that the rule is that “an employer may terminate or modify a contract with no fixed duration period after a reasonable time period, if it provides employees with reasonable notice, and the modification does not interfere with vested employee benefits.”27 Unilateral contracts raise several issues that are normally not presented by bilateral contracts. These issues, which are considered in the balance of this Section, concern the relevance of the offeree’s motivation, whether an offeror is liable to a person who performs the requested act but

25.  999 P.2d 71 (Cal. 2000). 26.  Id. at 79. 27.  Id. at 76.

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either did not know of the offer or did not appear to be motivated by the offer, and whether the offeree must notify the offeror that he has performed the requested act.

C.  THE OFFEREE’S MOTIVATION Suppose A makes an offer to B that invites acceptance by the performance of a specified act. B performs the act while knowing of the offer, but A claims that B’s performance was not motivated by the offer. The rule in such cases should be and largely is that the offeree’s motivation is irrelevant.28 The reason for this rule is captured in an eloquent passage by Cardozo: It will not do to divert the minds of others from a given line of conduct, and then to urge that because of the diversion the opportunity has gone by to say how their minds would otherwise have acted. If the tendency of the promise is to induce them to persevere, reliance and detriment may be inferred from the mere fact of performance. The springs of conduct are subtle and varied. One who meddles with them must not insist upon too nice a measure of proof that the spring which he released was effective to the exclusion of all others.29

Take, for example, the following story, which is imagined from, but is not part of, The Merchant of Venice: Portia, a wealthy heiress, was being ardently wooed by three suitors. One of these suitors, John, is closest to Portia’s heart. However, before Portia agrees to accept John’s proposal of marriage she asks him, “Would you love me if I wasn’t wealthy?” John replies, “How should I know?”

The reason John couldn’t know the answer to Portia’s question is that Portia’s wealth was part of her persona, just like the kind of music she loved, her politics, her height, her voice, and so forth. John knew that he loved Portia’s total persona, but he could not know whether he would have loved Portia if some element of that persona were different—​if, for example, Portia hated Beethoven, was an anarchist, was much taller than John, had a grating laugh—​or wasn’t rich. Once a person is given an inducement to perform a designated action it will be impossible for him to know that the inducement played no role in his taking that action. This point is illustrated by Klockner v. Green.30 Edyth Klockner was the stepmother of Richard Klockner and the stepgrandmother of Richard’s daughter, Frances. Richard and Frances looked after Edyth, and Edyth’s relationship to Richard and Frances was like that of a mother to her natural child and grandchild. In June 1965, Edyth told Richard that she wanted to compensate him for being so helpful, and that if he would agree to continue to look after her and let Frances 28.  This rule should also apply to bilateral contracts, although the issue seldom arises in that context. As Holmes put it, “[C]‌onsideration . . . must not be confounded with what may be the prevailing or chief motive in actual fact. A man may promise to paint a picture for five hundred dollars, while his chief motive may be a desire for fame. . . . But, nevertheless, it is the essence of a consideration, that, by the terms of the agreement, it is given and accepted as the motive or inducement of the promise.” Oliver Wendell Holmes, The Common Law 293 (1881). 29.  De Cicco v. Schweizer, 117 N.E. 807, 810 (N.Y. 1917). 30.  254 A.2d 782 (N.J. 1969).

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visit she would leave her real property to Richard and the balance of her estate to Frances. Edyth also discussed this promise with Frances. Edyth prepared two drafts of a new will to effectuate her promise, and her lawyer revised the second draft and sent it to her for execution. However, Edyth never executed the new will, apparently because she believed that making a will was a premonition of death. Edyth’s existing will left everything to her husband, who had predeceased her. As a result, the bulk of her estate passed by intestacy to her surviving blood relatives, and Richard and Frances took nothing. Richard and Frances then brought suit against Edyth’s executor to recover under Edyth’s promise. At the trial, Richard and Frances testified that they would have continued to perform the relevant services for Edyth even if she had not promised to compensate them. On that basis the trial court held for the executors. The New Jersey Supreme Court properly reversed. Richard and Frances might have believed that they would have rendered the services anyway, but they could not know that they would have done so.31 Similarly, in Simmons v.  United States,32 American Brewery sponsored a well-​publicized annual American Beer Fishing Derby. Under the Derby rules the brewery tagged one of the millions of rockfish in the Chesapeake Bay and named it Diamond Jim III. Anyone who caught the Diamond Jim III and presented it to the brewery together with the tag and an affidavit that the fish was caught on hook and line, would win $25,000. Simmons caught Diamond Jim about six weeks after it was tagged. Simmons knew about the contest, but as an experienced fisherman he also knew that his chances of landing Diamond Jim were miniscule, and he did not have Diamond Jim in mind when he set out to go fishing. The court held, in a tax context, that once Simmons had caught Diamond Jim, the brewery was legally obliged to award him the price. “It is not fatal” to Simmons’s claim, the court said, that he “did not go fishing for the express purpose of catching . . . the prize fish. So long as the outstanding offer was known to him, a person may accept an offer for a unilateral contract by rendering performance, even if he does so primarily for reasons unrelated to the offer.”33 Similarly, in Cobaugh v. Klick-​Lewis Inc.,34 Cobaugh, while playing in a golf tournament, unexpectedly found a new Chevrolet Beretta GT parked at the ninth hole, with a sign stating that a golfer who hit a hole-​in-​one would win the car. Cobaugh shot a hole-​in-​one and claimed the prize. The court held that there was consideration: In order to win the car, Cobaugh was required to perform an act which he was under no legal duty to perform. The car was to be given in exchange for the feat of making a hole-​in-​one. This was adequate consideration to support the contract.35

31.  Id. at 785–​86. 32.  308 F.2d 160 (4th Cir. 1962). 33.  Id. at 165. 34.  561 A.2d 1248 (Pa. Super. Ct. 1989). 35.  Id. at 1250. See also Champagne Chrysler-​Plymouth, Inc. v.  Giles, 388 So. 2d 1343 (Fla. Dist. Ct. App.  1980); Schreiner v.  Weil Furniture Co., 68 So. 2d 149 (La. Ct. App.  1953); Las Vegas Hacienda v. Gibson, 359 P.2d 85 (Nev. 1961); Grove v. Charbonneau Buick-​Pontiac, Inc. 240 N.W.2d 853 (N.D. 1976). But see Fernandez v. Fahs, 144 F. Supp. 630, 632 (S.D. Fla. 1956) (holding that a baseball fan did not “earn” a prize at a drawing because he would have attended the game even if no prize had been offered, and that since no consideration was exchanged, no contract was formed, and the prize was a gift).

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This position is also taken in Restatement Second Section 53, Illustration 1: A offers a reward for information leading to the conviction of a criminal. B, a friend of the criminal, knows of the reward and gives the information voluntarily. B is entitled to the reward even though he acts because he thinks he is about to die and wants both to ease his conscience and to revenge himself for a beating received by the criminal.

Suppose the offeror claims that she is not bound on the ground that the offeree performed the invited act because he had an overriding inducement—​other than the offer—​to do so. Illustration 2 takes the position that in such cases performance of the act does not constitute an acceptance: The facts being otherwise as stated in Illustration 1, B is interrogated by the police and threatened with arrest as an accomplice of the criminal. During the interrogation, without any mention of the reward, B is tricked into giving the information to clear himself. B is not entitled to the reward.

This position is unjustified. Even though B was tricked he knew of the reward offer, and it is impossible to rule out the possibility that this knowledge as well as the trick was an inducement to his action. There is no convincing way to distinguish Illustration 2 from Illustration 1.

D.  THE OFFEREE’S LACK OF KNOWLEDGE OF THE OFFER Suppose that A makes a general offer in the form of a unilateral contract, and B, who has no knowledge of the offer, performs the requested act. For example, A offers a reward for the return of her lost wallet and B finds and returns the wallet without having known of the reward. Should B be able to recover? This situation differs from those discussed in the previous section because now there is no possibility that the offer induced B’s action. The courts commonly hold that for this reason B cannot recover in these cases. This rule is dubious. It is true that when an actor could not possibly have been motivated by the offeror’s promise no bargain is made. But the issue here should be not whether a bargain was made, but whether liability should be imposed on the offeror. In many cases where B has conferred a benefit on A, A is under a moral obligation to compensate B for the value of the benefit. Without more the law should not and does not enforce that moral obligation, partly to avoid imposing upon A an obligation that he might not have voluntarily undertaken, and partly because of the difficulty of measuring the value of the benefit to B. However, if A confers a benefit on B that gives rise to a moral obligation to compensate A for the value of the benefit and B later promises to pay A for the benefit, B normally should be liable for the value of the benefit on restitutionary grounds. The same result should follow where B’s promise, in the form of a reward offer, is made before rather than after the benefit is conferred. Since the offer shows both that A was willing to pay for the benefit and how much the benefit was worth to her, A should be liable to pay fair compensation for the benefit, as presumptively evidenced by the amount stated in the offer. Such a rule would also be supported by policy, because if it became generally known that actors might get a reward for doing the kinds of things for which rewards are commonly offered, such as returning lost property or providing information about a criminal, more actors might take these kinds of actions. Partly for this reason, courts commonly make an

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exception when the reward is offered by a public entity. In such a case a person who performs the act is generally entitled to collect the reward even if she did not know about the reward beforehand.36 (Even when a government agency offers the reward, however, a person cannot claim the reward if she completed the requested performance before the reward was offered.37)

E.  REQUIREMENT OF NOTICE OF PERFORMANCE OF THE OFFEREE Where an offer calls for acceptance by an act a contract is complete as soon as the act is performed. In some cases the performance will naturally come to the offeror’s attention within a reasonable time after it occurs. In other cases—​for example, where the requested act is performed at a distant location—​the performance may not come to the offeror’s attention within a reasonable time. In such cases the offeror may be prejudiced if she is bound, because she may have planned her affairs in the reasonable belief that she was under no obligation to the offeree. Accordingly, even though a contract is formed by the offeree’s performance and the contract does not by its terms require any further action by the offeree, where the performance would not naturally come to the offeror’s attention within a reasonable time, and does not do so, as a matter of fairness the offeree should be required to bestir himself to give the offeror notice of the performance—​a type of duty to rescue. And indeed, the rule in such cases is that even though a contract is formed when the offeree has completed performance, the offeror’s duties under the contract are discharged if the offeree fails to notify the offeror within a reasonable time that performance has occurred,38 unless the offeror expressly or impliedly waived notice or the performance actually came to the offeror’s attention within a reasonable time.39 A difficult question is whether in such a case, the offeree should be able to sue in restitution for the benefit he conferred on the offeror. Providing such a remedy would be tempting—​after all, by hypothesis the offeror has received a benefit that she wanted and was willing to pay for, and the offeree did not confer the benefit officiously. On balance, however, allowing the offeree to sue in restitution in such cases would be inadvisable. The requirement of notice gives an 36.  See Eagle v. Smith, 9 Del. 293, 295–​96 (1871); Dawkins v. Sappington., 26 Ind. 199, 200 (1866). But see Glover v. Dist. of Columbia, 77 A.2d 788, 791 (D.C. 1951) (holding that knowledge of a reward is equally necessary when the reward is offered by a government agency or a private person or entity). 37.  Sumerel v. Pinder, 83 So. 2d 692, 693 (Fla. 1955) (claimant could not recover a reward for furnishing information to the Federal Bureau of Investigation when he had provided all the information before the reward offer was made). 38.  See, e.g., Harris v.  Time, Inc., 237 Cal. Rptr. 584 (Ct. App.  1987). A  magazine company sent out a direct-​mail advertisement offering a free watch “just for opening this envelope,” but the full text, which was apparent only after the envelope was opened, added that claimants must purchase a magazine subscription. The court held that although the text on the outside of the envelope was an offer for a unilateral contract, plaintiffs were required to notify the publisher of their acceptance by performance. Id. at 587–​88. Only one plaintiff had done so; as to him, the case was dismissed because “the law disregards trifles.” Id. at 585. See also Bishop v. Eaton, 37 N.E. 665, 668 (Mass. 1894); Restatement Second § 54. 39.  U.C.C. § 2-​206(2) provides that in a contract for the sale of goods, “If the beginning of a requested performance is a reasonable mode of acceptance, an offeror who is not notified of [such beginning of performance] within a reasonable time may treat the offer as having lapsed before acceptance.”

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offeree an incentive to notify the offeror that performance has been completed. If restitutionary relief was available most or all of that incentive would be removed.

I II.   O B L I G AT I O N S OF   A N OF F ER EE W HO H A S B E G U N PER F OR M A NCE In the case of an offer for a unilateral contract the offeree is not obliged to perform the invited act, any more than an offeree is obliged to accept an offer for a bilateral contract. (However, if the offeree begins to perform—​or, under the better view, during a reasonable time after the offer is made—​the offeror should be bound to keep the offer open until the offeree has a reasonable time to complete performance. Therefore, normally the offeree in effect has or should have an option, but not an obligation, to begin and complete performance within a reasonable time. This is the position taken in Restatement Second Section 45.) There is one exception if an offeree has begun to perform. Usually, the offeror will have no legitimate complaint if an offeree begins performing but stops before completion. In such cases the offeror will typically be in a better position than she was before she made the offer, because she will get the benefit of the offeree’s beginning performance for free. Sometimes, however, the offeree’s failure to complete performance, once begun, will make the offeror worse off than she would have been if the offeree had not begun. For example, if the performance consists of transporting goods and the offeree begins to transport the goods, as a matter of fairness the offeree should not have the right to abandon the goods midway. Furthermore, in some such cases the offeree knows or should know that beginning performance is likely to come to the offeror’s attention and that the offeror is likely to treat the beginning of performance as an implied promise by the offeree to complete. Such an implied promise should be enforceable if relied upon.

I V.   B I L AT E R A L CONT R A CT S Assume it is clear that an offer invites acceptance by a promise, and the offeree responds with an expression that purports to be a promissory acceptance but adds terms that are not in the offer, so that the response is a qualified or conditional acceptance. The rule under classical contract law was that to constitute an acceptance a response to an offer had to be a mirror image of the offer, and that any difference between the offer and the response, no matter how slight, would make the response into a counteroffer and thereby terminate the offeree’s power of acceptance.40 This rule had its deepest bite where the offer and response were embodied in competing forms. The standardized terms in such forms will never agree, because each party will have prepared a standard form whose terms are favorable to itself and unfavorable to its would-​be contracting partners. This common phenomenon is known as the battle of the forms. Under the mirror-​ image rule the responsive form constituted a counteroffer and took the offer off the table. 40.  See generally Poel v. Brunswick-​Balke-​Collender Co., 110 N.E. 619 (N.Y. 1919); Restatement Second § 59; see also Gardner Zemke Co. v. Dunham Bush, Inc., 850 P.2d 319, 322 (N.M. 1993).

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Because a form response to a form offer normally took the offer off the table, after the exchange of forms neither party was bound to a contract purely as a result of the exchange. However, if, as commonly occurred, the seller tendered performance, the tender would be deemed to have been made pursuant to the last form—​that is, the response to the offer, since that form constituted a counteroffer and therefore was the only offer on the table. Because no contract was deemed to have been formed by the exchange of forms, the buyer would be free to reject the seller’s tender. However, if, as also commonly occurred, the buyer accepted the tender, that acceptance would be deemed to be an acceptance of the last-​form/​counteroffer. This analysis was known as the last-​shot rule, because the terms of the contract would be the terms in the form that constituted the last shot in the battle of the forms. (The last shot could consist of either the seller’s form, if the exchange was initiated by a sales order, or the buyer’s form, if the exchange was initiated by a purchase order.) Although such forms can concern goods, services, or other kinds of commodities, for ease of exposition in the balance of this Section it will be assumed that the relevant transaction involves an offeror who is a would-​be seller of goods and an offeree who is a would-​be buyer of goods. The mirror-​image and last-​shot rules conflicted with the basic principles of interpretation. Under those principles a contractual expression should normally be given the meaning that would be attached to the expression by a reasonable person unless subjective elements are relevant and point in another direction. Form contracts consist of individualized, negotiated terms that normally cover performance issues, such as subject-​matter, price, quantity, delivery date, and credit terms; and standardized terms, often known as boilerplate, which normally cover nonperformance issues, such as limitations on damages, but may also cover relatively minor performance issues. For reasons discussed in Chapter 37, actors rarely read boilerplate terms. Accordingly, if an offeror receives a response to her offer that purports to be an acceptance and whose individualized terms match those of the offer, she will reasonably assume that the response is an acceptance, and therefore, so it should be under the general principles of interpretation. Because the mirror-​image and last-​shot rules conflicted with general principles of interpretation, under modern contract law the two rules have been very substantially eroded, especially by Uniform Commercial Code Section 2-​207. 41 That Section provides as follows: Additional Terms in Acceptance or Confirmation (1) A definite and seasonable expression of acceptance or a written confirmation which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon, unless acceptance is expressly made conditional on assent to the additional or different terms. (2) The additional terms are to be construed as proposals for addition to the contract. Between merchants such terms become part of the contract unless: (a)  the offer expressly limits acceptance to the terms of the offer; (b)  they materially alter it; or (c) notification of objection to them has already been given or is given within a reasonable time after notice of them is received. 41.  See also Restatement Second §59: “a definite and seasonable expression of acceptance is operative despite the statement of additional or different terms if the acceptance is not made to depend on assent to the additional or different terms. . . . The additional or different terms are then to be construed as proposals for modification of the contract. . . . Such proposals may sometimes be accepted by the silence of the original offeror.”

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(3) Conduct by both parties which recognizes the existence of a contract is sufficient to establish a contract for sale although the writings of the parties do not otherwise establish a contract. In such case the terms of the particular contract consist of those terms on which the writings of the parties agree, together with any supplementary terms incorporated under any other provisions of this Act.

Section 2-​207 needs a fair amount of interpretation—​it has been well described as “a murky piece of prose.”42 A fundamental point in understanding Section 2-​207 is that contracts can be formed under either Subsection 2-​207(1) or Subsection 2-​207(3), and important consequences follow from which of these Subsections apply.

A.  SECTION 2-​207(1) CONTRACTS Section 2-​207(1) provides that “a definite and seasonable expression of acceptance or a written confirmation which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon.” However, Section 2-​207(1) leaves open what constitutes “a definite . . . expression of acceptance” for purposes of that Section. Certainly the offeree’s response must purport to be an acceptance. Certainly too, given the language of Section 2-​207(1), a response to an offer can constitute a definite expression of acceptance even if the standardized terms of the response diverge from those of the offer. However, if an offeree’s response diverges from the offer in its individualized terms the response normally should not be considered a definite expression of acceptance, because there is a reasonably good chance that the individualized terms will be read so that the offeror will understand that a bargain has not yet been completed. For example, in Koehring Co. v. Glowacki,43 Koehring circulated a letter listing nine items of surplus machinery that were available for sale at its plant on an “as is, where is” basis. The term “as is, where is” meant that the buyer would bear the cost and risk of loading the machinery onto a truck. Glowacki then phoned Koehring, asking about the price. Koehring responded that a bid for the machinery must be $16,500 and must be in the form of a telegram. Glowacki telegraphed a bid of $16,000. Koehring called Glowacki, reiterating that the bid must be $16,500. Glowacki responded with a bid of $16,500, “FOB [free on board], our truck, your plant, loaded.” The term FOB loaded meant that the seller, Koehring, rather than the buyer, Glowacki, would bear the cost and risk of loading the machinery onto the truck. Koehring responded with a telegram that purported to accept Glowacki’s bid but reiterated that the machinery was sold as is, where is, meaning that the buyer would bear that cost and risk. Glowacki did not perform, and Koehring brought suit. The court properly held that no contract had been formed. There was no definite and seasonable acceptance because both parties realized or should have realized that they had not reached an agreement on who would bear the cost and risk of loading the machinery onto a truck.44 42.  Sw. Eng’g. Co. v. Martin Tractor Co., 473 P.2d 18, 25 (Kan. 1970). 43.  253 N.W.2d 64 (Wis. 1977). 44.  Id. at 69. See also, e.g., Columbia Hyundai, Inc. v.  Carll Hyundai, Inc., 484 S.E.2d 468, 470 (S.C. 1997) (when disputes concern negotiated provisions rather than boilerplate terms, “a contract may be ‘beyond the reach of 2-​207 and adrift on the murky sea of common law’ ”).

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In Koehring the exchanges between the parties were individualized phone calls and telegrams rather than forms. In most commercial cases, however, an offeree responds to a form offer with a form whose individualized terms match those of the offer although the standardized terms do not. In such cases there is a “definite and seasonable” expression of acceptance despite the difference between the standardized terms. This is the paradigm case at which Section 2-​207(1) is directed, and in such cases a contract will normally be concluded under Section 2-​207 by the exchange of forms despite the differences between the standardized terms in the two forms. Moreover, this will be true even if the differences between the standardized terms are material. This conclusion follows from the implicit premise of Section 2-​207: that few people read standardized terms, so neither party will realize that there are material differences between the standardized terms in the two forms. This conclusion also follows from the goal of Section 2-​207, because if material differences in standardized terms prevented a contract from being formed, Section 2-​207 would seldom be applicable, since there are always material differences in the standardized terms of a form offer and a form acceptance. Finally, and most important, this conclusion follows from the language of Section 2-​207, because Section 2-​207(2)(b) provides that between merchants an additional term in an acceptance is to be construed as a proposal for an addition to the contract, which will become part of the contract unless, among other things, the additional term would materially alter the contract.45 By implication Section 2-​207(2)(b) recognizes that a contract may be formed even if the response to the offer includes different terms that materially alter the offer, although those terms will not become part of the contract. Now assume that a contract is formed under Section 2-​207(1) because there is a form offer and a form acceptance, the individualized terms of the two forms match, the acceptance qualifies as a definite expression of acceptance, and the response does not provide that acceptance is made expressly conditional on the offeree’s assent of the additional or different terms. What then are the terms of the contract? Between merchants that issue is governed in the first instance by Section 2-​207(2), which provides that the additional terms in the acceptance became part of the contract unless (1) the offer expressly limits acceptance to the terms of the offer, (2) the additional terms would materially alter the contract, or (3) the offeror has already objected to the additional terms or objects within a reasonable time after receiving notice of the terms. Surprisingly, however, a contract formed under UCC Section 2-​207(1) may include significant terms added by the acceptance. It might be thought that any additional term in the acceptance that is significant would drop away under the “materially alter” exclusion in Section 2-​207(2)(b). After all, in general legal usage a term is considered material if it has economic significance or would be likely to affect a party’s decision whether to enter into a transaction. However, the Official Comment to Section 2-​207 utilizes a different, more stringent, test for materiality:  whether the additional term would result in “surprise or hardship.” The Official Comment to Section 2-​207 gives the following examples: 4. Examples of typical clauses which would normally “materially alter” the contract and so result in surprise or hardship if incorporated without express awareness by the other party are: a clause negating such standard warranties as that of merchantability or fitness for a particular purpose in circumstances in which either warranty normally attaches . . . [or] a clause requiring that complaints be made in a time materially shorter than customary or reasonable. 45.  As will be shown below, additional terms can have an effect even though they fall away, but that effect doesn’t prevent the additional terms from falling away.

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5. Examples of clauses which involve no element of unreasonable surprise and which therefore are to be incorporated in the contract unless notice of objection is seasonably given are: a clause setting forth and perhaps enlarging slightly upon the seller’s exemption due to supervening causes beyond his control, similar to those covered by the provision of this Article on merchant’s excuse by failure of presupposed conditions or . . . a clause fixing a reasonable time for complaints within customary limits . . . ; a clause providing for interest on overdue invoices or fixing the seller’s standard credit terms where they are within the range of trade practice and do not limit any credit bargained for; a clause limiting the right of rejection for defects which fall within the customary trade tolerance for acceptance “with adjustment” or otherwise limiting remedy in a reasonable manner (see §§ 2-​718 and 2-​719).

A number of cases have upheld the inclusion in a contract of additional terms in the acceptance that were material in the ordinary sense of that term but did not involve surprise or hardship. For example, although an arbitration provision is pretty clearly material in the normal sense of the term, in Aceros Prefabricados, S.A. v. TradeArbed, Inc.46 the court held that an additional term in an acceptance that required all disputes to be arbitrated became part of the contract because it did not fall within the surprise-​or-​hardship test. Similarly, in Southern Illinois Riverboat Casino Cruises, Inc. v. Triangle Insulation and Sheet Metal Co.47 the court erroneously held that an additional term in an acceptance that significantly limited the offeror’s remedies became part of the contract. The Official Comment to Section 2-​207 suggests that an additional term in the acceptance will drop away if it would result in surprise or hardship. Some cases suggest that an additional term that is not surprising will not be deemed to cause hardship.48 Most cases, however, treat surprise and hardship as independent tests.49 Moreover, under Section 2-​207 it is possible for additional terms to become part of a contract even though the terms are proposed after the contract is made, provided the terms satisfy the tests of Section 2-​207(2)(a)-​(c). As pointed out in Aceros Prefabricados, S.A. v. TradeArbed, Inc.,50 UCC Section 2-​207 Official Comment 2 states: Under [UCC Article  2] a proposed deal which in commercial understanding has in fact been closed is recognized as a contract. Therefore, any additional matter contained either in the writing

46.  282 F.3d 92, 100 (2d Cir. 2002). 47.  302 F.3d 667 (7th Cir. 2002). 48.  Union Carbide Corp. v. Oscar Mayer Foods Corp., 947 F.2d 1333, 1336–​37 (7th Cir. 1991); cf. Aceros, 282 F.3d at 101–​02 (2d Cir. 2002). 49.  For example, in Maxon Corp. v.  Tyler Pipe Indus., Inc., 497 N.E.2d 570 (Ind. Ct. App.  1986), the court said: . . . [E]‌ven if Tyler [the offeror] was not surprised by the indemnity clause in Maxon’s invoice, the clause is nevertheless a material alteration if its incorporation without Tyler’s express awareness would result in hardship. There can be no doubt that Maxon’s indemnity clause would impose serious hardship if incorporated without Tyler’s express awareness. By its very nature, a clause which shifts liability from a negligent party to an innocent party imposes hardship. Accordingly, we hold that Maxon’s indemnity clause constitutes a material alteration as a matter of law.

Id. at 576. Similarly, in Horning Co. v. Falconer Glass Industries, Inc., 730 F. Supp. 962, 967 (S.D. Ind. 1990), the court held that although a term limiting consequential damages was not surprising because of industry practice, the term did not become part of the contract because it would result in hardship. 50.  282 F.3d 92, 98 (2d Cir. 2002).

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intended to close the deal or in a later confirmation falls within Subsection (2)  and must be regarded as a proposal for an added term. . . . Therefore, were we to find that the contract between Aceros and TA was formed on January 12 . . . then the [later] confirmation orders would constitute written confirmation, stating terms additional to the January 12 agreement, and analysis would proceed under Section 2-​207(2).

So much for additional terms in a response to an offer. But what about different terms in a response? Section 2-​207(1) states that “a definite and seasonable expression of acceptance . . . operates as an acceptance even though it includes terms that are additional to or different from those offered. . . .” In contrast, Section 2-​207(2) refers to the effect of additional terms in an acceptance but says nothing about the effect of different—​or perhaps more accurately, conflicting—​terms. One possible interpretation of these provisions is that Section 2-​207(2) does not address different terms since it is unnecessary to do so, either because different terms necessarily materially alter the terms of the contract and therefore fall away under Section 2-​207(2)(b) or because the terms of an offer give implicit notice of objection to different terms, which therefore fall away under Section 2-​207(2)(c). Such an interpretation, however, would defeat the purpose of Section 2-​207, because it would shift the law from the undesirable last-​shot rule to an undesirable first-​shot rule, under which the terms of the offer would always prevail. The courts have properly avoided this result by adopting the rule that Section 2-​207(2) doesn’t apply to different terms in an acceptance, and if a contract is formed under Section 2-​207(1) the conflicting terms in both the acceptance and the offer drop out.51 This rule is known as the knockout rule, because its effect is to knock conflicting terms of the offer and the acceptance out of the contract. Under the knockout rule if a Section 2-​207(1) contract is formed, the contract consists of those terms of the offer that are not knocked out by conflicting terms in the acceptance, those terms in the acceptance that do not conflict with terms of the offer and do not drop out under Section 2-​207(2)(a)–​(c), and terms supplied by law, trade usage, or the like. The knockout rule rests on several supports. One support is provided by Official Comment 6 to Section 2-​207: If no answer is received within a reasonable time after additional terms are proposed, it is both fair and commercially sound to assume that their inclusion has been assented to. Where clauses on confirming forms sent by both parties conflict each party must be assumed to object to a clause of the other conflicting with one on the confirmation sent by himself. As a result the requirement that there be notice of objection which is found in Subsection (2) is satisfied and the conflicting terms do not become a part of the contract. The contract then consists of the terms originally expressly agreed to, terms on which the confirmations agree, and terms supplied by this Act, including Subsection (2). The written confirmation is also subject to Section 2-​201. Under that Section a failure to respond permits enforcement of a prior oral agreement; under this Section a failure to respond permits additional terms to become part of the agreement.

51.  See Daitom, Inc. v.  Pennwalt Corp.  741 F.2d 1569, 1578–​79 (10th Cir. 1984); Gardner Zemke Co. v. Dunham Bush, Inc., 850 P.2d 319, 326–​27 (N.M. 1993).

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The support provided by Comment 6 is shaky because the Comment seems directed at confirmations sent after a contract is made rather than at the forms that comprise the original contract. A much stronger support for the knockout rule is that the rule is required to make Section 2-​207 work in the manner it was intended to work, by not privileging either set of terms. The following hypothetical illustrates the application of the knockout rule: Greek Letters. A sends B a form offer that consists of individualized terms and the standardized terms Alpha, Beta, Gamma, Delta, and Epsilon. B responds with an acceptance that consists of matching individualized terms and the standardized terms Eta, Theta, Iota, Kappa, Lambda, and Omega. The terms Eta and Theta in the acceptance differ from the terms Alpha and Beta in the offer. The term Iota in the acceptance does not conflict with the terms of the offer, but would materially alter the contract. The terms Kappa, Lambda, and Omega do not conflict with the terms of the offer, materially alter those terms, or otherwise fall within Section 2-​207(2)(a)-​(c).

In this hypothetical the terms Alpha and Beta in the offer would drop out of the contract under the knockout rule because they conflict with the terms Eta and Theta in the acceptance. The terms Eta and Theta in the acceptance would drop out of the contract for the same reason. The term Iota in the acceptance would drop out of the contract because it would materially alter the contract. The contract would then consist of the individualized terms; the standardized terms Gamma, Delta, and Epsilon from the offer; the standardized terms Kappa, Lambda, and Omega from the acceptance; and terms supplied by law, trade usage, or the like.

B.  SECTION 2-​207(3) CONTRACTS An important exception to Section 2-​207(1) complicates the applicability of that Subsection. Under the proviso in the last clause of the Subsection no contract is formed under 2-​207(1) if the acceptance “is expressly made conditional on assent to the additional or different terms.” A  contractual term in a response to an offer that falls within this proviso is referred to as a conditional-​assent provision. To constitute a conditional-​assent provision it is not enough that the response to the offer states that acceptance is conditional on certain additional or different terms becoming part of the contract. Rather, the response must state that acceptance is conditional upon the offeror’s assent to the additional or different terms.52 Since no contract is formed under Section 2-​207(1) if the response includes a conditional-​ assent provision, if such a provision is included then unless something more happens the offeror and the offeree are both free to walk away from the proposed deal. But suppose something more does happen. Specifically, suppose that although no contract is formed under Section 2-​207(1)

52.  A contract may be concluded, even in this kind of case, but the contract will be concluded not under Section 2-​207(1) by the exchange of forms, but under Section 2-​207(1) by delivery and acceptance of the relevant commodity.  ​A more difficult question is what language is needed if an acceptance is deemed to fall within the Section 2-​207(1) proviso. Some courts have in effect held that unless the language of the response virtually tracks language in the conditional-​assent proviso, the response will not fall within the proviso. See, e.g., Dorton v. Collins & Aikman Corp., 453 F.2d 1161, 1167–​69 (6th Cir. 1972). Other courts have taken a less stringent view. See, e.g., Step-​Saver Data Sys., Inc. v. Wyse Tech., 939 F.2d 91, 101–​02 (3d Cir. 1991).

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the seller ships the goods and the buyer accepts the shipment. In that case a contract is formed—​ not under Section 2-​207(1), but under Section 2-​207(3), which provides that “[c]‌onduct by both parties which recognizes the existence of a contract is sufficient to establish a contract for sale although the writings of the parties do not otherwise establish a contract.” The terms of a contract formed under Section 2-​207(3) consist of “those terms on which the writings of the parties agree, together with any supplementary terms incorporated under any other provisions of this Act.” A contract formed under Section 2-​207(3) is similar, but not identical, to a contract formed under Section 2-​207(1) and the knockout rule. If a contract is formed under Section 2-​207(1) then under the knockout rule conflicting standardized terms in the offer and acceptance knock each other out, but the standardized terms of the offer become part of the contract unless they are so knocked out. In contrast, under Section 2-​207(3) each and every standardized term in the offer drops out unless there is a matching term in the response.53 In practice, this means that the standardized terms of the offer and the response become part of the contract if they do not conflict. Take for example, the Greek Letters hypothetical. In a Subsection 2-​207(1) contract the terms Kappa, Lambda, and Omega in the offer would become part of the contract because there are no conflicting terms in the acceptance, so these terms would not be affected by the knockout rule. In a Section 2-​207(3) contract, however, those terms would not become part of the contract because they are not matched by terms in the response.

V.   S U B J E C T I V E A CCEPTA NCE An offeror may, if she chooses, invite an acceptance by the offeree’s subjective decision to accept. Why would an offeror invite such an acceptance? One possibility is that the offeror wants a contract to be formed at the earliest possible time. This kind of case is exemplified by Restatement Second Section 56, Illustration 2: A makes written application for life insurance through an agent for B Insurance Company, pays the first premium, and is given a receipt stating that the insurance “shall take effect as of the date of approval of the application” at B’s home office. Approval at the home office in accordance with B’s usual practice is an acceptance of A’s offer even though no steps are taken to notify A.

Another possibility is that the offer is prepared by the offeree for the offeror’s signature and the offeree wants the offeror to invite the offeree’s subjective acceptance. For example, in International Filter v. Conroe Gin, Ice & Light Co.54 International Filter, whose headquarters were in Chicago, made machinery to purify water for the manufacture of ice. Conroe Gin, Ice & Light Co., whose plant and office were in Conroe, Texas, made ice. On February 10, 1920, W.W.

53.  See, e.g., Diamond Fruit Growers, Inc. v. Krack Corp., 794 F.2d 1440, 1444 (9th Cir. 1986) (noting that unlike the common law’s last-​shot rule, which gives the advantage to whichever party sent the last form, § 2-​207(3) achieves a more neutral result, “giving neither party the terms it attempted to impose unilaterally on the other”); Jom Inc. v. Adell Plastics, Inc., 193 F.3d 47, 53 (1st Cir. 1999). 54.  277 S.W. 631 (Tex. Comm’n App. 1925).

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Waterman, an International Filter salesman, presented the following instrument (the instrument) to Henry Thompson, Conroe’s manager, at Conroe’s office: Gentlemen: We propose to furnish, f.o.b. Chicago, one No. two Junior (steel tank) International water softener and filter to purify water of the character shown by sample to be submitted. . . . Price: Twelve hundred thirty ($1,230.00) dollars. . . . This proposal is made in duplicate and becomes a contract when accepted by the purchaser and approved by an executive officer of the International Filter Company, at its office in Chicago. Any modification can only be made by duly approved supplementary agreement signed by both parties. This proposal is submitted for prompt acceptance, and unless so accepted is subject to change without notice. Respectfully submitted, International Filter Co. W.W. Waterman.

Thompson wrote on the instrument, “Accepted Feb. 10, 1920, Conroe Gin, Ice & Light Co., By Henry Thompson, Mgr.” and added, “Make shipment by Mar. 10.” On February 13, International Filter’s president endorsed the instrument at the company’s Chicago headquarters, “O.K. Feb. 13, 1920, P.N. Engel.” Although the instrument had the look and feel of an offer by International Filter (“We propose to furnish. . . .”), and was undoubtedly prepared by International Filter, legally the instrument was an offer by Conroe, not International Filter. An offer is a proposal to make a bargain contingent only on the offeree’s acceptance. Under the terms of the instrument Conroe could not conclude a bargain by acceptance. Rather, a bargain would be concluded only if the proposal was accepted by Conroe and then subjectively “approved by an executive officer of the International Filter Company, at its office in Chicago.” Accordingly, the instrument could not have been an acceptance. Instead, it constituted an offer by Conroe, to be accepted by International Filter through a subjective (that is, uncommunicated) approval of an executive officer at its headquarters. Offers that invite a subjective acceptance raise three basic issues. First. Should a contract be formed if the offeree subjectively accepts? The answer is yes. It is up to the offeror to determine whether a subjective acceptance suffices, and if the offer is properly interpreted to invite subjective acceptance, that kind of acceptance should suffice. International Filter so held. Conroe argued that a contract was not formed by Engel’s uncommunicated endorsement, but the court disagreed: “Here the fact of acceptance in the particular method prescribed by the offeror is established . . . Engel’s O.K. . . . on the paper at Chicago did that.” Second. Must the subjective acceptance be objectively manifested? Probably in most cases there will be an objective manifestation, as there was in International Filter. However, if the offer is properly interpreted as inviting a subjective acceptance whether or not objectively manifested, the law should not superimpose a requirement of objective manifestation. Third. Assuming a contract is formed by a subjective acceptance, should the offeree be required to notify the offeror that he has subjectively accepted the offer? In International Filter Conroe, the offeror, argued that even if Engel’s “O.K.” was an acceptance, International, the offeree, was required to notify Conroe of its acceptance and failed to do so. The court

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held that there was no such requirement.55 The same position is taken in Restatement Second Section 56, Illustration 2. This position is difficult to reconcile with the rule that notice of performance is required in the case of unilateral contracts, because there is a greater likelihood that in such a case an offeree’s performance will come to the offeror’s attention than there is that an offeree’s subjective decision will do so. It is easy for the offeree to give such notice, and as a matter of fairness he should be obliged to do so—​another type of duty to rescue in contract law.

V I .   E L E C T R O N I C A CCEPTA NCE Today, consumer and commercial contracts are commonly formed by electronic transactions. Two special statutes are potentially relevant to electronic contracting: the Uniform Electronic Transactions Act (UETA) and the Electronic Signatures in Global and National Communications Act (E-​SIGN). UETA is a model act proposed by the National Conference of Commissioners on Uniform State Laws for adoption by state legislatures. Although UETA has no legal force in itself, it has been adopted and put into legal force in almost every state. E-​SIGN is a federal statute that is generally comparable to UETA. Because E-​SIGN is a federal statute it would normally preempt UETA. However, E-​SIGN provides that subject to limited exceptions states may preempt E-​SIGN by adopting UETA. Because all but a few states have adopted UETA, in all but those few states UETA takes precedence over E-​SIGN. To reflect the widespread use of electronic contracting, the term record has come into use to encompass both written and electronic communications. UETA and E-​SIGN both define a record to mean “information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.”56 In a bread-​ and-​butter form of electronic contracting, A  sends an electronic offer to B, who responds with an electronic acceptance. In a more exotic form, both the offer and the acceptance are made by computers without human interaction other than the design and installation of the

55.  This rejection of a requirement of notice was particularly strong, because it is arguable that International did give notice, and the court could have rested its decision on that ground. On February 14, International wrote the following letter to Conroe: Feb. 14, 1920. Attention of Mr. Henry Thompson, Manager. Conroe Gin, Ice & Light Co., Conroe, Texas—​Gentlemen: This will acknowledge and thank you for your order given Mr. Waterman for a No. 2 Jr. steel tank International softener and filter, for 110 volt, 60 cycle, single phase current—​for shipment March 10th. Please make shipment of the sample of water promptly so that we may make the analysis and know the character of the water before shipment of the apparatus. Shipping tag is [enclosed], and please note the instructions to pack to guard against freezing.

Id. at 632. The court said, “[t]‌he letter of February 14th. . . . sufficiently communicated notice, if it was required.” Id. at 633. 56.  Unif. Elec. Transactions Act § 2(13), 7A pt. 1 U.L.A. 227 (1999); Electronic Signatures in Global and National Communications Act § 106(9), 15 U.S.C. § 7006(9) (2015).

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software programs.57 For example, in a type of electronic commerce known as Electronic Data Interchange (EDI), data in a standardized format is communicated electronically between computers.58 In a fully automated EDI environment trading partners develop software programs that eliminate human decision-​making for particular kinds of transactions. For example, A  may program its computer so that if A’s inventory of a given commodity falls below a designated level its computer will automatically generate and send to B’s computer an appropriate purchase order, including terms concerning description, price, quantity, and so forth. Similarly, B may program its computer to automatically accept any purchase order from A  whose terms fall within predefined parameters. Such a process permits ordering (offering), accepting, shipping, invoicing, and payment all to occur electronically, without human intervention.59

V I I .   W H E N A N   ACCEPTA NCE I S E F F E CT I VE In general, most contractual communications are effective when received. Acceptances, however, are treated in a special way. Under an early rule, which is still followed, if an acceptance is transmitted by mail, then unless the offer specifies otherwise the acceptance is effective when dispatched, provided it is sent by a means specified by the offeror or, if the offeror does not so specify, by a reasonable means. This rule is known as the mailbox rule or the dispatch rule, and is often associated with a famous English case, Adams v. Lindsell.60 For the mailbox rule to apply, the acceptance must be sent in a timely and proper manner and with appropriate care. However, unless the offeror prescribes the medium for communicating an acceptance, if the acceptance arrives on time a contract will be formed even if the offeree fails to use a reasonable medium or reasonable care in dispatching an acceptance. Thus, Restatement Second Section 67 provides that if an acceptance that is dispatched on time but through an unreasonable medium, or without reasonable care, nevertheless arrives on time, the acceptance will be effective on dispatch just as if it had been properly sent.61 In considering the issue, when should an acceptance be effective, three points must be kept in mind.

57.  See generally 2 Samuel Williston, Williston on Contracts § 6:41 (Richard A. Lord ed., 4th ed. 1990) (describing in detail the status of the rules and practices governing acceptance by electronic means). 58.  Transmissions of EDI messages may be made either directly between the parties or through service providers, which serve as a channel of communication for EDI transmissions and function as electronic-​ mail-​processing systems. They may maintain electronic mailboxes into which communications of trading partners can be placed. They may also interconnect with other service providers to permit communications between the providers’ respective customers. See Elec. Messaging Task Force, The Commercial Use of Electronic Data Interchange—​A Report and Model Trading Partner Agreement, 45 Bus. Law. 1645 (1990). 59.  See id. at 1655–​57. 60.  (1818) 106 Eng. Rep. 250; 1 B. & Ald. 681). 61.  See Restatement Second § 67.

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First, the issue arises in a variety of contexts, and different considerations may apply in different contexts. The most significant contexts will be discussed below. Second, in many contexts either a dispatch rule or a receipt rule would be justified. This is well-​illustrated by the divide on the issue between common law and civil law. Generally speaking, the common law applies a dispatch rule in the case of acceptance, whereas the civil law applies a receipt rule.62 Third, the issue may be affected by the mode in which the acceptance is transmitted. For ease of analysis, this Section begins by examining the effect of using regular mail to dispatch an acceptance and then examines the effect of using other modes of transmission.

A.  RECURRING SCENARIOS IN WHICH THE TIME-​OF-​EFFECTIVENESS ISSUE ARISES crossed revocation and acceptance .

One scenario in which the time-​of-​effectiveness issue arises occurs when an acceptance crosses with a revocation. Assume that A sends an offer to B by mail on June 1. The course of post is two days, so that B receives the offer on June 3. B accepts the offer by mail on that day and his acceptance reaches A on June 5. Meanwhile, however, on June 2 A has sent B a revocation, which reaches B on June 4. Here the revocation was dispatched before the acceptance was dispatched and was received before the acceptance was received. Nevertheless, under the mailbox rule a contract is formed; because a revocation, like most other contractual communications, is effective only when received (June 4) while an acceptance is effective when dispatched (June 3). An argument in favor of the mailbox rule in this scenario is that it pushes up the beginning of performance to the earliest possible date. Under the mailbox rule an offeree can safely begin to perform as soon as he dispatches his acceptance. In contrast, under a receipt rule an actor who has accepted by mail cannot safely begin performance until the time for course of post has passed without his having received a revocation. If it is assumed that, as seems likely, most offerors do not revoke, then offerors as a class are likely to prefer the mailbox rule because it is usually in their interest that performance begin as soon as possible. delay or failure of   transmission .

In another scenario a properly dispatched acceptance either fails to reach the offeror or is delayed past the time for acceptance. For example, suppose that Seller offers by mail to sell Blackacre to Buyer for $20,000 and gives Buyer five days in which to accept. Buyer promptly dispatches a letter of acceptance, but the letter miscarries and never reaches Seller, or reaches Seller in twenty days. After having waited ten days, Seller assumes that Buyer is not interested and sells Blackacre 62.  See United Nations Convention on Contracts for the International Sale of Goods (CISG) art. 18(2), 1489 U.N.T.S. 3, 62. This Article adopts a receipt rule: “An acceptance of an offer becomes effective at the moment the indication of assent reaches the offeror.” But Article 18(2) must be read in conjunction with Article 16(1), which provides that “an offer may be revoked if the revocation reaches the offeree before he has dispatched an acceptance.” Id. In other words, under the CISG once an offeree has dispatched an acceptance the offeror may no longer revoke, but if the acceptance is lost in the mail there is no contract. Accordingly, the CISG and the common law both protect the offeree against the possibility of revocation once the acceptance is dispatched, but the CISG places the risk of a lost communication on the offeree rather than the offeror.

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to someone else. Buyer, who has no reason to believe that his acceptance failed to reach Seller on time, or at all, disposes of premises in his possession in the expectation of occupying Blackacre. This scenario presents a difficult problem. On the one hand, application of the mailbox rule would allow offerees to begin performance at the earliest possible date (that is, immediately after dispatching the acceptance), which would benefit offerors as a class, because only a very few communications are likely to be lost or arrive late. On the other hand, unlike crossed-​ revocation-​and-​acceptance cases, where the offeror knows that the offeree decided to accept, in delay and failure-​to-​arrive cases the offeror is likely to believe that the offeree decided not to accept. The general rule is that the mailbox rule applies to delay and failure-​to-​arrive cases.63 However, expectation damages seem excessive in this context, and a better rule would be to hold the offeror liable only for the offeree’s reliance damages. what law governs a contract .

Where a contract has a relationship to two or more jurisdictions, under traditional choice-​of-​ law rules the place at which a contract is formed is a predominant factor in determining which jurisdiction’s law governs. Accordingly, if an acceptance is effective on dispatch the law of the jurisdiction from which the acceptance was dispatched would normally govern the contract. In contrast, if an acceptance is formed only on receipt the law of the jurisdiction in which the acceptance was received would normally govern the contract. options .

Some authorities, including Restatement Second, take the position that in the case of an option an acceptance is not effective until received.64 There is no sound reason to treat options differently than other offers, and other authorities apply the mailbox rule to the exercise of options.65 offeree ’ s change of   heart .

Another kind of problem arises when the offeree sends an acceptance and shortly thereafter sends a rejection of the offer or a repudiation of the acceptance. There are various permutations of this problem, depending on the order in which the communications are sent and received. The rule in such cases should be that normally an acceptance is effective on dispatch, so that a contract is formed at that point, but if a later-​sent rejection or repudiation leads the offeror to believe that the offeree does not intend to be bound despite the acceptance, and the offeror takes action in reliance on that belief, the offeree should be estopped from bringing suit on the contract.66 There is very little case law on these issues. Restatement Second adopts a variety of rules, most of which are consistent with the rule just stated. However, at least one is not: Restatement Second Section 40 provides that Rejection or counter-​offer by mail or telegram does not terminate the power of acceptance until received by the offeror, but limits the power so that a letter or telegram of acceptance started after

63.  The mailbox rule is also commonly applied to notices that are required either by contract or contract law. 64.  Scott-​Burr Stores Corp. v. Wilcox, 194 F.2d 989, 990–​91 (5th Cir. 1952); Cities Serv. Oil Co. v. Nat’l Shawmut Bank, 172 N.E.2d 104, 106 (Mass. 1961);) Restatement Second § 63. 65.  Shubert Theatrical Co. v. Rath, 271 F. 827, 833–​34 (2d Cir. 1921); Palo Alto Town & Country Vill. v. BBTC Co., 521 P.2d 1097, 1101 (Cal. 1974). 66.  For cases applying the dispatch rule to telephonic acceptances, see 2 Williston, supra note 57 § 6:34.

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the sending of an otherwise effective rejection or counter-​offer is only a counter-​offer unless the acceptance is received by the offeror before he receives the rejection or counter-​offer.

Under this rather convoluted rule, if (1) a rejection or counteroffer is sent, then (2) an acceptance is sent, then (3) the rejection is received, and then (4) the acceptance is received, there is no contract. The result under this rule does not turn on whether the offeror relied on the rejection or repudiation, and the comment to Section 40 makes clear that the rule of the Section is based on the probability of reliance rather than on actual reliance. The rule has little or nothing to recommend it. rejection followed by   acceptance .

A rejection is an expression by an offeree that turns an offer down. The general rule is that rejections, like most contractual communications other than acceptances, are effective only upon receipt.67 However, special problems arise when an offeree first dispatches a rejection and later changes his mind and dispatches an acceptance before the rejection is received. Because an acceptance is effective on dispatch and a rejection is effective on receipt, if the mailbox rule was applied to this scenario a contract would be formed on dispatch of the acceptance even if the offeror received the rejection before she received the acceptance. However, in such cases the offeror’s expectation will likely be that negotiations were terminated by the offeree’s rejection. If the offeror forms that expectation and relies on it the offeree should and will be estopped from enforcing the contract.68 But although the later-​arriving acceptance will not be effective as an acceptance it should and will be effective as a counteroffer creating a power of acceptance in the original offeror. Suppose the rejection arrives after the acceptance arrives? If the offeror receives the acceptance without having received the rejection his expectation is that a contract has been formed. That expectation should be protected. Accordingly, in such a case, the later-​arriving rejection is not effective as a rejection and does not relieve the offeree of liability under the contract. However, if the offeror believes the rejection is a repudiation of the contract and relies on that belief, the offeree should be and is estopped from enforcing the contract. repudiation of   acceptance .

A repudiation of an acceptance is a communication by an offeree who has dispatched an acceptance, which states that he has changed his mind and does not intend to be bound by his acceptance. In the case of a rejection the offeree turns down an offer. In contrast, in the case of a repudiation the offeree withdraws his own earlier acceptance. Accordingly, a repudiation can be dispatched only after an acceptance is dispatched, because before the acceptance is dispatched there is nothing to repudiate. Where an offeree sends both an acceptance and a later repudiation the result should turn on which communication arrives first. If the acceptance arrives first the offeror’s expectation is that a contract has been formed, and a later-​arriving repudiation should not override that expectation. The Restatement takes this position69 although the cases

67.  See Restatement Second § 40. 68.  See Restatement Second § 63. 69.  See id.

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are divided.70 Furthermore, if no contract was formed in this kind of sequence an offeree could speculate at the offeror’s expense by mailing an acceptance and then watching the market while the letter traveled through the mail. If the market moved in the offeree’s favor, she could let the acceptance ride, so that a contract would be formed. If the market moved against her, she could nullify the acceptance through a repudiation by an overtaking (faster) means of communication. If the repudiation arrives first the offeror should be able to rely on it. If he does, the offeree should and will be estopped from asserting that a contract was formed. withdrawal of   acceptance .

A withdrawal of an acceptance occurs when an offeree dispatches an acceptance and then manages to retrieve the acceptance before it reaches the offeror. For example, the offeree might mail a letter of acceptance and then retrieve it from the post office. There is very little law on this issue. The Restatement takes the position that the mailbox rule is applicable in such a case—​that is, a contract is formed when the acceptance is dispatched, and the withdrawal is therefore ineffective.71 Since the best justification for the mailbox rule is that the rule pushes up performance to the earliest possible date, and since where an offeror withdraws his offer before it is transmitted the offeree will not begin performing, it is not easy to see the rationale of the Restatement rule. Furthermore, there is an overwhelming practical problem in such cases: because the offeror never receives the acceptance, he likely will never learn that it had been withdrawn. interpretation of   an offer that sets a time limit for   acceptance .

Assume the following facts: On April 1, A makes an offer to B by mail. The course of post is two days. By its terms, the offer is open until April 5. B receives the offer on April 3 and mails an acceptance on April 4. B’s acceptance arrives on April 6—​that is, B’s acceptance is dispatched before April 5 but is received after April 5. Should A’s offer be interpreted to mean that B has to dispatch an acceptance by April 5 or that A must receive an acceptance by April 5? The better interpretation is that the acceptance must be dispatched by April 5, and this result is supported by case law.72 A related issue arises where an offer provides that it must be accepted within a designated period—​say ten days. Should the period begin to run from the date the offer is received or from the date it is sent? The better interpretation is that the period begins to run from the date the offer is received. This result is also supported by case law.73

70.  Compare Morrison v. Thoelke, 155 So. 2d 889, 905 (Fla. 1963) (contract formed) with Dick v. United States, 82 F. Supp. 326, 328–​29 (Ct. Cl. 1949) (contract not formed). 71.  Restatement Second § 63; see G.C. Casebolt Co. v. United States, 421 F.2d 710, 711 (Ct. Cl. 1970). 72.  See Falconer v. Mazess, 168 A.2d 558, 559–​60 (Pa. 1961). 73.  E.g., Caldwell v. Cline, 156 S.E. 55, 56 (W. Va. 1930).

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V I I I .   N E W M O D E S OF   T R A NS M I S S I ON The rules that govern the time at which an acceptance is effective were originally formulated when the basic modes of communication were face-​to-​face and by mail. Under those rules a mailed acceptance was governed by the dispatch rule. In contrast, a face-​to-​face acceptance was said to be governed by a receipt rule—​that is, an acceptance of a face-​to-​face offer was said to be effective only if and when the acceptance was heard by the offeror. It is not clear why either a dispatch or receipt rule was needed in the context of face-​to-​face conversations, because almost invariably the dispatch and the receipt will occur simultaneously: if A and B are conversing face to face, it’s exceptionally unlikely that A will accept B’s offer but B will not hear the acceptance. The rule was largely a construction of the commentators, not the courts. Accordingly, few if any cases have turned on when a face-​to-​face acceptance is effective. The rule may have been a product of a classical-​contract-​law distaste for the mailbox rule, which seemed to violate an axiom that a contractual expression must be communicated to be effective. As time went on, new technology led to new modes of communication—​first, electrical, such as telephone, telegraph, and telex; and later electronic, such as fax and email. With these new modes came new questions about whether an acceptance in one of the new modes was effective on dispatch or on receipt.74 This led to shallow and scholastic inquiries into whether a given new technology in was “more like” face-​to-​face communication or “more like” mail. Who cares? Unless the offeree uses a mode of transmission that carries a high risk of failure, it is difficult to see why all modes of transmission should not to be treated alike. Nevertheless, where the effective date of an acceptance has arisen as an issue in the context of a new technology, some authorities, including Restatement Second, have mechanically pigeonholed the relevant technology into one of the two traditional paradigms—​mail and face-​to-​face—​based on whether the technology resembles face-​to-​face communication, because it involves substantially instantaneous transmission and direct and immediate interaction, or resembles communication by mail, because it does not inherently involve such transmission and interaction. For example, Restatement Second Section 64 provides that “Acceptance given by telephone or other medium of substantially instantaneous two-​way communication is governed by the principles applicable to acceptances where the parties are in the presence of each other.” Of the few cases involving new technologies other than telegrams, most involved telex and concerned the question where a contract is formed for choice-​of-​law purposes. American cases held that at least for these purposes, a telexed acceptance was effective, and therefore a contract was formed, on dispatch.75 Much of the commentary concerning the effective date of an acceptance sent by one of the newer modes is meaningless, obsolete, or both. A telephonic acceptance, 74.  See 2 Williston, supra note 57 § 6:34. 75.  For example, in General Time Corp. v. Eye Encounter, Inc., 274 S.E.2d 391, 394–​95 (N.C. 1981), the court held that where a telexed acceptance was sent from North Carolina, the contract was made in North Carolina, so that suit could be brought in that state. In Norse Petroleum A/​S v. LVO Int’l, Inc., 389 A.2d 771, 773 (Del. Super. Ct. 1978) the court held that if a telexed acceptance was sent to Norway, Norwegian law governed. Two English cases look the other way. In Entores Ld. v. Miles Far East Corp., [1955] 2 Q.B. 327 at 334, the court held that where a contract is made by instantaneous communication, such as by telex, the contract is complete only when the acceptance is received by the offeror, so that where a telexed acceptance

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like a face-​to-​face acceptance, is unlikely not to be heard; telegram and telex are virtually gone; and although emails and other electronic communications are not necessarily dispatched and received simultaneously, the time lag between dispatch and receipt is normally measured in seconds or minutes. Furthermore, the commentators have tended to deal with newer modes of communication by using the mechanical test of whether the mode was more like face-​to-​face or more like mailed interaction, and the answer to that question, in turn, was said to depend on whether the mode involved “substantially instantaneous two-​way communication.” This conclusion seems to have been driven by classical-​contract-​law axiomatic reasoning, rather than normative considerations. So for example, the fourth edition of the Williston treatise states that “When the dispute revolves around the pure question of whether an offer has been accepted, so that a contract has been made, the courts should probably adopt the theoretically sounder view that analogizes these situations to those where the parties are in the presence of one another.”76 Generally speaking, all this was much ado about nothing, and the cases often do not follow the commentators. For example, the commentators often pigeonholed telephonic communications in the face-​to-​face category, so that the acceptance was effective only when heard, while the courts generally applied the dispatch rule to telephonic conversations, so that the acceptance was effective when spoken. The real issue concerning the newer modes of transmission is simple: Is there a function­al reason to distinguish an acceptance in any of those modes from an acceptance by mail? There isn’t. Accordingly, if the dispatch rule is deemed proper in the mail context then it should be followed in these other contexts as well. And although the law on this issue is not uniform, and is relatively sparse, a majority of the few relevant cases do apply the dispatch rule to the newer technologies.

was sent from Amsterdam to London the contract was made in England, and an action therefore could be brought on the contract in England. A comparable result was reached in Brinkibon Ltd. v. Stahag Stahl und Stahiwarenhandels GmbH, [1983] AC 34 (H.L.) at 42–​43.   UETA and E-​SIGN don’t address the issue. UETA Section 15 specifies in detail when an electronic rec­ ord is considered to be sent. Unif. Elec. Transactions Act § 15, 7A pt. 1 U.L.A. 274 (1999). However, the Comment to this Section states that “The effect of . . . sending and its import are determined by other law once it is determined that a sending has occurred.” (Emphasis added.) Id. at 275 cmt. 2. Presumably, “other law” includes contract law. E-​SIGN is to the same effect. In contrast, Section 215 of the Uniform Computer Information Transactions Act (UCITA) is intended to substitute a time-​of-​receipt rule for the mailbox rule in this case of electronic communication. Unif. Comput. Info. Transactions Act § 215, 7 pt. 2 U.L.A. 327 (2002). However, UCITA has only been adopted in two states. 76. 2 Williston, supra note 57, § 6:34, at 460–​61 (emphasis added).

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The Termination of an Offeree’s Power of Acceptance An offe r vests in th e of f eree the p ow er of ac cep ta n ce, that i s ,

the power to conclude a bargain with the offeror. Much of the law of offer and acceptance concerns the question: What kinds of events and expressions terminate that power? This and the following chapters address that question. The types of events and expressions that will be considered are lapse, revocation of offers for bilateral contracts, revocation of offers for unilateral contracts, indirect revocation, withdrawal of general offers, and death or incapacity.

I .   L APS E Perhaps the most common event that terminates the power of acceptance is lapse. The doctrine of lapse centers on the concept that there is a point in time at which it is too late to accept an offer. Put this way, the concept is simple. The difficult questions arise in determining how late is too late.

A.  THE GENERAL RULE Some offers state a fixed date or period for acceptance. Offers of this type seldom give rise to questions concerning lapse. Rather, most lapse questions arise when the offer does not state a fixed date or period for acceptance. The general rule in such cases is that the power of acceptance lapses after the expiration of a reasonable time.1 This rule is oversimplified, because it does not take subjective intentions into account and under the general principles of interpretation subjective intentions can be taken into account, where appropriate, in interpreting expressions. The courts should and do take these intentions into account in

1.  Restatement (Second) of the Law of Contracts § 41(1) (Am. Law Inst. 1981)  [hereinafter Restatement Second].

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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determining whether an offer has lapsed. For example, in Mactier’s Administrators v.  Frith2 Seller and Buyer were jointly interested in a shipment of brandy from France to New York. Seller in St. Domingo wrote to Buyer in New  York, proposing that Buyer take over Seller’s interest. More than two months after receiving this offer, and two weeks after the brandy had arrived in New York, Buyer posted an acceptance. Buyer’s acceptance crossed in the mails with a letter from Seller renewing the offer. The court held that Seller’s renewal letter was relevant to determining whether the offer had lapsed because the letter showed that Seller subjectively believed the offer was still open.3 Other cases have reached the same result through the theory of waiver. For example, in Forbes v. Board of Missions of Methodist Episcopal Church4 an offer was made on May 14 after extended discussions. The offer consisted of a written contract, signed by A, to convey real property to B for a designated consideration. Almost eight months later B signed the contract and delivered it to A through an intermediary. A gave the intermediary a receipt. The court held that although A might have had the right to decline B’s acceptance as too late, A waived the right to complain of the delay by making no objection to the acceptance, taking the contract that the intermediary proffered, and giving the intermediary a receipt.5

B.  THE CONVERSATION RULE The general rule governing lapse is supplemented by several special rules, the most prominent of which concerns offers that are made in the course of conversation. The rule on this issue is stated as follows in the Comment to Restatement Second Section 41: Where the parties bargain face to face or over the telephone, the time for acceptance does not ordinarily extend beyond the end of the conversation unless a contrary intention is indicated.

The rule is exemplified in Illustration 4: While A and B are engaged in conversation, A makes B an offer to which B then makes no reply, but on meeting A again a few hours later B states that he accepts the offer. There is no contract unless the offer or the circumstances indicate that the offer is intended to continue beyond the immediate conversation.

Under this rule an offer that would have been interpreted still to be open if it had been made by a means other than conversation is presumed to have lapsed solely because it was made in conversation. It seems unlikely that bargaining parties would invariably conclude that an offer made in conversation, which would not have lapsed had it been made by other means, ordinarily lapses the moment the conversation is over. Perhaps for this reason the conversation rule is normally formulated as a presumption. As Restatement Second puts it, the presumption may be overcome 2.  6 Wend. 103 (N.Y. 1830). 3.  Id. at 122–​23. See also R.E. Crummer & Co. v. Nuveen, 147 F.2d 3, 5 (7th Cir. 1945) (an offer does not lapse even after a reasonable time if the parties treat the offer as continuing in force). 4.  110 P.2d 3 (Cal. 1941). 5.  Id. at 9–​10. For other cases using the waiver theory to reach similar results, see Sabo v. Fasano, 201 Cal. Rptr. 270, 274 (Ct. App. 1984); Davies v. Langin, 21 Cal. Rptr. 682, 685–​86 (Ct. App. 1962).

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where “a contrary intention is indicated” or “the circumstances indicate [that the rule is otherwise inapplicable].” The conversation rule finds its support principally in secondary authorities rather than in case law. Of the handful of cases that have addressed the issue6 some are off-​point, and others seem to reject the rule. For example, in Textron, Inc. v. Froelich7 a fabricator of steel and wire products orally offered to sell a steel broker specified quantities of two sizes of steel rods at specified prices. The broker orally responded that he might want the rods but wished to check with his customers before buying them. Five weeks later the broker called the fabricator and agreed to buy one size of rods at the price originally proposed. Two days later he agreed to purchase the other size, again at the earlier-​proposed price. Subsequently, the broker refused to take the rods, claiming that no contract had been formed because under the conversation rule his acceptance was not timely. The fabricator brought suit. The trial court dismissed the fabricator’s claim, but the Pennsylvania Superior Court reversed: There may be times when a judge could find as a matter of law that an oral offer made in the course of a conversation terminates with the end of the conversation. If there is any doubt as to what is a reasonable interpretation, the decision should be left to the jury. In this case, the appellant had informed the appellee that he wanted time to contact some customers before accepting the offer, which was only natural for a steel broker. Under the circumstances, it is possible that a jury could have found that the oral offer continued beyond the end of the conversation.8

6.  The first edition of Williston cited only two cases in support of the rule: Mactier’s Adm’rs v. Frith, 6 Wend. 103 (N.Y. 1830), and Vincent v. Woodland Oil Co., 30 A. 991 (Pa. 1895). 1 Samuel Williston, The Law of Contracts § 54, at 92 & n.33 (1920). The Corbin treatise cited no case at all. 1 Arthur L. Corbin, Corbin on Contracts § 29, at 84–​88 (1963). Today, the two treatises cite only three additional cases: Akers v. J. B. Sedberry, Inc., 286 S.W.2d 617 (Tenn. Ct. App. 1955); Textron, Inc. v. Froelich, 302 A.2d 426 (Pa. Super. Ct. 1973); and Wagenvoord Broadcasting Co. v. Canal Automatic Transmission Serv., Inc., 176 So. 2d 188 (La. Ct. App. 1965). See 1 Samuel Williston, The Law of Contracts § 5:7, at 953 & n.4 (Richard A. Lord ed., 4th ed., 1990); 1 Arthur L. Corbin, Corbin on Contracts § 2.16, at 207 & n.7 (Joseph M. Perillo ed., rev. ed. 1993). Of the cases cited by Williston and Corbin, in Mactier’s Administrators the offer was made in a letter, not in a conversation. 6 Wend. at 120, and in Vincent and Wagenvoord the issue was whether the offer was effectively revoked. Vincent, 30 A. at 991; Wagenvoord, 176 So. 2d at 190. Vincent also stressed that the subject matter of the offer, oil-​producing wells, was liable to fluctuations in value that raised a presumption that time was of the essence, that a new development might at any hour materially affect the value of the wells, and that this was understood by the parties. Vincent, 30 A. at 991. 7.  302 A.2d 426 (Pa. Super. Ct. 1973). 8.  Id. at 427. See also Caldwell v. E.F. Spears & Sons, 216 S.W. 83 (Ky. 1919). Cobb, the plaintiff ’s agent, testified that the defendant had offered to accept 10¢ per pound for his hemp, and that Cobb replied, “Well, I want to see what I can do here with the farmers to-​day in locating crops and so on; and I will let you know.” Caldwell, supra, at 84. The next day, Cobb accepted the defendant’s offer. The trial court directed the jury to find for the plaintiffs if it believed from the evidence that the offer was not confined to the day upon which it was made, and the jury returned a verdict for the plaintiffs. The appellate court affirmed. “[T]‌he . . . question is whether the communication of the acceptance on the next day was within a reasonable time, under the circumstances of the case. That the answer should be in the affirmative we think there can be no doubt.” Caldwell, supra, at 85.

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C.  FAILURE TO NOTIFY AN OFFEREE THAT HIS ACCEPTANCE IS TOO LATE Suppose that A makes an offer to B and the offer does not state a date or period for acceptance. B accepts the offer after the expiration of a reasonable time but within a period of time that B could plausibly have believed, and did believe, was reasonable. The rule in such a case should be and is that although the acceptance does not form a contract the offeror is under a duty, imposed as a matter of fairness, to inform the offeree that his acceptance was too late. If the offeror fails to so, she will be liable on the contract. As stated in Phillips v. Moor:9 It is true that an offer, to be binding upon the party making it, must be accepted within a reasonable time . . . but if the party to whom it is made, makes known his acceptance of it to the party making it, within any period which he could fairly have supposed to be reasonable, good faith requires the maker, if he intends to retract on account of the delay, to make known that intention promptly. If he does not, he must be regarded as waiving any objection to the acceptance as being too late.10

This rule is an instantiation of the duty to rescue in contract law (see Chapter 9). In cases such as Phillips v.  Moor if the offeror does not give notice that the acceptance is too late the offeree may suffer a substantial loss by forgoing another opportunity or the like, while it costs the offeror virtually nothing to give such a notice.

I I .   R E V O C AT I O N OF   OF F ER S F O R   B I L AT E R A L CONT R A CT S An offer is a promise to enter into and perform a bargain on stated terms if the offeree accepts. The general rule is that unless an offeror explicitly or implicitly promises that the offer is irrevocable she may revoke the offer at any time before acceptance. Often, however, an offeror will expressly or impliedly promise to hold the offer open for a given period of time. In conventional usage, where such an offer is for a bilateral contract it is called an option if the promise to hold the offer open is given in exchange for consideration, and a firm offer if it is not. Although those terms are sometimes used interchangeably, the conventional usage will be followed in this book. An option is a bargain. Therefore, if an offeror revokes an option before it expires she is liable for expectation damages. In contrast, under classical contract law a promise to hold an offer open was unenforceable unless the offeree gave consideration for the promise, and an offeror who revoked a firm offer therefore was not liable for damages.11 This rule will be referred to in this book as the firm-​offer rule. 9.  71 Me. 78 (1880). 10.  Id. at 80; see also Kurio v. United States, 429 F. Supp. 42, 64 (S.D. Tex. 1970); Forbes v. Bd. of Missions of Methodist Episcopal Church, S., 110 P.2d 3, 8 (Cal. 1941); Sabo v. Fasno, 201 Cal. Rptr. 270, 274 (Ct. App. 1984); Davies v. Langin, 21 Cal. Rptr. 682, 686 (Ct. App. 1962); Restatement Second § 70. 11.  See, e.g., [1876] Dickinson v. Dodds, 2 Ch D. 463 (C.A.) at 472. (Eng.).

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Like most classical-​contract-​law rules, the firm-​offer rule was based on a combination of axiomatic and deductive legal reasoning. The axiom, which formed the major premise of the reasoning, was that only bargain promises are enforceable (although an exception was tolerated on purely historical grounds for promises under seal). The minor premise was that a promise to hold an offer open is not bargained for. (If it was bargained for it would be an enforceable option.) The deductive conclusion was that a firm offer is unenforceable. Accordingly, a promise to hold an offer open for a period of time, if not given for consideration, was treated as an unenforceable donative promise even though the promise was made in the world of commerce, not the affective world, and it was clear that the offeror had not the slightest intention of conferring a gift upon the offeree. The firm-​offer rule is unjustified. To begin with, an offeror makes a firm offer for self-​regarding reasons, not other-​regarding reasons. An offeror will not promise to hold an offer open unless she thinks that she will get a benefit from making the promise—​in particular, an increase in the probability of exchange with the offeree. In some cases an offeree is unlikely even to consider an offer unless the offer is firm. For example, if an offeree solicits an offer for the purpose of determining his costs in providing goods or services to third parties he is unlikely to consider a non-​firm offer because he could not reliably determine his costs on the basis of such an offer. In other cases an offeree is likely to give more deliberation to an offer if it is firm than if it is not. In considering whether to accept an offer an offeree must make an investment of time and, often, money. The offeree is more likely to make such an investment, or likely to make a greater investment, if he is sure that the offer will be held open while the investment is being made. The purpose of a firm offer is to induce the offeree to make such an investment so as to increase the probability that the offer will be accepted. Accordingly, although the firm-​offer rule may serve the immediate interests of a revoking offeror, the rule is against the long-​term interests of offerors as a class because it diminishes their ability to achieve their desired ends: if firm offers are unenforceable offerees will not make the kinds of investments in deliberation that such offers are intended to induce—​ or at least will make such investments at a much lower rate—​because of the risk of forfeiting the investment if the offer is revoked after the offeree has begun to invest but before he has accepted. Next, a firm offer should be enforceable as a structural agreement. A structural agreement is a dynamic promissory structure designed to increase the probability of exchange. A promise to hold an offer open is one example of such a structure. Firm offers normally do not arise out of the blue. Typically, the offeror, after discussion with the offeree, structures the offer to consist of terms that the offeror is willing to accept and the offeree is willing to seriously entertain. Firm offers therefore should be enforceable for the same reasons that all structural agreements should be enforceable: they enhance the probability of exchange. Indeed, a promise to hold an offer open is typically not just a structural agreement; it is also part of a bargain—​a bargain for a chance. That bargain is a unilateral contract, consisting of the offeror’s promise to hold the offer open in exchange for the offeree’s deliberation on the offer—​ that is, for the act of giving the offeror a chance. How do we know that an offeree did deliberate on the offer and thereby gave the offeror the chance that he was bargaining for? In firm-​offer cases the issue of enforceability arises only when the offeree wants to accept the offer. Therefore, it can fairly be presumed that the offeror has induced the deliberation that she sought. Is the chance of an increased probability of exchange as a result of such deliberation actually valuable to the offeror? That is not the law’s concern. The law does not need to speculate about the value to the offeror of the increased probability of exchange, because by making a firm offer the offeror

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reveals that for her this value is equal to or greater than the value she puts on her commitment. In any event inducing an offeree to give an offeror a chance will usually be much more valuable to the offeror than the piddling amount of cash that would transform the firm offer into an option. Finally, a rule that firm offers are enforceable is a better default rule than an unenforceability rule. It is easy for an offeror to contract around an enforceability rule by stating that the offer is revocable at any time. An unenforceability rule is harder to contract around because it is a rule of consideration, and rules of consideration cannot easily if at all be nullified by words. It is sometimes argued in favor of the firm-​offer rule that if a commitment is involved in a firm offer, it is one-​sided. However, it is difficult to see why that should be an argument against enforceability. Classical contract law placed mutuality high in the pantheon of virtues, but there is no reason of policy, morals, or experience that mutuality should be a condition to enforceability. As Thomas Scanlon has pointed out, if A provides assurance to B that she will do a certain act, knowing that B wants that assurance, A is under a moral duty to perform the act. If A does not want to come under such a duty she should warn B that she remains free to change her mind. A’s power to costlessly avoid coming under a duty to perform by providing such a warning makes it easy to conclude that A is duty-​bound if she fails to warn.12 Scanlon analyzes this duty in terms of fidelity: If (1) A voluntarily and intentionally leads B to expect that A will do x . . . ; (2) A knows that B wants to be assured of this; (3)  A  acts with the aim of providing this assurance, and has good reason to believe that he or she has done so; (4) B knows that A has the beliefs and intentions just described; (5) A intends for B to know this, and knows that B knows it; and (6) B knows that A has this knowledge and intent; then, in the absence of some special justification A must do x unless B consents to x’s not being done. The fact that potential B’s have reason to insist on such a duty of fidelity is in my view sufficient to establish it as a duty unless it would be reasonable for potential A’s to reject such a principle. Would the duty described impose an unreasonable burden on those who create expectations in others? They could of course avoid bearing any burden at all simply by refraining from intentional creation of any expectations about their future conduct. . . . [The fidelity principle] applies only when A knows that B wants assurance, and when A has acted with the aim of supplying this assurance and has reason to believe that he or she has done so, and when this and other features of the situation are mutual knowledge. No one could reasonably object to a principle imposing, in such cases, at least a duty to warn at the time the expectation is created—​to say, “This is my present intention, but of course I may change my mind,” or to make this clear in some other way if it is not already clear in the context. Since the burden of such a duty to warn is so slight, one can hardly complain if failure to fulfill it leaves one open to the more stringent duty to perform or seek permission to substitute.13

Of course, Scanlon here addresses moral rather than legal commitments, but the structure of his argument applies to legal commitments as well. As Jim Gordley has said, the fact that only one party is committed does not show that one-​sided commitments are unfair.14 One-​sided 12.  Thomas Scanlon, Promises and Practices, 19 Phil. & Pub. Aff. 199, 208 (1990). 13.  Id. at 208–​09. 14.  James Gordley, Enforcing Promises, 82 Cal. L. Rev. 547, 602 (1995).

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commitments “[are] fair if the advantage the committed party received was greater than any opportunity lost by making the commitment.”15 A person who makes a firm offer knows that she is making a one-​sided commitment, and believes that the advantages she gains by making the commitment exceed her costs. Why should the courts review the prudence or fairness of a firm offer any more than they should review the prudence or fairness of bargains generally? Indeed, all offers, not only firm offers, are one-​sided commitments. An offeror commits herself to enter into and perform a bargain on specified terms if the offeree accepts. Unless and until the offeree’s power of acceptance is terminated the offeree has power to bind the offeror, but the offeror does not have power to bind the offeree. The one-​sidedness argument is frequently stressed in the context of construction bidding. Typically, subcontractors make firm offers in the form of bids to general contractors, who in turn rely on the subcontractors’ bids to compile their own bids for the overall contract.16 Since an offer is a promise this reliance renders the offer—​that is, the bid—​enforceable (see Part III-​ C). If firm offers are enforceable, the subcontractor is bound although the general is not: the subcontractor is bound because the general contractor relied on the subcontractor’s bid, but the general contractor is not bound because the subcontractor did not rely on him. This can give rise to special complications. In particular, a general contractor may peddle the lowest subcontractor’s bid to the losing bidders to get them to reduce their bids and thereby land the subcontract, or may try to chop down the lowest subcontractor’s price by threatening to engage in bid-​peddling. However, there are straightforward means to enforce subcontractor’s bids while handling these complications. On the private-​ordering side, a subcontractor can provide that her bid is revocable at any time before acceptance. Subcontractors seem to rarely if ever take this approach, for the simple reason that a general contractor normally would not even consider such a bid. This illustrates that firm offers are made to advance the offeror’s interests. Or the subcontractor’s bid may provide that use of the bid by the general contractor will constitute an acceptance of the bid. Alternatively, a variety of legal rules could be adopted to address bid-​peddling and bid-​ chopping. Among these possible rules are the following:  (1) A  general contractor’s use of a subcontractor’s bid can be deemed to create a contract.17 (2) A subcontractor’s express or implied promise to hold her bid open for a period of time can be interpreted as subject to the implied condition that her bid will not be peddled or chopped. (3) If the subcontractor’s promise is to hold her bid open for a reasonable period, a general contractor who takes the time to engage in bid-​peddling or bid-​chopping should be deemed to exceed a reasonable time within which to accept the subcontractor’s bid. (4)  If a general contractor engages in bid-​peddling or bid-​ chopping, a subcontractor’s promise to hold her bid open should not be enforced on the basis of the contractor’s reliance, because justice does not require that reliance be protected in such a case. (5) Bid-​chopping could be deemed to constitute a counteroffer that terminates the gen­ eral contractor’s power of acceptance.18 In short, there are many ways of addressing the special 15.  Id. 16.  See Michael Gibson, Promissory Estoppel, Article 2 of the U.C.C., and the Restatement (Third) of Contracts, 73 Iowa L. Rev. 659, 703 (1988); Margaret N. Kniffin, Innovation or Aberration: Recovery for Reliance on a Contract Offer, as Permitted by the New Restatement (Second) of Contracts, 62 U. Det. L. Rev. 23, 24–​26 (1984). 17.  This issue will be discussed infra Chapter 55. 18.  See Section VII, infra.

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problem of one-​sidedness in construction bids without concluding that firm offers should be unenforceable because they are one-​sided.

I I I .   E X C E P T I O NS T O  T HE F I R M -​O F F ER   R UL E A mark of an unjustified rule is that courts, legislatures, or both adopt inconsistent exceptions to the rule, because a bad rule that is coupled with an inconsistent exception produces a good result. The firm-​offer rule carries this mark. Although the rule remains on the books and still has some bite19 it has been heavily eroded by inconsistent exceptions.

A.  NOMINAL CONSIDERATION To begin with, a number of cases hold that a firm offer is enforceable if nominal consideration—​ a few dollars—​changes hands.20 Restatement Second Section 71 adopts a general principle that nominal consideration does not suffice to make a promise enforceable.21 But Section 87(1)(a) makes an exception in the case of firm offers, adopting the rule that a firm offer is enforceable if the offer is in a writing signed by the offeror, states the purported consideration, and proposes an exchange on fair terms within a reasonable time.22 The rule that a firm offer is enforceable if there is nominal consideration is an inconsistent but desirable way to subvert the firm-​offer rule.

B.  EFFECT OF WRITING Next, UCC Section 2-​205 provides that with limited exceptions a firm offer to buy or sell goods is irrevocable if made in writing by a merchant: An offer by a merchant to buy or sell goods in a signed writing which by its terms gives assurance that it will be held open is not revocable, for lack of consideration, during the time stated or if no time is stated for a reasonable time, but in no event may such period of irrevocability exceed three months; but any such term of assurance on a form supplied by the offeree must be separately signed by the offeror.

Similarly, under numerous state statutes firm offers are enforceable if made in writing. For example, New York General Obligations Law Section 5-​1109 provides that if a firm offer is made in writing, then with minor exceptions the offer is irrevocable during the designated period. UCC Section 2-​205 and statutes such as New York G.O.L. Section 5-​1109 are inconsistent with 19.  See Mark B. Wessman, Retraining the Gatekeeper: Further Reflections on the Doctrine of Consideration, 29 Loy. L.A. L. Rev. 713, 720–​23 (1996). 20.  See Restatement Second § 71 cmt. b. 21.  See id. § 71 cmt. b, illus. 4–​5. 22.  See id. § 87(1)(a).

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the firm-​offer rule. If the firm-​offer rule was justified, the UCC and these statutes would not be. However, it is the UCC and the state statutes that are justified, not the firm-​offer rule.

C. AUCTIONS Still another exception concerns auctions. As discussed in Chapter 31, auctions may be conducted with or without reserve. In an auction that is announced to be with reserve an auctioneer’s act of putting a lot on the auction block is an invitation to bid, bids are offers, and the auctioneer can withdraw the lot from sale unless and until he knocks down his hammer.23 However, in an auction that is announced to be without reserve an auctioneer cannot withdraw a lot once it has been put on the auction block unless bidding does not begin within a reasonable time.24 In other words, in an auction stated to be without reserve the auctioneer must keep the offer to sell open even though he has been given no consideration for doing so. This is tantamount to a rule that an auction without reserve is an enforceable firm offer.25

D. RELIANCE Finally, under modern contract law a firm offer is enforceable if it is relied upon.26 This principle is adopted in numerous cases and is embodied in Restatement Second Section 87(2): “An offer which the offeree should reasonably expect to induce action or forbearance of a substantial character on the part of the offeree before acceptance and which does induce such action or forbearance is binding as an option contract to the extent necessary to avoid injustice.”27 Here, as elsewhere, Restatement Second gets it almost but not quite right. Reliance has an extremely important place in many areas of contract law, but the firm offer is not one of those areas. The question should not be whether a firm offer was relied upon but whether a firm offer was made. If a firm offer has been made it should be enforceable even without reliance for the reasons given earlier in this chapter. Furthermore, by its emphasis on reliance Restatement Second Section 87(2) muddies the remedial waters. Section 87(2) provides that a relied-​upon offer is binding as an option “to the extent necessary to avoid injustice.” This phrase is intended to make clear that damages for breach of a promise to hold an offer open that is enforceable only because of

23.  See U.C.C. § 2-​328(2)-​(3); see also Melvin Aron Eisenberg, Expression Rules in Contract Law and Problems of Offer and Acceptance, 82 Cal. L. Rev. 1127, 1172–​74 (1994). 24.  See U.C.C. § 2-​328(3). 25. In Barry v. Davies, [2000] 1 WLR 1962 (C.A.) at 1967 (Eng.), the court held that the auctioneer’s implied promise not to withdraw a lot from the auction block in an auction without reserve has consideration, because making a bid is a “detriment to the bidder, since his bid can be accepted unless and until withdrawn.” Although that is a plausible view, it fails to fully explain the without-​reserve rule. Under that rule, once a lot is put on the auction block it cannot be withdrawn unless bidding does not begin within a reasonable time. Accordingly, the auctioneer’s implied promise is enforceable even before any bid is made. See id. at 1965–​1967 (discussing the issue of consideration); Frank Meisel, What Price Auctions Without Reserve?, 64 Mod. L. Rev. 468, 468 (2001) (examining implications of Barry). A similar position was taken in J.W. Carter, Auction “Without Reserve”—​Barry v Davies, 17 J. Cont. L. 69 (2001) (discussing the case in detail). 26.  See, e.g., Drennan v. Star Paving Co., 333 P.2d 757, 760 (Cal. 1958). 27.  Restatement Second § 87(2).

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the promisee’s reliance can be measured in ways other than expectation damages Comment e to Section 87 makes this position clear: Full-​scale enforcement of the offered contract [under Section 87(2)] is not necessarily appropriate. . . . Restitution of benefits conferred may be enough, or partial or full reimbursement of losses may be proper. Various factors may influence the remedy: the formality of the offer, its commercial or social context, the extent to which the offeree’s reliance was understood to be at his own risk, the relative competence and the bargaining position of the parties, the degree of fault on the part of the offeror, the ease and certainty of proof of particular items of damage and the likelihood that unprovable damages have been suffered.

However, the revocation of an option gives rise to expectation damages, and there is no reason to treat firm offers differently. On the contrary, there are strong reasons to treat the remedies for breach of an option and the revocation of a firm offer the same way. Both options and firm offers are ancillary to and promote bargains, and indeed firm offers usually are bargains—​bargains for a chance. The reasons that expectation damages provide correct incentives to bargain promisors (see Chapter 5) therefore are also applicable to firm offers, and as a matter of positive law the courts usually do award expectation damages in such cases.28

I V.   R E V O C AT I O N OF   OF F ER S F O R   U N I L AT E R A L CONT R A CT S Suppose that A makes an offer to B to enter into a unilateral contract, that is, a contract to be formed by the exchange of a promise, in the form of an offer by A, for an act by B. Under classical contract law an offer to enter into a unilateral contract could be revoked at any time before the invited act had been completed, even if the offeree had begun to perform or had otherwise relied on the offer. This rule was exemplified in a pair of famous hypotheticals. In one, A offers B $100 to walk across the Brooklyn Bridge. After B has walked halfway across the Bridge A overtakes him and revokes. In the other A offers B $100 to climb a greased flagpole. After B has climbed halfway up A calls out to B and revokes. The result under classical contract law was the same in both hypotheticals: an offer for a unilateral contract is revocable until the requested act has been completed even if offeree had begun to act. Too bad for B. This rule will be referred to in this book as the unilateral-​contract rule. Like its cousin the firm-​offer rule, the unilateral-​contract rule was based solely on axiomatic and deductive reasoning, as follows: (1) An offer can be revoked at any time before it is accepted unless the offer is an option. (2) An offer for a unilateral contract is not an option, and such an offer is accepted by

28.  For an extended discussion of these issues along related but somewhat different lines, see Richard Craswell, Offer, Acceptance, and Efficient Reliance, 48 Stan. L.  Rev. 481, 499–​507 (1996). Craswell argues that courts should and do enforce offers when reliance by the offeree is efficient. One of the problems with this argument is that an accurate judicial determination of whether an offeree’s reliance is efficient is highly unlikely. The best judge of the efficiency of reliance by an offeree—​or any other promisee—​is the offeree himself, and the offeree expresses that judgment by the amount of reliance in which he engages.

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and only by completing the invited act. (3) Therefore, until the act is completed the offeror can revoke. The unilateral-​contract rule was unjustified for two reasons. First, the rule defeated the reasonable expectations of offerees. Peter Tiersma has put this point very well: [N]‌o reasonable person would intentionally create the sort of agreement that the traditional theory of unilateral contracts assumes. Suppose that a person, asserting his freedom to contract and his mastery over his offer, specifically intends to make a promise that will bind him not at the time he makes it, but only after the other party has completed a particular act in exchange. In other words, this promisor wishes to create the traditional unilateral contract. For example, he might tell the offeree that if she paints his house, he will—​once she is finished—​commit himself to paying her $1000. He makes it clear that he does not wish to be bound until she is completely finished, explaining to her that before she is finished he may revoke with impunity. What rational person would even buy the paint if she believed the speaker had not committed himself? The fact of the matter . . . is that very reasonable people spend substantial time and money doing the sorts of things that unilateral contracts attempt to induce them to do. The only rational explanation for such behavior is that . . . people believe the speaker is in fact committed then and there to paying the price if the conditions of the offer are met.29

Second, the unilateral-​contract rule, like the firm-​offer rule, favored revoking offerors but was against the interests of offerors as a class. It is in the interests of a party who makes an offer for a unilateral contract that the offeree act under the offer—​otherwise the offer would not be made—​and correspondingly that the offeree begin acting as soon as reasonably possible. If offers for unilateral contracts were revocable until the invited act was completed, offerees would not act under such offers, or at least would act at a much lower rate, because of the substantial risk of forfeiture that such an action would entail. Given the reasonable expectations of offerees and the best interests of offerors as a class, the rule should be that an offer for a unilateral contract is irrevocable until the expiration of a reasonable period during which the offeree, if he wishes to enter into the contract, begins the requested act and then diligently completes performance. A next-​best rule would be that an offer for a unilateral contract becomes irrevocable if and when the offeree takes action in reliance on the offer. Restatement First Section 45 (whose essentials are carried forward in Restatement Second Section 45)  broke away from the unilateral-​contract rule, but only in a half-​baked way. The framers of Restatement First—​in particular, Williston, as the Reporter—​understood that the unilateral-​contract rule was unsatisfactory. However, since the rule seemed to flow inexorably from the axioms of classical contract law, Williston struggled to find a way to depart from the rule without also departing from those axioms:30 he was willing to bend, but not to break. His solution was embodied in Restatement First Section 45: If an offer for a unilateral contract is made, and part of the consideration requested in the offer is given or tendered by the offeree in response thereto, the offeror is bound by a contract, the duty of 29.  Peter Meijes Tiersma, Reassessing Unilateral Contracts: The Role of Offer, Acceptance and Promise, 26 U.C. Davis L. Rev. 1, 29, 32–​33 (1992). 30.  In his article, Contracts Scholarship in the Age of the Anthology, 85 Mich. L.  Rev. 1406, 1453–​54, 1454 n.251 (1987), Allan Farnsworth pointed out an almost imperceptible but nevertheless important

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Contract Formation immediate performance of which is conditional on the full consideration being given or tendered within the time stated in the offer, or, if no time is stated therein, within a reasonable time.31

The theory behind this formulation was as follows: An offer for a unilateral contract carries with it an implied promise that the offeror will not revoke if the offeree begins and then diligently completes performance. If the offeree begins performance, that act concludes a bargain in the form of an option, in which the offeror’s implied promise to hold the offer open is exchanged for the offeree’s act of beginning performance. Since the option is a bargain it cannot properly be revoked, and if the offeror does revoke he will be liable for expectation damages based on the value of the contract that would have been formed by acceptance if the option had not been revoked. Unlike Restatement Second Section 87(2), discussed above, Section 45 takes the position that once an implied promise to keep an offer for a unilateral contract open becomes irrevocable, the remedy for breach of that promise is expectation damages. The theory is that despite the fact that liability under Section 45 is triggered only if the offeree takes a certain kind of action, Section 45 is not conceptualized as reliance-​based. Instead, under Section 45 the beginning of performance pursuant to an offer to enter into a unilateral contract is conceptualized as a bargain, consisting of the exchange of the beginning of performance for an implied promise to hold the offer open. To maintain this conceptualization, the text and comment of Section 45 draw a sharp distinction between beginning to perform and preparing to perform.32 Under Section 45, beginning to perform completes an implied bargain for an option and therefore makes enforceable the offeror’s implied promise to hold the offer open. In contrast, action in reliance by the offeree other than beginning to perform has no effect under Section 45, although the comment states that such action could have an effect under Section 90, which is reliance-​based, not bargain-​based. 33 The distinction in Section 45 between beginning to perform and preparing to perform is untenable as a matter of both practice and theory. Suppose A offers $10,000 to B if B produces a solution to a famous mathematical problem. B begins by developing new mathematical techniques that will be needed to solve the problem but will not be part of the proof. Has B prepared to perform, or has he begun to perform? And why should it matter? As Jim Gordley observes, in the Brooklyn Bridge hypothetical, under the preparation/​performance distinction if the offeree takes one step onto the Bridge the offeror cannot revoke, but if the offeree engages

progression in Williston’s thinking on this matter. In 1920, Williston stated in the first edition of his treatise that it “seems impossible on theory successfully to question the power [to revoke an offer for a unilateral contract before performance of the requested act has been completed] . . . though obvious injustice may arise.” Id. at 1453 (emphasis added) (quoting 1 Williston (1st ed.), supra note 6 § 60, at 100). Five years later, Williston stated that it “seems difficult on theory successfully to question the power” to revoke, “but great injustice may arise” if the power continues. Id. (emphasis added) (quoting ALI, Contracts Treatise No. 1 (a) Supporting Restatement No. 1, § 68, at 132 (1925)). 31.  Restatement (First) of Contracts § 45 (Am. Law Inst. 1932) [hereinafter Restatement First]. 32.  Restatement Second § 45 cmt. a. 33.  See Restatement Second § 45 cmt. f; Restatement First § 45 cmt. b.

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in massive preparations to get ready to cross the Bridge the offeror can revoke.34 Making important remedial consequences turn on whether an offeree has begun to perform, on the one hand, or has otherwise acted in reasonable reliance on the offer, on the other hand, is scholastic logic-​chopping. Indeed, even the framers of the Restatements had a hard time figuring out the difference between beginning to perform and preparing to perform. Take, for example, Illustrations 1 and 2 to Restatement Second Section 62: 1. A, a merchant, mails B, a carpenter in the same city, an offer to employ B to fit up A’s office in accordance with A’s specifications and B’s estimate previously submitted, the work to be completed in two weeks. The offer says, “You may begin at once,” and B immediately buys lumber and begins to work on it in his own shop. The next day, before B has sent a notice of acceptance or begun work at A’s office or rendered the lumber unfit for other jobs, A revokes the offer. The revocation is timely, since B has not begun to perform. 2. A, a regular customer of B, orders fragile goods from B which B carries in stock and ships in his own trucks. Following his usual practice, B selects the goods ordered, tags them as A’s, crates them and loads them on a truck at substantial expense. Performance has begun, and A’s offer is irrevocable.

There is no distinction between these two Illustrations. In Illustration 1, B has begun to work on the goods but he has not rendered the goods unfit for other jobs. In Illustration 2, B also has not rendered the goods unfit for other jobs—​B can simply unload the goods, uncrate them, and put them back in stock. It is true that in Illustration 2, B incurs a “substantial expense.” But no reason is apparent why incurring a substantial expense is relevant to determining whether an actor is preparing to perform or beginning to perform. Furthermore, buying goods at a time when they are not needed and doing work on goods, as in Illustration 1, may involve as much or more expense as the tagging, crating, and loading in Illustration 2.35 The untenable distinction between beginning to perform and preparing to perform serves to underline the impoverished rationale of Section 45. As in the case of firm offers for bilateral contracts, and for much the same reasons, the proper rule is that an implied promise to hold open an offer for a unilateral contract should be treated as an enforceable option ​and the remedy for breach of such a promise should be expectation damages.

34. Gordley, supra note 14, at 604–​05. 35.  Richard Craswell has suggested the following distinction between Illustrations 1 and 2. In Illustration 2, “[l]‌oading the truck is a relationship-​specific investment, for the expense of loading is wasted if [the buyer] backs out of the transaction.” In contrast, in Illustration 1, “the builder risked little . . . since even if the job offer were withdrawn, the lumber could still be used on the next job.” Craswell, supra note 29, at 529. This suggestion, however, does not account for the time value of the builder’s money and labor for purchasing and working on the lumber when it was otherwise unnecessary to do so. This time value is also relationship-​specific because it will be lost if the merchant’s revocation is effective.

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V.   “ I N D I R E C T R E VOCAT I ON” In the famous case of Dickinson v.  Dodds36 Dodds made a written offer to sell a property to Dickinson. Dodds made the offer on a Wednesday and promised to hold it open until 9:00 a.m. on Friday. On Thursday afternoon Dickinson acquired information that Dodds had changed his mind, although Dodds himself had not communicated a revocation to Dickinson. On Thursday evening, and again on Friday morning before 9:00 a.m., while knowing from secondhand information that Dodds probably had changed his mind, Dickinson tried to accept, but Dodds responded that it was too late because he had already sold the property. Dickinson brought suit. The court began by developing the rule, discussed above, that a firm offer is revocable until accepted. That rule was not in itself sufficient to allow Dodds to prevail, because Dodds had to establish not only that the offer was revocable but that it had been revoked. This presented a problem, because neither Dodds nor an agent of Dodds had communicated a revocation to Dickinson. The court dealt with this problem by laying down a second rule: that even though an offeror does not communicate a revocation, the offeree’s acquisition of knowledge that the offeror has changed his mind acts as a revocation.37 The school of classical contract law accepted this rule with reservations. Williston, for example, commented: Certainly there are . . . theoretical . . . difficulties involved in any rule allowing an effective revocation to be made by any one but the offeror. In theory, as an offer must be made by an act of the offeror moving toward the offeree, and no statement by third persons is sufficient, so it would seem that an offer could only be withdrawn by a direct expression of volition on the part of the offeror to the person to whom he had previously made the offer. . . . [C]‌ommunication is essential to the existence of revocation, indeed is the revocation. If so, it seems that the act of the offeror is as essential to withdraw his offer as to create it, and that the only way he can make his act effective is by communication from himself or his agent.38

Williston’s theoretical qualms were reflected in Restatement First Section 42, which grudgingly accepted the second rule of Dickinson v.  Dodds, but limited the cases to which it would apply: Where an offer is for the sale of an interest in land or in other things, if the offeror, after making the offer, sells or contracts to sell the interest to another person, and the offeree acquires reliable

36.  [1876] 2 Ch D. 463 (C.A.) at 464 (Eng.). 37.  Id. at 472–​75. On the revocability of firm offers, see Section II, supra. On the effect of the offeree’s knowledge that the offeror has changed her mind, see, e.g., McCutchan v. Iowa State Bank, 5 N.W.2d 813, 816 (Iowa 1942); Normile v. Miller, 306 S.E.2d 147, 150 (N.C. Ct. App. 1983), aff ’d as modified, 326 S.E.2d 11 (N.C. 1985); Giovanola v. Fort Lee Bldg. & Loan Ass’n, 196 A. 357, 360–​61 (N.J. Ch. 1938); Watters v. Lincoln, 135 N.W. 712, 715 (S.D. 1912); Knight v. Seattle First Nat’l Bank, 589 P.2d 1279, 1281 (Wash. Ct. App. 1979). 38.  1 Williston (1st ed.), supra note 6, § 57, at 97–​98 (emphasis added); see also C.C. Langdell, A Summary of the Law of Contracts 181 (2d ed. 1880).

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information of that fact, before he has exercised his power of creating a contract by acceptance of the offer, then the offer is revoked.39

Despite his theoretical qualms, Williston concluded that the result in Dickinson v.  Dodds was desirable.40 But if the result was desirable, how could there be theoretical qualms? Correspondingly, why was Restatement First Section 42 limited, as the reasoning in Dickinson v. Dodds was not, to the sale of “an interest in land or in other things”? Again, the answer lies in the axiomatic nature of classical contract law. One of the axioms of that system was that a power of acceptance could be terminated only by one of a closed set of events. As Williston put it in his first edition: The ways in which an offer may be terminated . . . are: (1) Rejection by the offeree; (2) Expiration of a time stated in the offer itself as the limit allowed for acceptance; (3) Expiration of a reasonable time, if no time limit is fixed by the offer; (4) Revocation by the offeror; (5) Death or insanity of either party.41

Williston’s theoretical difficulty, therefore, was that none of the events on this list had occurred in Dickinson v.  Dodds. As Willison correctly said, communication is as essential to a revocation as it is to an offer. Since the revocation in Dickinson v. Dodds was not communicated the offer could not have been revoked. If A says to B that she is making an offer to C, that is not an offer. Similarly, if A says to B that she is revoking an offer to C, that is not a revocation. But so what? The substantive question is not whether a revocation or some other event of the kind described on an axiomatic list has occurred, but whether an event has occurred of a kind that should terminate an offeree’s power of acceptance. If an offeree acquires reliable information that the offeror has changed her mind, at a time when the offer is revocable, the offeree does not have a legitimate expectation that he can conclude a bargain by his assent, and accordingly his power of acceptance should terminate. That is the position properly taken in Restatement Second, which provides simply that “[a]‌n offeree’s power of acceptance is terminated when the offeror takes definite action inconsistent with an intention to enter into the proposed contract and the offeree acquires reliable information to that effect.”42

39.  Restatement First § 42 (emphasis added). 40.  1 Williston (1st ed.), supra note 6, § 57. 41.  Id. Though Williston expanded this list in later editions, the revised list remained closed and axiomatic. For example, Samuel Williston, A Treatise on the Law of Contracts § 50A (Walter H.E. Jaeger ed., 3d ed. 1957) stated: The ways in which this continuing power created by the offer may be terminated . . . are: (1) Rejection by the offeree; (2) lapse of time specified or of a reasonable time where the offer is silent thereon; (3) occurrence of a condition laid down in the offer for that purpose; (4) the death or destruction of a person or thing necessary to the performance of the proposed contract; (5) supervening legal prohibition of such a contract; (6) revocation by the offeror; (7) death or legally incapacitating insanity of either party.

42.  Restatement Second § 43.

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V I .   T H E W I T HDR AWA L O F   G E N E R A L  OF F ER S Although the general rule under classical contract law was that an advertisement was not an offer, an exception was made for advertisements—​including mass mailings, posters, or the like—​that offered prizes or rewards. These types of advertisements are commonly referred to as general offers. General offers are almost invariably offers for unilateral contracts. Such offers are accepted by performance of the act specified in the offer. Suppose that a person who has made a revocable general offer attempts to revoke or withdraw the offer by publishing a retraction of the offer. As to an actor who became aware of the withdrawal of the general offer before he performed, began to perform, or otherwise justifiably relied, the withdrawal should and will be effective. As to an actor who performed, began to perform, or otherwise justifiably relied on the offer prior to its withdrawal, under the rules embodied in Restatement Second 45 and 87(2) concerning part performance pursuant to an offer for a unilateral contract and reliance on any type of offer, the withdrawal will be ineffective or at least not fully effective.43 But what about an actor who performed, began to perform, or otherwise justifiably relied after the notice of withdrawal was published but before the actor became aware of the withdrawal? There are not many cases on this issue,44 and those that exist are equivocal. Two of the leading cases are Shuey v. United States45 and Long v. Chronicle Publishing Co.46 In Shuey, on April 20, 1865, the Secretary of War published in newspapers a proclamation that the government would pay a $25,000 reward for the apprehension of John H. Surratt, one of the accomplices of John Wilkes Booth in the assassination of Abraham Lincoln, and liberal rewards for any information that conduced to Surratt’s arrest. Seven months later President Andrew Johnson published an order withdrawing the reward. Five months after that Shuey informed the American Minister in Rome that he had discovered and identified Surratt, who was then serving as a Zouave in the Pope’s army. At the request of the Minister Shuey kept watch on Surratt, and seven months later the Papal Government arrested Surratt. Both Shuey and the American Minister were unaware of the published withdrawal. Eventually Shuey was paid $10,000 under a special statute. He then sued for the balance of the $25,000 reward. The Supreme Court held that Shuey was not entitled to the balance, partly on the ground that in the absence of reliance a general offer can be revoked by a withdrawal published in the same way as the offer of the reward. “The offer of the reward not having been made to [Shuey] directly, but by means of a published proclamation, he should have known that it could be revoked in the manner in which it was made.”47 In Long, the San Francisco Chronicle had publicized a contest offering prizes to persons who sent the Chronicle the most new subscriptions accompanied by payments. During the last week 43.  However, the measure of damages in such cases can present difficult problems, because a person who has begun to perform under, or relied upon, an offer of a prize or reward might not have won even if the offer had not been withdrawn. This issue is discussed in Chapter 34, infra. 44.  See Corbin (rev. ed.), supra note 6, § 2.21; 1 Williston (4th ed.), supra note 6 § 5.12. 45.  92 U.S. 73 (1875). 46.  228 P. 873 (Cal. Dist. Ct. App. 1924). 47.  Shuey, 92 U.S. at 77.

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of the contest the Chronicle published a new contest rule under which a personal check would qualify as payment only if the check was for no more than $10. On the last day of the contest, Long sent in new subscriptions accompanied by the subscribers’ personal checks for $18 and $30. If the new contest rule was effective as to Long she was entitled only to third prize, but if the rule was not effective as to Long she was entitled to second prize. The Chronicle awarded Long the third prize, and Long sued for the second prize. The court held that the new rule was ineffective as to Long because the Chronicle knew who was participating in the contest, the participants were not that numerous, and therefore “the most natural thing to have been anticipated by each of the parties to the contract would have been an actual notification.”48 The few other cases that discuss the withdrawal of a general offer tend to accept the Shuey rule that a general offer can be revoked in the same manner that it is made, but then conclude that the rule is inapplicable on the facts because either the offeror could practicably have given individual notice, as in Long; the withdrawal was not publicized in the same manner as the offer; or the withdrawal was not sufficiently clear.49 Both commentators and the courts commonly consider the effectiveness of a published withdrawal of a general offer in terms of how general offers can be “revoked.” This terminology is inapt, for the same reason that the terminology “indirect revocation” is inapt: to constitute a revocation an expression needs to be communicated. The question should not be how general offers can be revoked, but whether a published withdrawal of a general offer should terminate the offeree’s power of acceptance.50 The functional problem is as follows: in a world of perfect cost-​free information and communication an offeror could know the identity of all persons who became aware of the offer and could costlessly communicate a withdrawal to those persons individually. Under those conditions, only individual withdrawals should be effective. In the real world, however, information and communication are neither perfect nor cost-​free. What should be the effect of a published but uncommunicated withdrawal under those conditions? A justification sometimes given for the Shuey rule is that unless a general offeror can terminate the offerees’ power of acceptance through a published withdrawal there would be no way for a general offeror to terminate the power of acceptance of offerees whose identity she does not know.51 This justification is unconvincing because the converse proposition is as strong or even stronger: if the offeree acts reasonably in response to an offer the offeror should be held liable because the offer is responsible for causing the offeree to act in this way. If the offeror did not want to be in a position where she could be liable even after publishing a withdrawal, she should have either refrained from making a general offer, conditioned the offer appropriately, or required persons who were planning to perform the requested act to register with her.

48.  Long, 228 P. at 876. Illustration 1 to Restatement Second Section 46 adopts the reasoning of Long. 49.  See, e.g., Carr v. Mahaska Cnty. Bankers Ass’n, 269 N.W. 494, 496–​97 (Iowa 1936); Woods v. Morgan City Lions Club, 588 So. 2d 1196, 1200 (La. Ct. App. 1991); Hoggard v. Dickerson, 165 S.W. 1135, 1139 (Mo. Ct. App. 1914); Vantage Point, Inc. v. Parker Bros., Inc., 529 F. Supp. 1204, 1217–​18 (E.D.N.Y. 1981). 50.  This terminology is used in the text, though not the title, of Restatement Second § 46: Where an offer is made by advertisement in a newspaper or other general notification to the public or to a number of persons whose identity is unknown to the offeror, the offeree’s power of acceptance is terminated when a notice of termination is given publicity by advertisement or other general notification equal to that given to the offer and no better means of notification is reasonably available.

51.  See, e.g., John Edward Murray, Jr., Murray on Contracts § 43, at 121 (5th ed. 2011).

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Another possible argument for the Shuey rule is that in the case of a general offer the offeree should make a daily check of the medium in which the offer was made to determine whether the offer has been withdrawn. Accordingly, this argument would go, it is unfair to allow an offeree to enforce a general offer that has been withdrawn through the same medium, because the offeree is at fault for not keeping up to date. This argument—​which was suggested in Shuey, where the court stated that the offeree “should have known that the offer could be revoked in the manner in which it was made”52—​is also unconvincing. If someone has seen an offer in a newspaper, why is he at fault for not reading that newspaper thereafter every day for weeks, months, or even years? In Long the court said, much more plausibly: The original rules [of the contest] contained neither an express declaration, nor anything from which it might reasonably be inferred, that any contestant for a prize under the subscription contest was either obliged, or was expected, to read possibly the whole of each and every edition of the newspaper thereafter published for the purpose of ascertaining whether or not any of the rules of the contest had been either modified or abandoned.53

There is one plausible rationale for the Shuey rule—​that because the offeror normally cannot prove that any given offeree knew of a published withdrawal, if the power to accept a general offer could not be terminated by such a publication, an offeree who knew of the published withdrawal could opportunistically claim that he did not. The issue then is one of choosing between two competing interests: the interest in protecting an offeror from this kind of opportunism, and the interest in protecting an offeree who accepts the offer in good faith without having knowl­ edge of the published withdrawal. In evaluating these competing interests it is relevant that general offers require acceptance by an act, not by a promise. This requirement gives some protection against opportunism. An offeree who becomes aware that the offer has been withdrawn is unlikely to opportunistically act under the offer because he knows that he will be buying into a lawsuit and may easily lose the value of the time and money he puts in. Furthermore, although the possibility of opportunism always needs to be weighed in determining whether a given legal rule should be adopted, that possibility is not in itself decisive. Many people choose to act morally rather than opportunistically, and even an opportunist will not succeed unless he perjuriously convinces the fact-​finder that he is telling the truth. On balance, therefore, a withdrawal of a general offer should only terminate the offeree’s power of acceptance if the offeror establishes that the offeree acquired knowledge of the withdrawal before relying on it, unless the offer otherwise provides.

V I I .   D E AT H O R I NCA PA CI T Y Under a traditional rule of contract law the death or incapacity of an offeror terminates the offeree’s power of acceptance if the offer is revocable when the death or incapacity occurs. This 52.  92 U.S. at 77. 53. 228 P. at 875.

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rule is unexceptionable where the offeree knows or has reason to know of the offeror’s death or incapacity before he accepts the offer. The rule is also unexceptionable where even in the absence of the rule the doctrine of unexpected circumstances would excuse the offeror’s estate from liability—​an example is a contract for personal services to be rendered by the offeror. The bite of the traditional rule, therefore, is that it applies even when the offeree accepts the offer before he either knows or has reason to know of the offeror’s death or incapacity, and in the absence of the traditional rule the offeror’s death or incapacity would not excuse her estate from liability. This bite should not be exaggerated. The traditional rule would normally be inapplicable to offers made by entities that have perpetual existence, such as corporations and governmental bodies. Indeed, the traditional rule would probably be deemed inapplicable to offers made by any business organization, even those that do not have perpetual existence. Probably too, the traditional rule would be deemed inapplicable to an offeror who transacted in a representative rather than an individual capacity, such as a trustee or an executor. Therefore, the principal application of the traditional death-​or-​incapacity rule is to cases in which the offer was made by an individual and the offeror’s estate is not excused by her death or incapacity under an unexpected-​circumstances doctrine. The traditional rule has been criticized on the ground that it defeats the reasonable expectations of an offeree who accepts an offer when he neither knew nor had reason to know of the offeror’s death or incapacity.54 The text of Restatement Second Section 48 adopts the traditional rule but the Comment criticizes it.55 “This rule,” the Comment states, “seems to be a relic of the obsolete view that a contract requires a ‘meeting of minds,’ and it is out of harmony with the modern doctrine that a manifestation of assent is effective without regard to actual mental assent.”56 Occasional cases have rejected the traditional rule that the death or incapacity of an offeror terminates the offeree’s power of acceptance if the offer is revocable. In Swift & Co. v. Smigel57 the offeror had been declared incompetent before the offer was accepted but the court nevertheless held that a contract was formed. The offer in that case was a guaranty by the offeror that he would pay for merchandise supplied to a corporation in which he had a substantial interest. The court stated: In the present instance decedent promised plaintiff to make good any bills for provisions incurred by a corporate business enterprise in which he had a one-​half stock interest. Had he not done so plaintiff presumably would not have taken on the business risk of selling to the corporation. It would seem to us that if plaintiff neither knew nor had any reason to know of decedent’s later adjudication as an incompetent during any portion of the time it was making the deliveries which gave rise to the debts here sued on, plaintiff ’s reasonable expectations based on decedent’s original continuing promise would be unjustifiably defeated by denial of recovery.

54.  See, e.g., Herman Oliphant, Duration and Termination of an Offer, 18 Mich. L.  Rev. 201, 209–​11 (1920); Note, Termination of Offers Contemplating Unilateral Contracts by Death, Insanity, or Bankruptcy of the Offeror, 24 Colum. L. Rev. 294, 295–​96 (1924). 55.  See Restatement Second § 48 cmt. a. 56.  Id. 57.  279 A.2d 895, 899–​900 (N.J. Super. Ct. App. Div. 1971), aff ’d, 289 A.2d 793 (N.J. 1972).

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If the situation is judged in terms of relative convenience, it would seem easier and more expectable for the guardian of the incompetent to notify at least those people with whom the incompetent had been doing business of the fact of adjudication than for the holder of a guaranty such as here to have to make a specific inquiry as to competency of the guarantor on each occasion of an advance of credit to the principal debtor.58

The great majority of cases, however, have upheld the traditional rule.59 It is easy to understand why this should be so where the rule only cuts off damages against the estate of an individual for nonperformance of an executory contract. As a practical matter a contract entered into by an individual will normally be worthless to her estate if she dies before performance is to occur, because normally there will be no way for the estate to perform. Think here of a sole entrepreneur who makes an offer in the ordinary course of business, then dies or becomes incapacitated, and no one can practicably take her place. Consider also that there may be no one who can timely perform the contract on the estate’s behalf because the appointment of a representative of an estate can be a lengthy process. Accordingly, it is understandable that the law would be reluctant to saddle an individual offeror’s estate with damages where the offeror died or became incapacitated before the offeree accepted. On the other hand, as Richard Craswell points out, it is often in an offeror’s interest that the offeree’s power of acceptance not be terminated by the unknown death or incapacity of the offeror,60 because the offeror may want to provide an incentive to the offeree to reliably take action without being concerned about an event of which he has no knowledge. Swift was a case of this sort. Under the offer in that case the offeror guaranteed extensions of credit by the offeree to a third party with whom the offeror was associated. It was therefore in the offeror’s interest that the offeree should be able to rely on the offer, and extend credit to the third party, unless and until the offeree actually learned of the offeror’s death or incapacity. The competing considerations that bear on the issues raised by the death or incapacity of an offeror are best reconciled by the following rule: If an offeree accepts an offer that was made by an individual who died or became incapacitated before the offer was accepted the offeree should not be entitled to recover expectation damages but should be entitled to recover, against the individual’s estate, reliance damages, that is, the amount of justifiable costs the offeree incurred after he accepted and before he learned of the offeror’s death or incapacity). In other cases the offeror’s death or incapacity, if unknown to the offeree, should not terminate the offeree’s power of acceptance.

58.  Id. at 899. 59.  See, e.g., New Headley Tobacco Warehouse Co. v. Gentry’s Ex’r, 212 S.W.2d 325, 327 (Ky. 1948) (an offer to extend term of lease was revoked on death of offeror); Beall v. Beall, 434 A.2d 1015, 1022 (Md. 1981) (when a husband and wife made an offer and the husband died, the offer lapsed); Johnson v. Moreau, 82 N.E.2d 802, 802–​03 (Mass. 1948) (where a partner offered partnership interest for sale but died three days before the acceptance was received, there was no contract); Am. Oil Co. v. Estate of Wigley, 169 So. 2d 454, 459 (Miss. 1964) (stating in dicta that notice of death is irrelevant or an offeror’s death is unnecessary to effect termination of an offere because death alone is sufficient). 60. Craswell, supra note 29, at 515–​16.

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V I I I .  R E JE C T I O N , COUNT ER -​O F F ER , A N D Q U A L I F I ED A CCEPTA NCE A recurring problem in offer-​and-​acceptance law is what kinds of responses to an offer should terminate the offeree’s power of acceptance. The underlying question in such cases should be whether the offeror would reasonably understand that the offeree’s response took the offer off the table. For example, suppose an offer states that it will be open for ten days, and as a result of a response by the offeree on the second day the offeror reasonably believes that the offer has been taken off the table. In that case the offeror will take no further steps to prepare for performance, and indeed may take steps based on the assumption that a contract will not occur. For example, the offeror may make a contract with a third party that she would not have made in the absence of the response. If the offeree then was able to accept on the tenth day, the offeror would be caught short.61 An obvious way to deal with the issue whether an offeree’s response terminates his power of acceptance would be to apply the general principles of interpretation to the response. This approach is sometimes utilized. More commonly, however, the offeree’s response is dealt with by application of expression rules under which a rejection, counteroffer, or conditional acceptance terminates the offeree’s power of acceptance. These rules, discussed below, are normally rationalized on an interpretive basis, although they sometimes seem to be taken as axiomatically true. (For a general discussion of expression rules, see Chapter 30.)

A. REJECTION A rejection is a response by an offeree that turns down the offer. Under a traditional expression rule, a rejection terminates the offeree’s power of acceptance.62 It is easy to justify this rule because it seems virtually certain that if the general principles of interpretation were applied, an offeror would reasonably understand a rejection to take her offer off the table. Although it is conceivable that in a few cases the general principles of interpretation would lead to a different result, such a scenario is so unlikely that the traditional expression rule is supported by an administrative justification. Even in this relatively easy case, however, the expression rule represents a prudential choice. If a rejection terminates the power of acceptance, that is not because a rejection logically has that effect but because the rejection rule is justified.

B.  COUNTER-​OFFERS A counteroffer is a response to an offer that concerns the same subject-​matter as the offer but makes a new, different offer.63 Under a traditional expression rule a counteroffer terminates 61.  See Restatement Second § 38 cmt. a; E. Allen Farnsworth, Contracts § 3.20, at 160–​61 (4th ed. 2004). 62.  See, e.g., Burton v. Coombs, 557 P.2d 148, 149 (Utah 1976). 63.  See Restatement Second § 39(1).

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the offeree’s power of acceptance.64 This rule is embodied in the Restatement Second Section 39, and the Comment to that Section justifies the rule on interpretive grounds. According to the Comment, the rule carries out “the usual understanding of bargainers that one proposal is dropped when another is taken under consideration; if alternative proposals are to be under consideration at the same time, warning is expected.”65 The force of this justification is doubtful. Suppose A says to B, “I will sell you my used Camry for $20,000 and I will give you three days to decide.” One day later B responds, “I will offer you $19,500 for the car.” It seems unlikely that the understanding of the parties would be that as a result of B’s response A’s offer is taken off the table. On the contrary, it seems likely that the parties would believe that A’s offer remained on the table because a counteroffer is normally intended to continue negotiations, not to terminate negotiations. As Corbin said: [A]‌counter offer ordinarily terminates the power to accept the previously made offer to which it is a “counter,” or reply, in the negotiation. The reasons given for this seem none too strong. . . . A counter offer has often been said to be a “rejection” of the prior offer; but this seems untrue in fact. . . . A counter offer is usually only a step in the haggling process, the purpose of which is to obtain the most advantageous terms. . . . It seems that there is some sort of feeling that an offeree should have but one chance, to accept or not to accept; he should take it or leave it. To the present writer, this does not carry much conviction.66

Accordingly, the counteroffer rule is unjustified. In part the rule reflects the static nature of classical contract law, in which negotiation is conceived to consist of episodic stages separated like watertight compartments—​offer, counteroffer, and so forth. In fact, however, negotiation tends to be fluid and dynamic rather than static and episodic. Use of the general principles of interpretation, rather than an expression rule, to determine whether a given counteroffer would be reasonably understood to take the offer off the table would properly capture the fluid and dynamic character of the negotiation process. Like other unjustified rules, the counteroffer rule is subject to significant exceptions. Under one exception an inquiry regarding the possibility of different terms does not terminate the offeree’s power of acceptance.67 Under another exception a request for different terms does not terminate the power of acceptance.68 Under a third exception a counteroffer does not terminate the offeree’s power of acceptance if it is accompanied by a statement that the original offer is being held under advisement.69 These exceptions tend to erode any administrative benefits the counteroffer rule might be intended to achieve. because the boundaries between a counteroffer, 64.  Id.; § 39; see also Duval & Co. v. Malcom, 214 S.E.2d 356, 358 (Ga. 1975). 65.  Restatement Second § 39 cmt. a; see also 1 Williston (1st ed.), supra note 6, § 51, at 86–​87 (“The reason [a counter-​offer operates as a rejection] is that the counter-​offer is construed as being in effect a statement by the offeree not only that he will enter into the transaction on the terms stated in his counter-​ offer, but also by implication that he will not assent to the terms of the original offer”). 66. 1 Arthur Linton Corbin, Corbin on Contracts § 90, at 382–​83 (1st rev. ed. 1963). 67.  Restatement Second § 39 cmt. b, illus. 2. 68.  Home Gas Co. v. Magnolia Petroleum Co., 287 P. 1033, 1034–​35 (Okla. 1930); Stevenson, Jaques, & Co. v. McLean, [1880] 5 QBD 346 at 350 (Eng.). 69.  Restatement Second § 39 cmt. c.

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an inquiry, a request, and a statement that the offer will be held under advisement will often be unclear. Suppose A offers to sell his car to B for $7,400. If B responds, “I’ll pay you $7,100” that is a counteroffer. If B responds, “Will you take less?,” that is an inquiry. If B responds, “Will you throw in a new car radio?,” that is a request. But what about “Will you take $7,100?,” or “How about $7,100?,” or “At this time, I can only offer $7,100, but I will get back to you if things change”?70 The Illustrations to Restatement Second Section 39 exemplify the brittle and unpersuasive nature of the counteroffer rule and its exceptions. Illustration 1 states: A offers B to sell him a parcel of land for $5,000, stating that the offer will remain open for thirty days. B replies, “I will pay $4,800 for the parcel,” and on A’s declining that, B writes, within the thirty day period, “I accept your offer to sell for $5,000.” There is no contract.71

In contrast, Illustration 2 states: A makes the same offer to B as that stated in Illustration 1, and B replies, “Won’t you take less?” A answers, “No.” An acceptance thereafter by B within the thirty-​day period is effective. B’s inquiry was not a counter-​offer, and A’s original offer stands.72

But why can it be confidently concluded that A would understand her offer to be taken off the table when B replies, “I will pay $4,800 for the parcel,” but not when B replies, “Won’t you take less?” The exceptions to the counteroffer rule also show that the rule operates almost entirely on those who do not know the law. If an offeree knows the law he can avoid the force of the counteroffer rule by couching his response as an inquiry or a request, or by accompanying his counteroffer with a statement that the offer is being held under advisement. Only those offerees who do not know the counteroffer rule and its exceptions are likely to suffer from its bite. In short, in many or most cases the counteroffer rule is incongruent with the general principles of interpretation and not supported by any noninterpretive policy. The rule should be either dropped entirely or downgraded to a maxim.

C.  CONDITIONAL ACCEPTANCES A conditional (or qualified) acceptance is a response to an offer that purports to accept the offer but includes proposed new terms.73 Under a traditional expression rule a conditional acceptance 70.  See, e.g., King v. Travelers Ins. Co., 513 So. 2d 1023, 1026 (Ala. 1987) (“The attorney for the defendants who handled the ‘settlement’ testified that there was no rejection or counter-​offer, only an inquiry as to whether the plaintiffs would consider a structured settlement with a different payment arrangement. The trial court apparently believed that testimony. . . . This was not plainly and palpably wrong.”). See also the closely related cases, discussed infra in the text accompanying notes 82–​87, concerning qualified acceptances. 71.  Restatement Second § 39 cmt. a, illus. 1. 72.  Id. § 39 cmt. b, illus. 2. 73.  See Restatement Second § 59.

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terminates the offeree’s power of acceptance.74 This rule is even more incongruent with the gen­ eral principles of interpretation than the counteroffer rule. If an offeree’s response purports to accept the offer, the offeror is likely to understand that her offer is still on the table even if the response includes proposed new terms. The conditional-​acceptance rule is subject to the same exceptions as the counteroffer rule, and several more. One additional exception is that the inclusion of a new term in a purported acceptance does not make the acceptance conditional if the term was implied in the offer.75 For example, in Panhandle Eastern Pipe Line Co. v.  Smith76 Panhandle had discharged Smith, an employee, but offered to withdraw the discharge if Smith agreed to certain terms. Smith agreed to the terms but added a request to see his personnel file, and stated that he would contest any mistakes found in the file. The court held that Smith’s acceptance was not qualified because all employees had the right to inspect their personnel files and “[a]‌n acceptance is still effective if the addition only asks for something that would be implied from the offer and is therefore immaterial.”77 Under another exception an acceptance accompanied by a request for new or different terms is not a counteroffer. For example, in Culton v. Gilchris78 the court held that an acceptance of an offer to lease a farmhouse, which was accompanied by a request to build a cookroom onto the farmhouse, did not attach a condition, and therefore did not prevent formation of a contract. Similarly, in King v. Travelers Ins. Co.79 the court held that the defendants did not make a counteroffer to plaintiffs’ settlement offer by asking whether plaintiffs would consider a structured settlement with an alternative payment arrangement. As in the case of counteroffers, the exceptions to the conditional-​acceptance rule significantly erode the rule’s certainty. For example, in Valashinas v. Koniuto80 A offered to purchase B’s interest in a partnership for a designated price. B accepted the price but added, “I will be ready, willing and able to give you a complete Bill of Sale . . . as of December 31st . . . or sooner if you so choose.” The offeror argued that this response was a conditional acceptance and therefore terminated the offeree’s power of acceptance. The court disagreed, holding that the statement about the closing date was “no more than a suggestion, request or overture,” and a contract was formed by the offeree’s response.81 The brittle state of the law governing the effect of an offeree’s response to an offer is further illustrated by Perillo’s summary of that law: [I]‌f A makes an offer to B to sell an object for $5,000, the offer to remain open for thirty days, and B says “I’ll pay $4,800”, this would be a counter-​offer but if he said “will you take $4,800?” this would be a counter-​inquiry. If B said “your price is too high” this could be considered to be a comment on the terms. If he said “send lowest cash price”, this would be a request for a modification of the offer and not a rejection. If B said “I accept but I would appreciate it if you gave me the benefit of a 5% 74.  Id. § 59, cmt. a. 75.  See Restatement Second § 59 cmt. b. 76.  637 P.2d 1020 (Wyo. 1981). 77.  Id. at 1023. 78.  61 N.W. 384, 385 (Iowa 1894). 79.  513 So. 2d 1023 (Ala. 1987). 80.  124 N.E.2d 300 (N.Y. 1954). 81.  Id. at 302.

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discount,” this would be an acceptance which requests or suggests a modification of the contract. If B said, “I accept your offer and I hereby order a second object”, there is a contract and B has made a separate offer and not a counter-​offer.82

Given the incongruence between the conditional-​acceptance rule and the general principles of interpretation, as well as the brittle nature of the distinctions to the rule, the rule is unjustified and should be dropped.

D.  THE MIRROR-​IMAGE RULE Under classical contract law the conditional-​acceptance rule was accompanied by a companion rule commonly known as the mirror-​image or ribbon-​matching rule. Under this rule an acceptance that deviates from the offer in any respect, no matter how minor, is a conditional acceptance. Although the mirror-​image rule is sometimes taken to be a special application of the conditional-​ acceptance rule, it is not. The conditional-​acceptance rule concerns the effect of a conditional acceptance, whereas the mirror-​image rule concerns what constitutes a conditional acceptance. The difference between the two rules is particularly salient where a merchant seller and a merchant buyer engage in what is known as a battle of the forms: Except for very large-​scale transactions, transactions between merchants are normally consummated by an exchange of forms rather than by a negotiated agreement. The purchaser’s form is typically referred to as a purchase order. The seller’s form is typically referred to as a sales order. A contract may be initiated by either kind of form. If a contract is initiated by a purchase order then the purchase order is normally an offer. If a contract is initiated by a sales order then the sales order is normally an offer. In either case the issue arises whether the offeree’s responsive form is an acceptance, which completes a contract, or a counteroffer, which terminates the offeree’s power of acceptance. The terms of purchase orders and sales orders can be divided into two broad categories. The first category consists of terms that are negotiated or at least discussed. Typically, these terms are individualized to each transaction and specify the performance that each party is to render. Examples are terms that describe the commodity that is to be purchased and sold, the quantity, the price, the place of delivery, the time of delivery, and the time of payment. The second category consists of standardized terms that are formulated for mass use without regard to any particular transaction. Typically, these terms for the most part specify consequences of nonperformance. Examples are terms that specify the time within which claims must be filed, require arbitration of disputes, or consent to the jurisdiction of a designated court in the event of a dispute. Standardized terms are usually not negotiated or even discussed by the parties, and normally differ radically between the buyer’s and the seller’s forms. Because a responsive form invariably differs from the initiating form—​that is, from the offer—​under the mirror-​image rule the exchange of a purchase order and a sales order does not constitute a contract. Instead, there is a battle of the forms under which the responsive form is deemed a counteroffer and thereby terminates the offeree’s power of acceptance, unless the terms relate to a sale of goods, in which case a special UCC rule applies. (See below.) A much different result would normally follow from the general principles of interpretation, which would focus on whether the individualized terms in the two forms matched up. Merchants

82.  Joseph M. Perillo, Calamari & Perillo on Contracts, § 2.20, at 84 (6th ed. 2009).

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usually do not read the standardized terms in each other’s forms. Indeed, a purchasing agent or salesperson who read every form that came across his desk probably would be discharged for lack of productivity, because reading forms would take up all his time (see Chapter 37 for more on form contracts). Accordingly, in most cases under the general principles of interpretation a responding form would be reasonably understood by the offeror as an acceptance if the individualized terms of the response correspond to the individualized terms of the offer even though the standardized boilerplate in the two forms differed. For this reason, under modern law the mirror-​image rule has been dropped as to contracts for the sale of goods. UCC Section 2-​207(1) provides that “[a]‌definite and seasonable expression of acceptance . . . which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon, unless acceptance is expressly made conditional on assent to the additional or different terms” (emphasis added). This Section applies even if the standardized terms, and the differences between them, are material.83 Section 2-​207 is often thought to represent a break with the common law84 but in fact the Section simply chooses one common law approach over another: in determining whether a responsive form is an acceptance Section 2-​207 applies the general principles of interpretation rather than the mirror-​image expression rule. Although Section 2-​207(1) applies only to contracts for the sale of goods, the principle that underlies the Section can be extended by analogy. For example, the Comment to Restatement Second Section 59 adopts the rule that “a definite and seasonable expression of acceptance is operative despite the statement of additional or different terms if the acceptance is not made to depend on assent to the additional or different terms.” Recent cases also support the extension of UCC Section 2-​207 to non-​sale-​of-​goods contracts by analogy.85

I X .   A   L O O K  BA CK A significant part of offer-​and-​acceptance law consists of expression rules. A few of these rules are justified. For example, the rule that a rejection terminates the power of acceptance is justified because application of the general principles of interpretation would almost always lead to the same conclusion at greater administrative cost. Similarly, the rule that an auctioneer does not make an offer unless the auction is without reserve is justified because the rule is probably known to most parties who participate in auctions and serves to maintain a balance between conflicting auction communities. However, most of the expression rules that govern the offer-​ and-​acceptance process cannot be supported on interpretive grounds. Those rules should be dropped in favor of a case-​by-​case application of the general principles of interpretation.

83.  Id. § 2-​207(2)(b). 84.  See Rite Fabrics, Inc. v. Stafford-​Higgins Co., 366 F. Supp. 1, 7 (S.D.N.Y. 1973). 85.  See, e.g., Knapp v. McFarland, 344 F. Supp. 601, 612–​13 (S.D.N.Y. 1971), modified and remanded on other grounds, 457 F.2d 881 (2d Cir. 1972). The court, referring to UCC Section 2-​207 by analogy, held that a new provision in an acceptance concerning the timing for payment of an agreed $155,000 bonus upon completion of litigation did not convert the acceptance into a counteroffer: “[E]‌xpressions of assent by an offeree, which contain immaterial deviations from the original offer, do not constitute counter-​offers but, rather, operate to bind the parties to an enforceable contract.” Id. at 613.

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Offer-​and-​acceptance rules based on principles of consideration run into similar difficulties. These consideration-​based rules—​most notably, the firm-​offer rule—​are unjustified because they mischaracterize the dynamics of the offer-​and-​acceptance process and frustrate both the reasonable expectations of offerees and the ability of offerors as a class to realize their objectives. It might be argued that these expression-​and consideration-​based rules are justified by some noninterpretive policy. One such policy might be that contract-​formation should not be made easy because otherwise liability concerns might diminish the rate of contract formation. However, such a policy would be inconsistent with the basic goal of facilitating the power of well-​informed actors to further their shared objectives through contracting. Furthermore, such a policy would have only limited explanatory power because some rules of offer and acceptance make contracting easier, not harder. This is true, for example, of the rule that in case of doubt an offer can be accepted by either promise or performance as the offeree chooses and the rule that an acceptance is effective on dispatch even if it crosses with an earlier dispatched revocation or is delayed or lost in the mails. Alternatively, it might be argued that expression-​and consideration-​based rules are justified by a policy that contract-​formation should not be made easy because of the bite of expectation damages in cases involving a quick breach, that is, a breach that consists of a renunciation that occurs very shortly after contract-​formation. Expectation damages in such cases may seem draconian where the promisor could not have made plans, or forgone other opportunities, between the time of the contract-​formation and the time of breach. Making contract-​formation difficult may help prevent such a draconian result. This justification, however, is also unsatisfactory. Although allowing expectation damages for quick breach presents difficulties, so would prohibiting such damages. In some kinds of contracts—​such as those concerning fungible commodities or publicly traded stocks—​hours, minutes, and even seconds may be crucial. Serious administrative problems would be presented if courts were required to determine on a case-​by-​case basis how quick was too quick to justify the award of expectation damages. Moreover, if there was indeed a policy against granting expectation damages for quick breach, that policy should apply even if a contract clearly was formed. Implementing such a policy in a covert way, by formulating expression rules that are not substantially congruent with the general principles of interpretation, will therefore be bound to result in the inconsistent treatment of comparable transactions. In sum, while a few of the rules governing termination of a power of acceptance may be justified, most are not. Those rules should be dropped.

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Prizes and Rewards I .   C O N S I DER AT I ON Prizes and rewards may be either freely bestowed for achievement, such as the Nobel, or awarded as due, such as prizes in contests or rewards for the return of lost property. Prizes and rewards that are freely bestowed for achievement normally do not raise issues of contract law. Accordingly, in this book the terms prize and reward will be used restrictively to mean offers of prizes or rewards that can be earned only by fulfilling a specified condition or performing a specific act. So defined, prizes and rewards normally constitute prototypical offers for unilateral contracts. At least in form, prize and reward cases are mirror images of illusory-​promise cases. In illusory-​promise cases, A makes a commitment to B as an incentive to B to give A a chance—​ that is, a chance to show why A is a desirable trading partner. In prize and reward cases A makes a commitment to B (the offer of a prize or reward) as an incentive to B to take a chance—​that is, to take the chance that his efforts or expenditures in seeking to qualify for the prize or reward will be rewarded if appropriate. Reward offers seldom present consideration problems, because to claim a reward the offeree normally must perform a designated act that has actual or imputed value to the offeror. Similarly, in contests for prizes in which contestants must either pay money to enter, perform some designated act to win, or both, the promise of a prize is normally enforceable without regard to the objective value of the claimant’s act. For example, in Simmons v. United States1 American Brewery sponsored a well-​publicized annual American Beer Fishing Derby. Under the Derby rules the brewery tagged one of the millions of rockfish in Chesapeake Bay and named it Diamond Jim III. Anyone who caught Diamond Jim III, and presented it to the brewery together with the tag and an affidavit that the fish was caught on hook and line, would be entitled to a prize of $25,000. Simmons caught Diamond Jim III about six weeks after it was tagged and soon thereafter received the prize. Simmons knew about the Derby, but as an experienced fisherman he also knew that his chances of landing Diamond Jim III were minuscule, and he did not have Diamond Jim III in mind when he set out to go fishing. The court held (in a tax context) that once Simmons had caught the fish the Brewery was legally obliged to award him the prize: “It is not fatal to his claim . . . that [Simmons] did not go fishing for the express purpose of catching one of the prize 1.  308 F.2d 160 (4th Cir. 1962).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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fish. So long as the outstanding offer was known to him, a person may accept an offer for a unilateral contract by rendering performance, even if he does so primarily for reasons unrelated to the offer.”2 Similarly, in Cobaugh v.  Klick-​ Lewis, Inc., Cobaugh, while playing in a golf tournament, unexpectedly found a new Chevrolet Beretta at the ninth tee together with signs that proclaimed: “HOLE-​IN-​ONE Wins this 1988 Chevrolet Beretta GT Courtesy of KLICK-​LEWIS Buick Chevy Pontiac $49.00 OVER FACTORY INVOICE in Palmyra.”3 Cobaugh shot a hole-​in-​ one and claimed the prize. The court held that there was consideration: In order to win the car, Cobaugh was required to perform an act that he was under no legal duty to perform. The car was to be given in exchange for the feat of making a hole-​in-​one. This was adequate consideration to support the contract.4 Courts have had more difficulty with contests in which the offerees are not required either to pay money to enter the contest or to perform a designated act to win. Examples are promotional games that do not require a purchase, such as magazine-​clearinghouse sweepstakes or scratch-​off games that can be picked up free at retail locations. Some courts have held that the prizes in such games are unenforceable for lack of consideration.5 However, these prizes should be enforceable, because promotional games are structural agreements. Although promotional games are the mirror image of illusory-​promises in form, in substance they are mutual bargains for a chance: the contestant enters the contest for the chance of winning, while the promoter stages the game to increase the chance of selling its merchandise. Under the structure of these games, contestants must sample the promoter’s wares either by coming to a store to play an in-​store game or by reading through direct-​mail advertising to find a contest entry form. The greater the volume of customers or readers the greater the probability of transacting.6

2.  Id. at 165. 3.  561 A.2d 1248, 1249 (Pa. Super. Ct. 1989). 4.  Id. at 1250; see also Champagne Chrysler-​Plymouth, Inc. v.  Giles, 388 So. 2d 1343 (Fla. Dist. Ct. App. 1980); Schreiner v. Weil Furniture Co., 68 So. 2d 149, 151 (La. Ct. App. 1953); Las Vegas Hacienda, Inc. v. Gibson, 359 P.2d 85, 86 (Nev. 1961); Grove v. Charbonneau Buick-​Pontiac, Inc., 240 N.W.2d 853, 856 (N.D. 1976). But see Fernandez v. Fahs, 144 F. Supp. 630, 632 (S.D. Fla. 1956) (a prize at a baseball-​ game drawing was a gift because the winning contestant would have attended the game even if the prize had not been offered). Usually in this kind of case the promoter of the contest does not deny that the offer is enforceable but instead argues that some condition was not satisfied, that there was a mistake of some sort, that there was a problem of interpretation (see, e.g., Grove, 240 N.W.2d at 862), or that the contest was illegal under the gambling laws (see, e.g., Chenard v. Marcel Motors, 387 A.2d 596, 598–​99 (Me. 1978)). In Cobaugh Klick-​Lewis had offered the car as a prize for a charity golf tournament two days earlier and had mistakenly neglected to remove the car and the posted signs prior to Cobaugh’s hole-​in-​one. Cobaugh, 561 A.2d at 1250. 5.  See, e.g., Yellow-​Stone Kit v. State, 7 So. 338, 339 (Ala. 1890); Clark v. State, 80 So. 2d 308, 310 (Ala. Ct. App. 1954); Cal. Gasoline Retailers v. Regal Petroleum Corp., 330 P.2d 778, 786 (Cal. 1958); Cross v. People, 32 P. 821, 822 (Colo. 1893); Mobil Oil Corp. v. Attorney Gen., 280 N.E.2d 406, 411 (Mass. 1972). 6.  Mark Wessman points out that at the margin certain kinds of prizes do not fit the unilateral-​contract model. See Mark B. Wessman, Is “Contract” the Name of the Game? Promotional Games as Test Cases for Contract Theory, 34 Ariz. L. Rev. 635 (1992).

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I I .   R E MEDI ES Prizes and rewards raise two difficult damages issues. (1)  What measure of damages should be utilized if the reward or prize is not forthcoming? (2) What should be the remedy for the wrongful denial of a contestant’s chance to win a prize?

A.  DAMAGES FOR AN UNPAID REWARD OR PRIZE The underlying problem in measuring damages for an unpaid reward or prize is that, as Karl Llewellyn pointed out, typically a prize or reward is “vastly greater than the worth of the offeree’s time and skill measured on a pure per diem and out of pocket basis.”7 Furthermore, a prize is often vastly greater than the market value of the benefit that the prizewinner confers upon the contest’s promoter. Simmons is a good example: the value of the benefit conferred on the brewery was extremely small—​perhaps the publicity that Diamond Jim had been caught—​while the prize was $25,000.8 What justifies measuring damages by the claimant’s expectation—​that is, the amount of the prize or reward—​when that amount greatly exceeds both the claimant’s investment in time, skill, and costs and the market value of any benefit that the claimant conferred on the offeror? In the context of ordinary bargains a major justification for expectation damages is that the expectation measure gives the promisor appropriate incentives for performance and precaution. In prize and reward cases, however, normally the only duty of the promisor is to pay. Although in theory an actor who offers a prize or reward might breach because she finds a more attractive use for her money, or fails to take appropriate precautions to ensure that she would have sufficient funds on hand to make a payoff, in the context of prizes and rewards those explanations are likely to be thin. Rather, the main reasons for awarding expectation damages in such cases lie elsewhere—​in particular, in the role of probability. Begin with prizes. Although the amount of a contest prize may seem out of proportion to the contest winner’s investment in time, skill, and costs, when viewed probabilistically the prize is usually not disproportionate to the winner’s investment. Any given contestant usually has only a very small chance of winning a prize—​often, an infinitesimal chance. To induce people to enter a contest, therefore, the prize must be sufficient to make the contestant’s investment worthwhile, given the very low probability of success. When a contestant’s investment in participating in a contest is adjusted for the probability that the investment will yield a return the prize is often not in fact disproportionate to the investment. Think of a lottery in which a contestant may win $950,000 for an investment of $1. If the odds of winning are one million to one, the prize is not disproportionate to the winner’s investment. Similar considerations apply in determining the benefit derived by the promoter. The benefit that the contest-​winner bestows on the contest-​promoter may be only a tiny fraction of the prize. However, the benefit to the promoter from running the contest will be much greater, and a rational promoter will set the prize at an amount less than that benefit.

7.  See K.N. Llewellyn, Our Case-​Law of Contract: Offer and Acceptance, II., 48 Yale L.J. 779, 806 (1939). Llewellyn was precipitous because unilateral-​contract analysis later enjoyed a major upswing. 8.  308 F.2d 160, 164 (4th Cir. 1962).

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Accordingly, running the contest will normally result in a benefit to the promoter even though the overwhelming proportion of the benefit will flow from players other than the winner. Furthermore, because the benefit to promoters depends upon contestants’ belief that contest-​winners will be paid in full, it is in the interest of promoters as a class that offers of contest prizes be fully enforceable. Now consider rewards. If we ask what motivates an actor, A, to offer a reward, it is useful to consider A’s alternatives. Suppose A wants to achieve Result R. A could attempt to achieve that result through a bilateral contract with B. For example, if Result R is locating a missing person, A could make a bilateral contract with B Detective Agency under which B promises to locate the person. Often, however, it will be uncertain in such cases whether Result R can actually be achieved. In the hypothetical, for example, it may be uncertain whether anyone can locate the missing person. Therefore, often B will not be willing to promise to produce Result R, but instead will only be willing to promise to use designated efforts to produce Result R. The advantage of such a contract is that it assures A that someone she regards as reliable will expend efforts to achieve her end. The disadvantage is that normally A will be required to pay B even if his efforts are unsuccessful. Alternatively, A might make a unilateral reward offer for producing Result R rather than a bilateral contract. The advantage to A of offering a reward rather than entering into a bilateral contract is that A will only be obliged to pay if Result R is achieved. The disadvantage is that A is not assured that anyone will invest any efforts to achieve Result R. Because A will not know what amount is required to provide unknown members of the public with a sufficient incentive to invest in achieving Result R, A may offer a reward whose amount is a significant fraction of the value she places on the result. Here again, the issue of disproportionality between the amount of the claimant’s investment and the reward may be considered to be an issue. However, just as enforcing prizes according to their terms is in the interest of contest-​promoters as a class, so too enforcing rewards according to their terms is in the interests of reward-​offerors as a class. It is true that after a reward-​offeror gets the result she wants, it may be in her individual self-​interest to compensate a successful claimant only for his investment. However, before the offeror gets what she wants the picture is much different. The amount of a reward may be disproportionate to the claimant’s investment, but because a reward-​offeree is normally compensated only if his efforts bear fruit and no one else qualifies first, the claimant’s investment may well be wasted. In effect, a reward-​offeree, like a prize-​contestant, bets his investment of costs, time, and trouble against the prospect of obtaining the reward.9 To induce members of the public to make that bet the reward must be high enough so that the amount of the reward, adjusted by the probability of attaining it, exceeds the investment that potential claimants will likely have to make. If rewards were enforced only to the extent of the successful claimant’s investment, claimants would be stiffed on their bets and reward-​offerors would be unable to make binding offers in the amount they believed necessary to achieve the results they desire. What about the potential for disproportion between the reward and the value of the claimant’s efforts? Although the value of a claimant’s efforts may be much less than the amount of the reward, the reward-​offeror derives a benefit—​such as new patronage—​that almost certainly exceeds the reward, or he would not have offered a reward in the stated amount. 9.  See Llewellyn, supra note 7, at 806.

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B.  LOST CHANCES Suppose a promoter runs a contest; after the contest has begun, the promoter wrongfully disqualifies a contestant, and it cannot be determined whether the contestant would have won a prize if he had not been disqualified. In such a case the promoter’s breach has clearly caused a loss to the contestant: Before the promoter acted wrongfully the contestant had a chance to win the contest. After the promoter acted wrongfully, he did not. Therefore, as a result of the promoter’s wrongful act the contestant has lost an asset—​the chance to win the contest—​and the promoter should be liable for the value of that asset. By way of analogy, suppose that A steals a lottery ticket owned by B. A should be liable to B for the value of the ticket. Similarly, if A is the promoter of a lottery and wrongfully refuses to include B’s lottery ticket in the drawing, A should be liable to B for the value of the ticket. If A is the promoter of a contest and wrongfully disqualifies contestant B, A should be liable to B for the value of B’s chance to win a prize in the contest. The leading case is Chaplin v. Hicks,10 decided by the English Court of Appeals in 1911. Hicks, a well-​known actor and theater manager, ran a contest for actresses. The prizes were theatrical engagements. The not-​very-​appealing rules of the contest were as follows: Contestants would send photographs of themselves to Hicks. Hicks would divide England into ten districts, and would publish, in a newspaper in each district, photographs of the candidates he had selected. Newspaper readers would then vote for the contestants they considered to be the most beautiful. Thereafter, Hicks would interview fifty finalists, consisting of the five candidates in each district with the highest votes. From these fifty finalists, Hicks would select twelve winning candidates, who would receive theatrical engagements.11 Chaplin became one of the fifty finalists, but Hicks did not interview her. Chaplin then brought an action against Hicks for the loss of her chance of being selected as one of the twelve winners. At trial Chaplin was awarded damages of £100. The Court of Appeals affirmed. Lord Justice Moulton stated: Is expulsion from a limited class of competitors an injury? To my mind there can be only one answer to that question; it is an injury and may be a very substantial one. Therefore the plaintiff starts with an unchallengeable case of injury, and the damages given in respect of it should be equivalent to the loss. . . . . . . Is there any such rule as that, where the result of a contract depends on the volition of an independent party, the law shuts its eyes to the wrong and says that there are no damages? Such a rule, if it existed, would work great wrong. Let us take the case of a man under a contract of service to serve as a second-​class clerk for five years at a salary of £ 200 a year, which expressly provides that, at the end of that period, out of every five second-​class clerks two first-​class clerks will be chosen at a salary of £ 500 a year. If such a clause is embodied in the contract, it is clear that a person thinking of applying for the position would reckon that he would have the advantage of being one of five persons from whom the two first-​class clerks must be chosen, and that might be a very substantial portion of the consideration for his appointment. If, after he has taken the post and worked under the contract of service, the employers repudiate the obligation, is he to have no 10.  [1911] 2 KB 786. 11.  Id. at 786–​88. The rules of the contest had been changed after the initial applications had been made due to an unexpectedly heavy volume of applications, but the plaintiff agreed to the changes. See id. at 787.

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remedy? He has sustained a very real loss, and there can be no possible reason why the law should not leave it to the jury to estimate the value of that of which he has been deprived. Where by contract a man has a right to belong to a limited class of competitors, he is possessed of something of value, and it is the duty of the jury to estimate the pecuniary value of that advantage if it is taken from him.12

Other English and Commonwealth cases are in accord,13 and a similar approach prevails in the United States.14 Restatement Second Section 346(3) provides: If a breach is of a promise conditioned on a fortuitous event and it is uncertain whether the event would have occurred had there been no breach, the injured party may recover damages based on the value of the conditional right at the time of breach.

Comment d to this section states: d. Fortuitous event as condition. In the case of a promise conditioned on a fortuitous event . . . , a breach that occurs before the happening of the fortuitous event may make it impossible to determine whether the event would have occurred had there been no breach. It would be unfair to the party in breach to award damages on the assumption that the event would have occurred, but equally unfair to the injured party to deny recovery of damages on the ground of uncertainty. . . . Under the rule stated in Subsection (3) [the injured party] has the alternative remedy of damages based on the value of his conditional contract right at the time of breach, or what may be described as the value of his “chance of winning.” The value of that right must itself be proved with reasonable certainty, as it may be if there is a market for such rights or if there is a suitable basis for determining the probability of the occurrence of the event.

Lord Justice Moulton’s opinion in Chaplin v. Hicks did not state with precision how the value of a contestant’s chance should be measured. The best approach is to use the greater of the ex ante or the ex post value of the chance. When, as would usually be the case, there is no established market for the chance, its ex ante value should be the price that a willing buyer of the

12.  Id. at 795–​96. 13.  See Howe v Teefy (1927) 27 SR (NSW) 301 (Austl.) (chance to make profits from betting on and touting a racehorse); Hawrysh v. St. John’s Sportsmen’s Club, [1964] 46 D.L.R. 45 (Manitoba Q.B.) (Can.) (chance for competing for a prize in a bowling competition); Sanders v. Parry, [1967] 2 All E.R. 803 (chance to retain a client’s business); Macrae v. Clarke [1866]1 LR-​CP 403 (Eng.) (chance to get payment of a debt from a debtor imprisoned for the debt); Hampton & Sons, Ltd. v. George, [1939] 3 All ER 627 (KB) (Eng.) (chance to make a commission on the sale of a hotel); Schilling v. Kidd Garrett Ltd, [1977] 1 NZLR 243 CA (N.Z.) (chance to retain a franchise to sell power saws). 14.  See Miller v. Allstate Ins. Co., 573 So. 2d 24, 29 (Fla. Dist. Ct. App. 1990): [I]‌t is now an accepted principle of contract law . . . that recovery will be allowed where a plaintiff has been deprived of an opportunity or chance to gain an award or profit even where damages are uncertain. . . . This alternative theory of recovery was established under the English Common Law. . . . Recovery was based not on the value of the contract; instead the value of the plaintiff ’s opportunity or chance of success at the time of the breach became the basis for the award.

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chance would pay a willing seller.15 This approach was implied in the opinion of Lord Justice Vaughan Williams, concurring in Chaplin v. Hicks: It is true that no market can be said to exist. None of the fifty competitors could have gone into the market and sold her right; her right was a personal right and incapable of transfer. But a jury might well take the view that such a right, if it could have been transferred, would have been of such a value that every one would recognize that a good price could be obtained for it.16

Typically, the amount that a willing buyer would pay a willing seller in such cases will be based on the expected value of the chance. In Van Gulic v. Resource Development Council for Alaska17 a promoter had staged a lottery. Under the rules of the lottery the contestants’ tickets were to be drawn one by one from a bin. The last ticket drawn would win the grand prize of $10,000. At a point when only three tickets, owned by A, B, and C, remained in the bin, the lottery operators mistakenly, and in breach of the contest rules, drew the tickets owned by B and C simultaneously, and overlooked that A’s ticket was still in the bin.18 The operators then compounded their breach by putting back all the lottery tickets and re-​drawing them. A’s ticket was not drawn, and he brought suit. If the operators had drawn only B’s ticket or only C’s ticket, as they should have done, instead of drawing the two tickets simultaneously, the last two tickets would have been either those of A  and B or those of A  and C.  Therefore, at the time of the breach A had a 50 percent chance of winning $10,000.19 The court gave A the choice of $5,000 in damages, or participation in a re-​drawing involving only his ticket and that of B and C (who had agreed to split any winnings).20 Similarly, Illustration 5 to Restatement Second Section 348(3) provides: A offers a $100,000 prize to the owner whose horse wins a race at A’s track. B accepts by entering his horse and paying the registration fee. When the race is run, A wrongfully prevents B’s horse from taking part. Although B cannot prove that his horse would have won the race, he can prove that it was considered to have one chance in four of winning because one fourth of the money bet on the race was bet on his horse. B has a right to damages of $25,000 based on the value of the conditional right to the prize.

15.  See Elmer J. Schaefer, Uncertainty and the Law of Damages, 19 Wm. & Mary L.  Rev. 719, 763–​64 (1978). 16.  2 KB at 793. 17.  695 P.2d 1071 (Alaska 1985). 18.  Id. at 1071–​72. 19.  Id. at 1074. 20.  See id.; see also Mange v.  Unicorn Press, Inc., 129 F.  Supp.  727, 730 (S.D.N.Y. 1955)  (stating, in a case involving a lost chance to win a puzzle contest, that “there appears to be a liberal trend towards allowing . . . the jury to determine the value of the chance of which plaintiff was deprived”); Wachtel v. Nat’l Alfalfa Journal Co., 176 N.W. 801, 805 (Iowa 1920) (lost chance to win a magazine contest); Hall v. Nassau Consumers’ Ice Co., 183 N.E. 903 (N.Y. 1933) (lost chance of payment of a bond); Kan. City Mex. & Orient Ry. Co. v. Bell, 197 S.W. 322, 323 (Tex. Civ. App. 1917) (lost chance of prize at a livestock show). But see Phillips v. Pantages Theatre Co., 300 P. 1048 (Wash. 1931) (no recovery for lost chance in a “movie contest for beginners”); Collatz v. Fox Wis. Amusement Corp., 300 N.W. 162 (Wis. 1941) (no recovery for lost chance in a question-​and-​answer contest).

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Implied-​in-​Law and Implied-​in-​Fact Contracts Most c ontracts are explicit ly ag reed u p on . How ever, s o m e

contracts are implied in fact rather than explicit. An implied-​in-​fact contract is a true contract. It differs from a run-​of-​the-​mill contract only in that the parties’ assent, although real, is not explicit. For example, suppose that Janet Jones raises her hand to bid at an auction. No one makes a higher bid, and the auctioneer knocks down his hammer. Even though Jones did not say “I offer,” that is implied from raising her hand, and even though the auctioneer did not say “I accept,” that is implied from knocking down his hammer. Or suppose that every day Mary Moore passes a produce store on her way to work and stops to buy an apple for lunch. One day, Moore is in a hurry to catch her bus, so she takes an apple from a bin outside the store, catches the shopkeeper’s eye, and waves the apple at him. The shopkeeper nods back. Even though Moore didn’t say, “I offer to buy this apple for the price posted on the bin” that is implied from her waving the apple at the shopkeeper and her past practice, and even though the shopkeeper did not say “I accept your offer,” that is implied from his nodding his head and his past practice. Because an implied-​in-​fact contract is a real contract the usual remedy for breach of an implied-​ in-​fact contract is expectation damages. Whether the defendant was unjustly enriched is normally irrelevant. There is another category of legal obligations whose name is similar to implied-​in-​fact contracts but whose content is completely different. This category consists of implied-​in-​law contracts, sometime referred to as quasi-​contracts. Implied-​in-​law contracts are not contracts; we might just as well call a zebra an implied-​in-​law horse. Instead, implied-​in-​law contracts are obligations that are based on unjust enrichment. These obligations are referred to as contracts for purely historical reasons. In early times English common law was a formulary system. Under this system a prospective plaintiff could obtain a judicial remedy only if the transaction that gave rise to his grievance came within—​that, is was described by—​an established form of action, or writ, or could be made to come within such a form or writ through a fictional allegation that the defendant was not allowed to deny. Originally, there were only two writs for actions in contract—​covenant and debt. A suit in covenant could be brought for, and only for, breach of a contract under seal. A suit in debt could be brought for, and only for, breach of a contract that Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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involved a quid pro quo, full performance by the plaintiff, and an unperformed promise by the defendant to pay a sum certain as her part of the quid pro quo. Many contracts did not satisfy the requirements of either covenant or debt. Furthermore, both covenant and debt were burdened with archaic procedures. As a result of these drawbacks a new contract action called assumpsit (meaning, roughly, that a defendant had assumed or undertaken an obligation) was developed. Assumpsit had two major advantages over covenant and debt. It was a general contract action, rather than being restricted to certain types of contracts, and it was not burdened with archaic procedures. As a result, there was constant pressure to expand assumpsit to cover contractual actions that were theretofore covered by covenant and debt. For historical and technical reasons, to accomplish that end it was necessary to create a new kind of assumpsit, known as indebitatus assumpsit. In this form of action the plaintiff alleged that the defendant, who was already indebted to the plaintiff, made a new promise to pay the debt. The allegation that the defendant had made a new promise to pay an existing debt was treated as a legal fiction: the plaintiff was not required to prove the allegation and the defendant was not permitted to deny it. However, the defendant could deny that he was indebted to the plaintiff before he made his (fictional) promise to pay the (nonexistent) debt. Until the development of indebitatus assumpsit there was no writ that covered unjust enrichment. However, once it became law that in indebitatus assumpsit the allegation that the defendant had made a new promise to pay was fictional, the path was open to bringing cases based on unjust enrichment in this form of action. To follow this path, the plaintiff would allege that (1) as a result of certain conduct (for example, the payment of money to the defendant by mistake) the defendant had been unjustly enriched at the plaintiff ’s expense, and (2) that the defendant had thereafter promised to pay the plaintiff the amount of this enrichment. The defendant could deny that the conduct described in the first allegation had occurred, or could assert that even if the alleged conduct had occurred it did not result in his being unjustly enriched. However, the defendant was not permitted to deny the allegation that he later made a new promise to pay, because that allegation was fictional. Hence the name implied-​in-​law contracts, that is, transactions that although not really contractual are brought in assumpsit, a contract form of action, through the legal fiction that the defendant made a new promise to pay the amount by which she had been unjustly enriched. Although implied-​in-​fact and implied-​in-​law contracts are distinguishable in theory, and although implied-​in-​law contracts are not contracts, there are strong connections between implied-​in-​law and implied-​in-​fact contracts. Partly this is because in practice there is an uncertain boundary between cases in which liability is based on a real although implied contract and cases in which liability is based on unjust enrichment. This is illustrated by Bastian v. Gafford.1 In March 1972 Gafford asked Bastian, a contractor, if Bastian would be interested in constructing an office building for him. After several discussions Bastian agreed to construct the building and began drafting the plans. After the plans were substantially completed Gafford contacted a bank to get financing. The bank told Gafford that it required a firm bid by a contractor. However, Bastian told Gafford that he would only construct the building on a cost-​plus basis. As a result Gafford hired an architect to prepare a second set of plans and employed another contractor to construct the building using those plans.

1.  563 P.2d 48 (Idaho 1977).

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Bastian then filed a lien on the building in the amount of $3,250 for goods and services rendered in preparing the plans, and began an action to foreclose the lien, alleging that there was an implied-​in-​fact contract to compensate him for his services. The trial court entered judgment for Gafford on the ground that he had not been unjustly enriched because he did not use Bastian’s plans in constructing the office building. The Idaho Supreme Court reversed on the ground that in basing its decision on unjust enrichment the trial court failed to distinguish between a quasi-​contract (that is, a contract implied in law) and a contract implied in fact: Although unjust enrichment is necessary for recovery based upon quasi-​contract, it is irrelevant to a contract implied in fact. . . . For [Bastian] to recover under the latter theory, it is not necessary that [Gafford] either used the plans or derive any benefit from them. It is enough that he requested and received them under circumstances which imply an agreement that he pay for [Bastian’s] services.2

Similarly, if Seller and Buyer contract for the sale of 1,000 tons of steel at $30/​ton, and Seller immediately renounces the contract, Buyer can sue for expectation damages even though he has conferred no benefit on Seller. But what was it that Bastian and Gifford impliedly agreed to? The court ducked this issue. “We express no opinion,” the court said, “on what performance was requested, on whether the requested performance was tendered, and on whether the circumstances imply an agreement to compensate appellant.”3 On the facts, it is possible to imply an agreement under which Gafford agreed to pay for Bastian’s time if he decided not to use Bastian’s plans. Such an implication, however, would be much better supported by ideas of fairness, or of unjust enrichment in a very broad sense, than by anything that could be drawn from the conversations reported in the court’s opinion.

2.  Id. at 49. 3.  Id.

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Incomplete Contracts T h i s c ha p t e r c o n c e r n s a c lu s t e r o f i s s u e s r e l at e d t o i n c o m plete

contracts: the effects of indefiniteness and gaps, provisions in an agreement that contemplate the execution of a further contractual instrument, the enforceability of promises to negotiate in good faith, and implied obligations to negotiate in good faith. As a preface to considering these issues, three points of terminology need to be clarified. incompleteness .

The issues considered in this chapter are commonly said to result from the incompleteness of a contract. The term incompleteness will be used in this book because it is conventional. In economic theory, however, a “complete contract” means a contract that specifies the parties’ rights, duties, and remedies under every possible state of the future world. Under this conception every contract is incomplete, because it would be prohibitively expensive, if not virtually impossible, to delineate and negotiate all the possible future states of the world that could bear on a contract, and all the consequences of each state and combination of states. Therefore, the mere fact that a contract is incomplete in some way should not and does not have any legal relevance. To put this differently, in contract law the term incomplete does not mean incomplete. Instead, the term is shorthand for rules concerning whether an agreement should be unenforceable because it is too indefinite, when and how a court should fill gaps in an agreement, what is the effect of provisions in an agreement that contemplate the execution of a further instrument, and when is there a duty to negotiate in good faith to make an indefinite agreement sufficiently definite, to fill gaps, or to reach a contemplated final agreement. pre -​c ontractual liability .

Commentators often refer to the imposition of liability under an initial agreement that is to be fleshed out by future negotiations as pre-​contractual liability. That terminology is incorrect. With very limited exceptions liability in these cases normally should and does rest on either bargained-​ for or relied-​upon promises. Such liability therefore is normally contractual, not pre-​contractual. bound .

The issues raised by incomplete contracts are sometimes approached by asking whether parties to an agreement believed that they were legally bound by the agreement. That question should not be and is not part of American contract law. Rather, contract law should and does ask whether the parties have engaged in acts that should make them legally bound. So, for example, if Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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two parties have made a bargain it is irrelevant that neither party knew that a bargain is legally enforceable: the parties are bound not because they intended to be legally bound, but because they entered into a bargain.

I.   I N D E F I N I T E N ES S A ND  GA PS A. INDEFINITENESS One set of rules in the incomplete-​contracts cluster concerns the effect of the indefiniteness of an agreement. The relationship between the basic rules of offer-​and-​acceptance law, on the one hand, and the rules concerning the indefiniteness of agreements, on the other, is not always clear. A basic rule of offer-​and-​acceptance law is that an expression will not constitute an offer unless it is sufficiently definite. But why then should contract law have another rule about the indefiniteness of agreements? If an expression is not sufficiently definite to constitute an offer, no contract can be formed. If an expression is sufficiently definite to constitute an offer, what room is left to argue that a resulting agreement is too indefinite to constitute a contract? One answer to this question is that the concept of indefiniteness of agreements reflects the fact that in reality contracts often are not formed by an offer-​and-​acceptance sequence. Instead, many contracts are formed by simultaneous actions, such as simultaneously executed joint signatures, handshakes, concurring that “It’s a deal,” or the like. In the context of such cases the concept of indefiniteness has two very different aspects. First, the indefiniteness of an agreement may show that the parties did not regard themselves as having concluded a bargain or made any other sort of commitment. In that case the agreement should not be enforceable as and when made, although subsequent conduct may result in a contractual obligation. Second, even if the parties believed they had made a bargain or some other type of commitment, their agreement may be unenforceable if it lacks sufficient detail for the court to fashion an appropriate remedy. This second aspect of indefiniteness was applied in Academy Chicago Publishers v. Cheever.1 Academy Chicago Publishers approached the widow of John Cheever, a celebrated author, about the possibility of publishing a collection of Cheever’s previously uncollected short stories. Eventually, a publishing agreement was signed, which provided in part as follows: Agreement made this 15th day of August 1987, between Academy Chicago Publishers or any affiliated entity or imprint (hereinafter referred to as the Publisher) and Mary W. Cheever and Franklin H. Dennis of the USA (hereinafter referred to as Author). Whereas the parties are desirous of publishing and having published a certain work or works, tentatively titled The Uncollected Stories of John Cheever (hereinafter referred to as the Work). . . . 2. The Author will deliver to the Publisher on a mutually agreeable date one copy of the manuscript of the Work as finally arranged by the editor and satisfactory to the Publisher in form and content. . . . 5. Within a reasonable time and a mutually agreeable date after delivery of the final revised manuscript, the Publisher will publish the Work at its own expense, in such style and manner and

1.  578 N.E.2d 981 (Ill. 1991).

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at such price as it deems best, and will keep the Work in print as long as it deems it expedient; but it will not be responsible for delays caused by circumstances beyond its control.2

Academy and its editor, Franklin Dennis, assumed the task of locating and procuring Cheever’s uncollected stories and delivering them to Mrs. Cheever. Dennis and Mrs. Cheever received an advance against royalties of $750 each. By the end of 1987, Academy had located and delivered to Mrs. Cheever more than sixty uncollected stories and Academy sold the paperback rights for $225,500, which presumably would be divided between the parties. Shortly thereafter, Mrs. Cheever informed Academy that she objected to publication of the book and attempted to return her advance. In response, Academy brought suit for declaratory judgment. The trial court entered an order declaring that the parties’ agreement was enforceable, and that Mrs. Cheever would comply with her obligation of good faith and fair dealing if she delivered a manuscript that included at least ten to fifteen stories and totaled at least 140 pages. The intermediate appellate court affirmed, but the Illinois Supreme Court reversed. It is pretty clear from the formality and rhetoric of the agreement in Cheever, and the provision of an advance, that the parties believed that they had concluded an agreement, which was embodied in their written instrument. The Illinois Supreme Court essentially admitted as much. However, the Court said, the terms of the agreement were too indefinite to determine whether the agreement had been breached. . . . [A]‌major source of controversy between the parties is the length and content of the proposed book. The agreement sheds no light on the minimum or maximum number of stories or pages necessary for publication of the collection, nor is there any implicit language from which we can glean the intentions of the parties with respect to this essential contract term. The publishing agreement is similarly silent with respect to who will decide which stories will be included in the collection. . . . 3

B. GAPS Closely related to the issue of indefiniteness is the issue how to treat gaps (including omissions or open terms) in an agreement. The concept of gaps lacks clarity, because it is intertwined with two other major issues in contract law. First, the concept of gaps is often difficult to untangle from the issue of interpretation, because interpretation often involves filling gaps in an agreement. For example, courts will often read open terms as requiring a reasonable performance. Suppose that A  contracts with B to build a house with a shingle roof. If the contract does not specify the quality of the shingles, a court should and normally would hold that A is obliged to install shingles that are reasonable, considering the kind of shingles that are customary for this kind of house in this kind of neighborhood and other relevant factors. Similarly, if the contract does not specify a time for completion of the house, a court would normally hold that A is obliged to complete the house within a reasonable time, considering the amount of time usually required to construct a house of this

2.  Id. at 982–​83. 3.  Id. at 984.

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kind, the weather during the construction period, and other relevant factors. These holdings could be viewed as either interpreting the contract or filling gaps in the contract. Second, the concept of gaps is often difficult to untangle from the issue of indefiniteness, because indefiniteness usually turns on the presence of gaps, so that a court must decide whether to fill the gaps or not. Against this background, an analysis of how incomplete contracts should be treated requires an understanding of why contracts may be incomplete. Five types of reasons stand out: Case 1. Although the parties have reached agreement on some terms, they do not regard themselves as having completed a deal or made any other form of commitment. Case 2. The parties regard themselves as having concluded a deal or made some other type of commitment. The agreement or commitment is incomplete, but only because at a certain point in every negotiation the cost of negotiating additional terms will exceed the value of negotiating those terms. As stated in Rego v. Decker,4 “[e]‌xcept in transactions involving very large amounts of money or adhesion contracts to be imposed on many parties, contracts tend to be skeletal, because the amount of time and money needed to produce a more complete contract would be disproportionate to the value of the transaction to the parties.” Case 3. The parties regard themselves as having concluded a deal or made some other type of commitment, but the agreement or commitment is incomplete because the parties want to leave open the possibility of further development of their contract as the future unfolds. In these cases, the parties are unable to agree on how to resolve several matters or unwilling to invest the time required to resolve the matters—​which may never become relevant—​but want to go forward with the deal, leaving the resolution of those matters to later negotiation or, if that fails, to adjudication. The parties do not necessarily contemplate that further negotiations will be required, but they leave that possibility open. As stated in Arok Construction Co. v. Indian Construction Services:5 Business people are not soothsayers, and can neither provide in advance for every unforeseen contingency nor answer every unasked question regarding a commercial agreement. . . . Nor are entrepreneurs perfect at drafting legal documents. Finally, parties may want to bind themselves and at the same time desire to leave some matters open for future resolution in order to maintain flexibility.

Case 4. The parties regard themselves as having concluded a deal or made some other type of commitment. The agreement or commitment is incomplete because the parties cannot make a complete agreement until a certain state of the world is revealed. Case 5. The parties regard themselves as having concluded a deal or made some other type of commitment. The parties’ agreement is incomplete because they want to take advantage of an efficient division of labor. Businesspersons are expert in determining and negotiating central performance terms, such as subject matter, quantity, and price. Typically, however, they are not experts in determining and negotiating most nonperformance terms, such as terms that concern the consequences of various kinds of failures to perform. Conversely, lawyers are not expert at determining and negotiating central performance terms, but they are experts in determining and negotiating most nonperformance terms. Accordingly, in complex high-​stakes transactions,

4.  482 P.2d 834, 837 (Alaska 1971). 5.  848 P.2d 870, 876 (Ariz. Ct. App. 1993).

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such as mergers or purchases of high-​priced capital goods, it is common for the businesspersons to negotiate the major performance terms of the deal, which are set forth in a memorandum of understanding, letter of intent, commitment letter, or the like, and then turn over the deal to their lawyers to reach a more complete agreement by negotiating the nonperformance terms and minor performance terms.6 Agreements that fall within Case 1 should not be enforceable. Since the parties do not regard themselves as having made a deal or any other type of commitment, without more there is nothing to enforce. In contrast, where agreements fall within Cases 2, 3, 4, or 5 the courts should take all reasonable steps to enforce the parties’ agreement. Since in each of these cases the parties regarded themselves having concluded a deal or made some other type of commitment, a failure to enforce their agreement would frustrate rather than effectuate the intentions of the parties, thereby violating the basic principles of contract law.7 This is particularly true because incompleteness is often not the reason a deal breaks down. Rather, incompleteness often or usually serves as an opportunistic defense. A promisor may want to get out of a contract because she decides either that she will lose money on the contract or that she could make more money elsewhere. She goes to her lawyer and tells him she wants out. The lawyer reviews the contract and tells the promisor, “Okay, you have a defense of indefiniteness.” The promisor replies, “What does that mean?” The lawyer responds, “Don’t worry, I’ll take care of it.” Some version of this scenario likely occurred in Cheever. Mrs. Cheever had asked for and received an advance of $750 and signed a very formal agreement. Only when Dennis had unearthed more than sixty unpublished Cheever stories, and paperback rights to the book were sold for $225,500, did Mrs. Cheever try to get out of the contract, and undoubtedly the reason was greed, not indefiniteness.8 Many, perhaps most, modern courts understand that refusing to enforce a contract on the ground that it is indefinite or too gappy often will frustrate the intention of the parties. For example, in Rego v. Decker, the court stated that “Courts would impose too great a burden on the business community if the standards of certainty were set too high.”9 Similarly, in Arok Construction the court stated, “[C]‌ourts are often presented with incomplete bargains when the parties intend and desire to be bound. . . . Refusing the enforcement of obligations the parties intended to create and that marketplace transactions require hardly seems the solution.”10 As discussed in Chapter 1, contract-​law doctrines can be ranged along various spectra. One spectrum runs from the static to the dynamic. A contract-​law doctrine lies at the static end of this spectrum if its application turns entirely on what occurred at the moment in time when a contract was formed. A contract-​law doctrine lies at the dynamic end if its application turns in significant part on a moving stream of events that precedes, follows, or

6. Alan Schwartz & Robert E. Scott, Precontractual Liability and Preliminary Agreements, 120 Harv. L. Rev. 661 (2007) model and analyze a subclass of Case 4, in which one or both parties makes a significant investment after there has been a promise to negotiate in good faith but before the final contract is made, and explore why parties would make such risky investments. 7.  See supra Chapter 1. 8.  Peter Kurth, Uncollecting Cheever, Salon, (Nov. 25, 1998), http://​www.salon.com/​1998/​11/​25/​sneaks_​ 150/​ (reviewing Anita Miller, Uncollecting Cheever, The Family of John Cheever v. Academy Chicago Publishers (1998)). 9.  482 P.2d at 837. 10.  848 P.2d at 876.

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constitutes the formation of a contract. A second spectrum runs from the binary to the multifaceted. Doctrines are binary if they organize the experience within their scope into only two categories. Doctrines are multifaceted if they organize the experience within their scope into several categories. Classical contract-​law doctrines lay almost wholly at the static and binary ends of these spectra. Accordingly, under classical contract law an agreement was characterized as either an enforceable final contract or as unenforceable preliminary negotiations—​nothing in-​between. This binary characterization was reflected in binary outcomes: no liability up to the time when a final contract was made; full liability for expectation damages thereafter.11 Gaps were also treated in a static and binary fashion. Either a gap did not prevent a contract from being sufficiently definite, in which case the gap would be filled by the court and the contract would be enforceable, or the gap did prevent a contract from being sufficiently definite, in which case the contract would be unenforceable. In the area of incomplete agreements, as in other areas, modern contract law has significantly departed from the static and binary rules of classical contract law. Among these departures are rules that recognize that the formation of a contract may be a dynamic, evolving process, rather than a process that is located at a fixed moment in time. For example, Uniform Commercial Code Section 2-​204(2) provides that “An agreement sufficient to constitute a contract for sale may be found even though the moment of making it is undetermined.”12 Similarly, Restatement Second Section 22(1) provides that “A manifestation of mutual assent may be made even though neither offer nor acceptance can be identified and even though the moment of contract formation cannot be determined.”13 Correspondingly, in the areas of indefiniteness and gaps UCC Section 2-​204 provides that even though one or more terms are left open, a contract for sale does not fail for indefiniteness if the parties have intended to make a contract and there is a reasonably certain basis for giving an appropriate remedy. UCC Section 2-​305 provides that the parties if they so intend can conclude a contract of sale even though the price is not settled. In such a case the price is a reasonable price at the time for delivery if either nothing is said as to price, the price is left to be agreed by the parties and they fail to agree, or the price is to be fixed in terms of some agreed set or recorded by a third person and no price is so set or recorded. UCC Section 2-​308 provides that if the place of delivery of goods is not specified, it is the seller’s place of business, or, if he has none, his residence. Section 2-​309 provides that if the time for shipment, delivery, or any other action under a contract is not specified, it shall be a reasonable time if not otherwise provided by the UCC or agreed upon by the contracting parties. UCC Section 2-​310 provides that unless otherwise agreed, payment is due at the time and place at which the buyer is to receive the goods. In short, if the parties intended to make a contract for the sale of goods the contract can be enforceable even though it fails to state price, time of payment, and time and place of delivery and payment.14

11.  Proceedings April 29, 1926, 4 A.L.I. Proc. App’x 88–​89, 91–​92, 95–​96, 98–​99 (1926). 12.  U.C.C. § 2-​204(2). 13.  Restatement (Second) of Contracts § 22(1) (Am. Law Inst. 1979)  [hereinafter Restatement Second]. See, e.g., Springstead v. Nees, 109 N.Y.S. 148, 150 (App. Div. 1908). 14.  U.C.C. Sections 2-​305, 2-​308, 2-​309, and 2-​310 are commonly referred to as gap-​fillers, because they specify terms to fill in gaps that parties leave in a contract for the sale of goods. Gap-​fillers are default rules,

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I I .  F U RT H E R -​I N S T R UM ENT-​T O-​ FOL L O W P R O V I S I O NS A ND PR OM I S ES T O   N E G O T I AT E I N  GOOD  FA I T H Another set of issues in the incomplete-​contracts cluster concerns cases in which an agreement would look final except that it included a provision that the deal would be wrapped up in a further instrument, and no further instrument was executed. Often the initial agreement would clearly be enforceable but for the inclusion of such a provision. The question then is, what is the legal significance of such a provision? Again the rule of classical contract law was binary and static: if the parties intended the further instrument to be only an evidentiary memorial of the terms of their agreement, and the agreement was otherwise sufficiently definite, then the agreement was enforceable despite the lack of a further instrument.15 However, if the parties intended not to be bound unless and until a further instrument was executed, so that the further instrument was to be the consummation of their negotiations, then the agreement was unenforceable. Under this rule, either the parties’ contemplation of a further instrument prevented the formation of a contract, in which case there was no liability, or it did not, in which case there was a contract and liability for expectation damages. A closely related issue is the enforceability of an agreement to reach a final agreement. Classical contract law adopted the rule that an agreement to agree was unenforceable, which by implication precluded the enforceability of an agreement to negotiate in good faith to reach agreement. The most famous statement of this rule was made by Lord Wensleydale in Ridgway v. Wharton:16 An agreement to be finally settled must comprise all the terms which the parties intend to introduce into the agreement. An agreement to enter into an agreement upon terms to be afterwards settled between the parties is a contradiction in terms. It is absurd to say that a man enters into an agreement till the terms of that agreement are settled. Until those terms are settled he is perfectly at liberty to retire from the bargain.17

that is, provisions the law reads into a contract in the absence of agreement on a relevant issue. The theory of how default rules should be constructed is contested, but most commentators take the position that, with certain exceptions, default rules should be based on the term that the parties probably would have agreed upon if the relevant issue had been addressed. This approach leaves open two possible conceptions. Under one conception the default rule should be the term that the actual parties probably would have agreed upon. This conception takes into account the bargaining power and risk-​averseness of the actual parties, the intensity with which the parties held various positions, and the like. Under the second conception, the default rule should be the term that reasonable persons in the positions of the parties probably would have agreed upon. The second conception is much more attractive, in part because determining the actual parties’ relative bargaining power, degree of risk-​averseness, intensity, and the like, at the time they made the contract, would be extremely difficult; in part because even if those elements could be determined, it would be highly problematic to assess how they would have played out in the negotiation of any given issue; and in part because it is unseemly to create default rules that favor the stronger party just because he was the stronger party. 15.  See Restatement Second § 27. 16.  (1857) 10 Eng. Rep. 1287; 6 H.L.C. 238. 17.  Id. at 1313; 6 H.L.C. at 304–​05.

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Lord Wensleydale’s reasoning was purely axiomatic, and like all axiomatic legal reasoning was deeply flawed. An agreement to enter into an agreement upon terms to be afterwards settled is not a contradiction in terms: it is an agreement. Lord Wensleydale admitted as much when he concluded that “Until those terms are settled [a party] is perfectly at liberty to retire from the bargain.” (Emphasis added.) In contrast to the static rule adopted in classical contract law, modern contract law has properly adopted the dynamic principle that a promise to negotiate in good faith is enforceable if given for consideration. The adoption of this principle is important not only in itself, but also because, as will be discussed in the balance of this chapter, it provides a foundation for the dynamic treatment of all incomplete-​contracts issues. Although the issues raised by further-​instrument-​to-​follow provisions, on the one hand, and the enforceability of promises to negotiate in good faith, on the other, are separate in principle, the two issues are frequently joined at the hip. Accordingly, this Section will begin by considering cases in which the issues arise together. Three somewhat overlapping categories will be examined: cases involving an explicit or virtually explicit bargained-​for promise to negotiate in good faith, cases involving an implicit bargain to negotiate in good faith, and cases in which a party’s conduct gives rise to an obligation to negotiate in good faith.

A.  CASES INVOLVING AN EXPLICIT OR VIRTUALLY EXPLICIT BARGAINED-​FOR PROMISE TO NEGOTIATE IN GOOD FAITH Cases involving an explicit or virtually explicit bargained-​for promise to negotiate in good faith are very easy to resolve because they are simply garden-​variety contracts. A leading case in this category is Itek Corp. v. Chicago Aerial Industries, Inc.18 In spring 1964, Itek became interested in acquiring the assets of Chicago Aerial Industries (CAI). Approximately 50 percent of CAI’s stock was owned by its president and the estates of two founders. Negotiations reached a climax in autumn 1964, when CAI conditionally accepted an offer by Itek to purchase CAI’s assets for $13 per share. The principal CAI shareholders agreed to the transaction and CAI’s board agreed to recommend the transaction to the remaining shareholders. On January 4, 1965, CAI informed Itek that its board and principal shareholders had agreed to the transaction, subject to the following conditions: Itek would obtain the necessary financing, an informal letter of intent would be executed, the details would be worked out, and formal agreements would be prepared to the parties’ satisfaction. Subsequently, Itek arranged the financing, and on January 15 a letter on Itek letterhead was signed by both parties. The letter recited the consideration on both sides, and then stated: . . . Itek and CAI shall make every reasonable effort to agree upon and have prepared as quickly as possible a contract providing for the foregoing purchase by Itek and sale by CAI, subject to the approval of CAI Stockholders, embodying the above terms and such other terms and conditions as the parties shall agree upon. If the parties fail to agree upon and execute such a contract they shall be under no further obligation to one another.19

18.  248 A.2d 625 (Del. 1968). 19.  Id. at 627.

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CAI and Itek then began the preparation of a formal agreement. Meanwhile, however, CAI and its principal shareholders secretly began negotiating with another would-​be buyer and soon reached an agreement to sell the stock held by the largest CAI shareholder to that buyer for more than Itek had agreed to pay. CAI then notified Itek that it was terminating their transaction as a result of unforeseen circumstances and the failure of the parties to reach agreement. Itek then sued CAI for breach of contract. The trial court granted summary judgment for CAI based on the sentence in the letter agreement stating that if the parties failed to agree upon and execute a formal contract they would be under no further obligation to one another. The Delaware Supreme Court reversed: [I]‌t is apparent that the parties obligated themselves to “make every reasonable effort” to agree upon a formal contract, and only if such effort failed were they absolved from “further obligation” for having “failed” to agree upon and execute a formal contract. We think these provisions of the January 15 letter obligated each side to attempt in good faith to reach final and formal agreement. . . . . . . There is . . . evidence which, if accepted by the trier of fact would support the conclusion that [after the letter agreement was signed], in order to permit its stockholders to accept a higher offer, CAI willfully failed to negotiate in good faith and to make “every reasonable effort” to agree upon a formal contract, as it was required to do.20

In Itek the parties agreed to make “every reasonable effort to agree upon . . . a contract.”21 Such agreements are often supplemented by, or implied from, a promise not to negotiate with third parties. For example, in Channel Home Centers v.  Grossman,22 Frank Grossman, a real estate broker and developer, was in the process of acquiring ownership of Cedarbrook Mall.23 The Mall had fallen on hard times, and Grossman intended to revitalize it through an aggressive rehabilitation-​and-​leasing program. In late November 1984, Grossman informed Channel Home Centers, a division of Grace Retail Corporation, which operated home-​improvement stores, of the availability of a store location in the Mall. Channel indicated that it wanted to lease the site. Grossman then requested that Channel execute a letter of intent that, as Grossman put it, could be shown to “other people, banks, or whatever.”24 Apparently, Grossman was anxious to get Channel’s signature on a letter of intent that could be used to help secure financing for his purchase of the Mall by showing banks that he had a major tenant lined up. In response to Grossman’s request, Channel submitted a detailed letter of intent setting forth a great number of highly specific lease terms. The letter specified that execution of the lease was expressly subject to Grace’s approval of the essential business terms of the lease, Channel’s approval of the status of title for the site, and Channel’s obtaining, with Frank Grossman’s cooperation, all necessary permits and zoning variances for the erection of Channel’s signs. The letter concluded: To induce the Tenant [Channel] to proceed with the leasing of this Store, you [Grossman] will withdraw the Store from the rental market, and only negotiate the above described leasing transaction to completion. 20.  Id. at 629. 21.  Id. at 627. 22.  795 F.2d 291 (3d Cir. 1986). 23.  For ease of exposition, “Grossman” is used here as shorthand for Frank Grossman, his sons, and a corporation they controlled. 24.  795 F.2d at 293.

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Please acknowledge your intent to proceed with the leasing of the store under the above terms, conditions and understanding by signing the enclosed copy of the letter and returning it to the undersigned within ten (10) days from the date hereof.25

Frank Grossman promptly signed the letter and returned it to Channel. Both parties then initiated procedures directed toward satisfaction of the lease contingencies, and on January 11 Grace’s legal department sent Frank Grossman a forty-​one-​page draft lease. Shortly thereafter, Mr. Good Buys, a major competitor of Channel, contacted Frank Grossman and stated that it would be interested in leasing space at the Cedarbrook Mall. Mr. Good Buys agreed to make base-​level annual rental payments that were substantially greater than those that Channel had agreed to in the letter of intent. On February 6, Frank Grossman notified Channel that “negotiations [are] terminated as of this date.”26 Channel then brought suit for breach of contract. The trial court concluded that the letter of intent did not bind the parties to any obligation and was unenforceable for lack of consideration. The Third Circuit reversed: It is hornbook law that evidence of preliminary negotiations or an agreement to enter into a binding contract in the future does not alone constitute a contract. Appellees believe that this doctrine settles this case, but in so arguing, appellees misconstrue Channel’s contract claim. Channel does not contend that the letter of intent is binding as a lease or an agreement to enter into a lease. Rather, it is Channel’s position that this document is enforceable as a mutually binding obligation to negotiate in good faith. By unilaterally terminating negotiations with Channel and precipitously entering into a lease agreement with Mr. Good Buys, Channel argues, Grossman acted in bad faith and breached his promise to “withdraw the Store from the rental market and only negotiate the above-​described leasing transaction to completion.”. . . The letter of intent, signed by both parties, provides that “[t]‌o induce the Tenant [Channel] to proceed with the leasing of the Store, you [Grossman] will withdraw the Store from the rental market, and only negotiate the above described leasing transaction to completion.” The agreement thus contains an unequivocal promise by Grossman to withdraw the store from the rental market and to negotiate the proposed leasing transaction with Channel to completion. Evidence of record supports the proposition that the parties intended this promise to be binding. . . . Accordingly, the letter of intent and the circumstances surrounding its adoption both support a finding that the parties intended to be bound by an agreement to negotiate in good faith.27

Viewed in light of the basic principles of contract law, Itek, Channel Home, and cases like them are unremarkable, despite their sharp break with classical contract law. In each case a party made a bargained-​for promise and then broke it. In Itek there was a bargain, in the form of a bilateral contract, to use every reasonable effort to agree upon a final contract. In Channel Home there was a bargain, in the form of a unilateral contract, under which Channel Home performed the act of providing a commitment letter in exchange for Grossman’s promise not to

25.  Id. 26.  Id. at 296. 27.  Id. at 298–​300 (internal citations and footnotes omitted).

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negotiate with third parties and instead to negotiate the transaction with Channel to completion. Bargained-​for promises to negotiate in good faith should be and are just as enforceable as any other bargained-​for promise. What, then, is significant about cases such as Itek and Channel Home? First, these cases explicitly recognize that there can be an obligation to negotiate in good faith. In Itek, the court said that “the provisions of the [letter of intent] obligated each side to attempt in good faith to reach final and formal agreement.”28 In Channel Home, the court said that “the letter of intent and the circumstances surrounding its adoption both support a finding that the parties intended to be bound by an agreement to negotiate in good faith.”29 Second, these cases properly reverse the classical contract law rule that agreements to agree are not contracts and the implication of that rule that agreements to negotiate in good faith are unenforceable. Why did the courts in Itek and Channel Home speak of a duty to negotiate in good faith, rather than simply repeating or paraphrasing the literal promises—​in Itek, to “make every reasonable effort to agree upon . . . a contract” and in Channel Home, to “withdraw the Store from the rental market, and . . . negotiate the . . . leasing transaction to completion”? There are two possible, not inconsistent explanations. One is that the courts were simply applying the well-​ established rule that a contract must be performed in good faith. Where the required performance consists of negotiation, then under that doctrine the negotiation must be conducted in good faith.30 The second explanation is that the only way to make sense of an obligation to negotiate is to require negotiation in good faith.

B.  CASES IN WHICH THERE IS AN IMPLICIT BARGAINED-​FOR PROMISE TO NEGOTIATE IN GOOD FAITH Cases such as Itek and Channel Home are important in helping to establish that parties can contract to negotiate in good faith. However, these cases lack extensive analysis and involve either an explicit or near-​explicit promise to negotiate in good faith, a promise to take the relevant commodity off the market, or both. In contrast, in the widely followed case, Teachers Insurance and Annuity Association of America v. Tribune Co.,31 Judge Pierre Leval developed an extensive and masterful analysis of the duty to negotiate in good faith in the context of an implicit promise to do so. The case concerned a commitment letter and laid a foundation for reanalyzing the entire cluster of incomplete-​contract issues. The facts of the case were as follows: Tribune Company owned two large newspapers—​the Chicago Tribune and the New York Daily News. To raise cash Tribune decided to sell the News Building. To this end Tribune entered negotiations to sell the Building to LaSalle Partners as part of a three-​party transaction. The proposed transaction was complex: LaSalle would pay for

28.  Itek Corp. v. Chi. Aerial Indus., Inc., 248 A.2d 625, 629 (Del. 1968). 29.  795 F.2d at 299–​300. 30.  See, e.g., LLMD v. Marine Midland Realty Credit Corp., 789 F. Supp. 657, 660 (E.D. Pa. 1992). 31.  670 F. Supp. 491 (S.D.N.Y. 1987).

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the News Building by giving Tribune a note secured by a mortgage. The note was to be non-​ recourse, that is, LaSalle would have no liability if the note was not paid, although in that case the noteholder could foreclose on the Building under the mortgage. This transaction would produce no cash for Tribune. However, Tribune would then match-​fund the mortgage note, that is, would borrow from a third-​party lender an amount of money equal to the amount of the note, in exchange for its own promissory note. The agreement with the third-​party lender would provide that Tribune could pay its promissory note by putting (delivering, in place of that note) the non-​ recourse note that LaSalle would give Tribune. If Tribune did so, it would end up with cash from the third-​party lender, and the lender would end up with LaSalle’s non-​recourse note and a mortgage on the Building. To compensate the third-​party lender for the risk inherent in that potential outcome, Tribune would pay the lender an above-​market interest rate on its promissory note. The complex nature of the proposed transaction was largely driven by tax motives, but there was also an accounting motive. Tribune believed that because it would have the right to put the mortgage note to its lender in full satisfaction of its debt to the lender, it would not be required to include the debt on its balance sheet. Instead, Tribune believed, it could employ offset accounting, under which it would eliminate from its balance sheet both its debt to the third-​party lender and the mortgage note it received from LaSalle by offsetting the two, and describing the debt and mortgage note in the footnotes to its financial statements. Tribune prepared a list of six institutions, including Teachers Insurance and Annuity Association of America (Teachers or TIAA) that Tribune believed would have the means and flexibility to make a loan with these specifications. All the institutions except Teachers promptly rejected the deal. On August 20, 1982, Scott Smith, Tribune’s vice president and treasurer, sent Martha Driver, a Teachers executive, an Offering Circular term sheet describing the proposed transaction. For tax reasons Tribune wanted to complete the transaction during 1982. Accordingly, Smith’s letter stated that “While we are flexible on funds delivery, our objective is to have a firm commitment from a lender by September 15, 1982. Consequently, we need to move the due diligence and negotiation process along very quickly.”32 On September 16 Teachers’ Finance Committee met and approved the loan to Tribune, and Driver told Smith that Teachers would promptly issue a commitment letter. Teachers’ commitment letter included a two-​page Summary of Proposed Terms which was drawn from Tribune’s term sheet and the parties’ ensuing conversations. The commitment letter covered all the basic economic terms of the proposed loan. Neither Tribune’s term sheet nor Teachers’ commitment letter referred to Tribune’s using offset accounting. Instead, the commitment letter stated that the agreement between Teachers and Tribune was “contingent upon the preparation, execution and delivery of instruments . . . in form and substance satisfactory to TIAA and to TIAA’s special counsel,”33 and that the transaction documents would contain the usual and customary representations and warranties, closing conditions, other covenants, and events of default “as we and our special counsel may deem reasonably necessary to accomplish this transaction.”34 The letter concluded by inviting Tribune to “evidence acceptance of the conditions of this letter by having it executed below by a duly authorized officer”35 and added 32.  Id. at 493. 33.  Id. at 494. 34.  Id. 35.  Id.

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that “Upon receipt by TIAA of an accepted counterpart of this letter, our agreement to purchase from you and your agreement to issue sell and deliver to us . . . the [described] securities, shall become a binding agreement between us.”36 The “binding agreement” language in Teachers’ commitment letter caused serious concern to Tribune’s lawyers. Tribune’s outside counsel advised Smith not to sign a letter that contained this language,37 but having been turned down by five other institutions Smith did not want to risk losing Teachers’ commitment. Therefore, he did not question the binding-​agreement language. Instead, he executed the commitment letter on Tribune’s behalf and added a notation that the commitment letter was subject to certain modifications outlined in his covering letter. In the covering letter Smith wrote that “[O]‌ur acceptance and agreement is subject to approval by the [Tribune] Company’s Board of Directors and the preparation and execution of legal documentation satisfactory to the Company.”38 The cover letter, like the commitment letter, made no mention of offset accounting. On October 28, Tribune’s board authorized its officers to effect the borrowing “with all of the actual terms and conditions to be subject to the prior approval by resolution of the Finance Committee.”39 Meanwhile, however, interest rates had dropped rapidly and were substantially below the rates that prevailed when Teachers and Tribune had entered into the commitment letter and, therefore, the rate Tribune was obliged to pay. In addition, Tribune became concerned that its accountants would not approve Tribune’s proposed use of offset accounting. On December 6, Tribune and LaSalle closed the sale of the News Building. Teachers grew worried that Tribune, which could now borrow at substantially lower rates, was seeking to back out of the transaction, and pressed Tribune to put the loan agreements into final form. To this end Teachers dropped a demand it had made for conditions on Tribune’s ability to exercise the put, and asked for a meeting to iron out all open issues. But the fall in interest rates, together with doubts as to the availability of offset accounting, now made the deal much less attractive to Tribune. Smith replied to Teachers that there was no point in meeting unless Teachers first agreed that Tribune’s obligation to close the loan would be conditional on Tribune’s ability to use offset accounting. Teachers responded that Tribune’s accounting was not part of the deal. When Tribune exhibited no further interest in pursuing the transaction, Teachers brought suit. To decide the case, Judge Leval created a tripartite categorization of agreements that are in some way preliminary. The first category consists of agreements that have no binding effect, such as agreements that so provide. The second category consists of agreements in which the parties contemplate the execution of a more formal agreement but nevertheless intend to presently bind each other to render the performances specified in the agreement. Leval characterized these agreements as agreements that are “preliminary only in form—​only in the sense that the parties desire a more elaborate 36.  Id. 37.  A few days before, Tribune had entered into a letter of intent with LaSalle for the sale of the building, which in contrast expressly provided that it was “not a binding agreement.” Id. at 494 n.1. 38.  Id. at 500. 39.  Id. at 495.

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formalization of the agreement.”40 In this type of agreement, the parties have bound themselves to render designated substantive performances. (By way of analogy, if Roberta tells her lifelong friend Barbara that she is getting married on June 10, invites Barbara to the wedding, and says she will send a formal announcement later, it would be reasonable for Barbara to conclude that she has been invited to the wedding at that point.) Leval called these agreements preliminary contracts: A preliminary contract occurs when the parties have reached complete agreement, including agreement to be bound, on all the issues perceived to require negotiation. Such an agreement is not the first stage of an ongoing negotiation. Instead, it is a final agreement, so that the agreement to follow is simply a formalization of an agreement that has already been reached, like a formal invitation to a wedding sent after the wedding guest has already been asked to attend and said he would be there. In such cases, execution of a [later] agreement is not necessary, but merely considered desirable. Therefore, the fact that the parties contemplate memorializing their agreement in a more formal agreement does not prevent their agreement from immediately taking effect.41

Since the agreements that Leval called preliminary contracts are final and binding, and therefore not really preliminary, a better term to describe these agreements is to-​be-​formalized contracts. The third category consists of agreements that do not bind the parties to render designated substantive performances, but do bind the parties to a process—​specifically, the process of negotiating in good faith to consummate a final contract. Such agreements typically embody a mutual commitment to contract on the basis of agreed-​upon major terms, while recognizing the existence of open terms that still must be negotiated. Of course, the existence of open terms may suggest that no binding contract has been reached, but that is not necessarily so. The parties, Leval said, “can bind themselves to a concededly incomplete agreement in the sense that they accept a mutual commitment to negotiate in good faith in an effort to reach final agreement within the scope that has been settled in the preliminary agreement.”42 Leval called such agreements binding preliminary commitments.43 A  to-​be-​formalized contract binds both parties in recognition of the fact that a contract has been reached to render substantive performances despite the anticipation of further formalities. In contrast, a binding preliminary agreement “does not commit the parties to their ultimate contractual objective, but rather to the obligation to negotiate the open issues in good faith in an attempt to reach the alternate objective within the agreed framework.”44 A party to a to-​be-​formalized contract has a legal right to demand that his counterparty render performance of the contract even if no further steps were taken to formalize

40.  Id. at 498. 41.  See Restatement Second § 27. Cf. Miller Constr. Co. v. Stresstek, 697 P.2d 1201 (Idaho Ct. App. 1985). There, Miller sued Stresstek to recover the difference between (1) the amount it paid for work done on a highway overpass, and (2) the amount Stresstek had bid for the same work. Miller had orally accepted Stresstek’s bid, but Stresstek maintained that it was not bound because it had not signed a written contract. The court affirmed the lower court’s holding that under the circumstances “a written contract, while contemplated by the parties, was merely a formality and that they intended to be bound by their oral agreement.” Miller, supra, at 1204. 42.  Tribune, 670 F. Supp. at 498. 43.  Id. 44.  Id.

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the contract. In contrast, a party to a binding preliminary agreement does not have a legal right to demand performance. However, he does have a right to demand that his counterparty negotiate the open terms of the agreement in good faith with a view toward arriving at a final contract.45 Leval pointed out that: This obligation does not guarantee that the final contract will be concluded. If both parties comport with their obligation, as good faith differences in the negotiation of the open issues may prevent a reaching of final contract. . . . The obligation does, however, bar a party from renouncing the deal, abandoning the negotiations, or insisting on conditions that do not conform to the preliminary agreement.46

Tribune marks a significant jump forward from Itek and Channel Home for two reasons. First, unlike Itek and Channel Home, in Tribune the parties did not explicitly agree to negotiate in good faith (although they did use language normally associated with a contract, such as “binding commitment”). Second, and more important, is the analysis that Leval developed to deal with incomplete contracts—​in particular, the tripartite distinction between (1) agreements that have no binding effect at all, (2) to-​be-​formalized contracts that immediately bind the parties to render a designated substantive performance, and (3) binding preliminary agreements, which bind the parties to negotiate in good faith to reach a final contract. Applying this tripartite regime to the facts of Tribune, Leval concluded that the Tribune-​ Teachers commitment letter was a binding preliminary agreement, which obliged the parties to seek to conclude a final loan by negotiating in good faith to resolve the open terms. In reaching this conclusion, Leval pointed out that the exchange of letters between the parties was replete with the terminology of a binding contract, such as “please evidence acceptance of the conditions of this letter by having it executed below by a duly authorized officer”;47 “[u]‌pon receipt by [Teachers] of an accepted counterpart of this letter, our agreement to purchase from you and your agreement to issue, sell and deliver to us . . . the captioned securities, shall become a binding agreement between us”;48 and “[a]ccepted and agreed to.”49 The surrounding circumstances also showed that a binding commitment was precisely what Tribune wanted. [Tribune’s proposal letter advised Teachers that] Tribune wanted to have a “firm commitment from a lender by September 15, 1982.” If such a “firm commitment” meant nothing more than Tribune now contends it does, such a commitment would have been of little value, as the lender would have remained free to abandon the loan if it decided at any time that the transaction did not suit its purposes, whether because of changed interest rates or for any reason: Tribune wanted a firm commitment because it felt it needed to be sure the transaction would be concluded by the end of the year.50 45.  See id. 46.  Id. 47.  Id. at 499. 48.  Id. 49.  Id. 50.  Id. at 500.

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Finally, Leval concluded that Tribune’s reservation that “our acceptance and agreement is subject to approval by the Company’s Board of Directors and the preparation and execution of legal documentation satisfactory to the Company,”51 and similar reservations on Teachers’ side, were not incompatible with an intention to be bound: Since the parties recognize that their deal will involve further documentation and further negotiation of open terms, such reservations make clear the right of a party, or of its Board, to insist on appropriate documentation and to negotiate for or demand protections which are customary for such transactions. . . . [T]‌he reservation of Board approval and the expressed “contingen[cy] upon the preparation, execution and delivery of documents” did not override and nullify the acknowledgment that a “binding agreement” had been made on the stated terms; those reservations merely recognized that various issues and documentation remained open which also would require negotiation and approval. If full consideration of the circumstances and the contract language indicates that there was a mutual intent to be bound to a preliminary commitment, the presence of such reservations does not free a party to walk away from its deal merely because it later decides that the deal is not in its interest. . . .52 Teachers would not have been free to walk away from the loan by reason of a subsequent decision that the transaction was not in Teachers’ interest. Nor could Tribune.53

The tripartite regime of Tribune concerning incomplete contracts differs from classical contract law in two critical respects. First, the regime of classical contract law was binary: either a contract was fully enforceable when and as made or it was not enforceable at all. In contrast, the Tribune regime is multifaceted, because it includes an intermediate state lying between no liability and full liability. Second, and more important, the regime of classical contract law was static, because it focused only on the initial agreement. In contrast, the Tribune regime is dynamic, because it is based not only on the initial agreement but on the parties’ commitments concerning their future conduct in connection with reaching a final contract and the way in which their conduct unfolds. A possible objection to enforcing an implied promise to negotiate in good faith is that such a promise might be found where it had not been made. This kind of concern, however, runs throughout the law and does not seem more serious in this area than in many others. In any event, there is an easy way to deal with this problem. A businessperson or lawyer who wants to assure that a duty to negotiate in good faith will not arise on the basis of an instrument need only insert a term so providing into the relevant instrument. Of course, businesspersons and lawyers will often not want to request such a term because the response of the counterparty may be to walk away in dismay, anger, or both. The likelihood of such a reaction serves to emphasize how often a promise to negotiate in good faith is implicit in letters of intent and like instruments. Another possible objection to the duty to negotiate in good faith in the Tribune context is that the duty is not administrable because a court cannot readily determine whether a party 51.  Id. at 494. 52.  Id. at 500. 53.  Id. at 500–​01.

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failed to negotiate in good faith. This objection would not have much weight. In most cases there is no real doubt about this issue because the defendant clearly acted in bad faith—​for example, by simultaneously negotiating with a third party for a better deal, as in Itek and Channel Home, or by breaking off negotiations with no good reason.54 Of course, a well-​schooled party might opportunistically go through the motions of bargaining in good faith while having no sincere desire to reach agreement. However, the law should not take the position that a commitment to negotiate in good faith is unenforceable just because some parties who act in bad faith may escape liability. In any event, a party who negotiates in bad faith typically leaves so many fingerprints that it is very easy to determine that she acted wrongfully. Moreover, opportunistically going through the motions in such cases may be a difficult trick to pull off. To be successful the opportunist must avoid probing the market for a better deal during the course of the negotiations, which may be unappealing. An opportunist may also have to show that he made a good faith counteroffer to the proposal he objected to. This may not be easy: if the counteroffer is unreasonable it will evidence bad faith; if the counteroffer is reasonable it may be accepted. These points are exemplified in Teachers Insurance & Annuity Association v. Butler.55 One City Centre Associates (OCCA) undertook the development and construction of a high-​rise office building in Sacramento. To proceed with construction OCCA needed interim financing, and to obtain interim financing OCCA needed a commitment for permanent financing to take out the interim lender. In September 1982 Teachers proffered to OCCA a commitment letter for permanent financing, which OCCA accepted. Under the letter Teachers agreed to lend, and OCCA agreed to borrow, $20 million for a thirty-​five-​year term at a fixed interest rate of 14.25 percent, plus a kicker in the form of a contingent interest in rental returns over the life of the loan. Voluntary prepayment by OCCA was permitted only during the last eighteen years of the loan, and even then only upon payment of a premium OCCA agreed. The closing of the loan was scheduled for mid-​1983. Before that time Teachers’ counsel sent proposed final agreements to OCCA for review and comment. Under one provision of these agreements (the default-​fee provision) if Teachers accelerated payment of the loan by reason of OCCA’s default, a tender by OCCA of the entire indebtedness would be deemed to constitute a voluntary prepayment, which would trigger payment of the premium.56 Prior to the closing, interest rates dramatically declined, so that the loan from Teachers became much less attractive to OCCA. Just before the closing, OCCA notified Teachers that it was unwilling to accept the loan if the final agreements contained the default-​fee provision. Teachers then brought suit to recover damages based on OCCA’s failure to negotiate in good faith. OCCA’s purported objection to the default-​fee provision, Teachers claimed, was only a pretext for OCCA’s unwillingness to proceed with the transaction as a result of the dramatic decline in interest rates.57 OCCA conceded that the commitment letter was binding. However, it argued, the commitment letter made no provision for a default-​fee provision, so that OCCA’s refusal to accept the default-​fee provision was not a failure to negotiate in good faith. The court held for Teachers, pointing to a variety of circumstances that made it clear that OCCA had not negotiated in good faith. For example, almost from the time that OCCA had 54.  See, e.g., Arnold Palmer Gold Co. v. Fuqua Indus., Inc., 541 F.2d 584, 589 (6th Cir. 1976). 55.  626 F. Supp. 1229 (S.D.N.Y. 1986). 56.  Id. at 1230–​31. 57.  Id.

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obliged itself under the commitment letter it began communicating with other lenders and brokers to find a better loan. Furthermore, although OCCA knew sometime in February 1983 that the closing agreements contained the default-​fee provision it made no objection to the provision until April 26, only four days before the closing was scheduled. In addition, OCCA insisted that the default-​fee provision be deleted in its entirety: it made no counteroffers with respect to the amount of a default fee, nor was it willing to negotiate the terms of such a fee. Finally, the default-​fee provision requested by Teachers reflected the intent of the deal, and the inclusion of such a provision was the custom in the California real estate financing market. Indeed, nine months after rejecting Teachers’ default-​fee provision OCCA signed closing agreements with another lender that included a default-​fee provision.58 The court concluded that “Defendants’ actions during the last few months prior to the scheduled closing date conclusively establish that, as the closing drew near, the defendants deliberately intended not to proceed with this loan—​at least not on the terms contained in the Commitment Letter.”59 The ease with which bad faith is shown in cases such as Itek, Channel Home, Tribune, and Butler appears typical. Of course, it is possible that bad faith will be erroneously found where it does not exist. That risk does not seem more serious than the risk of error in the application of many other legal principles. In any event, the risk can be reduced by requiring an actor who asserts that his counterparty did not negotiate in good faith to make a clear showing. In short, although a further-​instrument-​to-​follow provision may show that the preliminary agreement was not intended as a final contract, the question will remain whether the initial agreement committed the parties to negotiate in good faith to reach a final contract. Often, as in Tribune, the answer will be that it did. That is especially likely where the reason for the further-​ instrument-​to-​follow provision was to move on to the next stage in the negotiation process, in which the principals would turn over the deal to lawyers for finalization. The baseline obligation created by an implicit promise to negotiate in good faith in a further-​instrument-​to-​follow case is that neither party will break the deal by backing out of the settled terms of the preliminary agreement, either directly by insisting on renegotiating the terms or indirectly by refusing to accept the fair implications of those terms. That does not mean that a party is obliged to reach a final contract. It may turn out that negotiations break down because there is a range of reasonable provisions that will effectuate the terms of the preliminary agreement and the parties have a good faith disagreement over where in the range the final provision should be. Often too, negotiations to reach a final contract smoke out hidden problems in the initial agreement that cannot be resolved. Neither of these possible barriers to reaching a final contract conflict with an implicit promise to negotiate in good faith to reach a final contract that is consistent with the preliminary agreement.

C. REMEDY A final issue raised by promises to negotiate in good faith concerns the remedy for breach. In principle the remedy for breach of a bargained-​for promise to negotiate in good faith should

58.  Id. at 1234–​35. 59.  Id. at 1233.

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be the same as the remedy for the breach of any other bargain promise, that is, expectation damages or specific performance. As stated by Judge Posner: [I]‌f the plaintiff can prove that had it not been for the defendant’s bad faith the parties would have made a final contract, then . . . provided that [the loss of the benefit of the contract] is a foreseeable consequence, the defendant is liable for that loss. . . . The difficulty, which may well be insuperable, is that since by hypothesis the parties had not agreed on any of the terms of their contract, it may be impossible to determine what those terms would have been and hence what profit the victim of bad faith would have had. . . . But this goes to the practicality of the remedy, not the principle of it. Bad faith is deliberate misconduct, whereas many breaches of “final” contracts are involuntary—​liability for breach of contract being, in general, strict liability. It would be a paradox to place a lower ceiling on damages for bad faith than on damages for a perfectly innocent breach, though a paradox that the practicalities of proof may require the courts in many or even all cases to accept.60

Giving due weight to the administrative concerns to which Judge Posner alludes, courts should and sometimes do award expectation damages where those concerns can be overcome. For example, in Kansas Municipal Gas Agency v.  Vesta Energy Co.,61 Vesta and KMGA had entered into three Letter Agreements looking toward “the execution of a mutually agreeable contract for the supply of natural gas to KMGA by Vesta.”62 Each Letter Agreement provided that “Should [the parties] fail to reach a mutually agreeable contract, this Letter Agreement shall be null and void.”63 The parties were unable to reach a contract and Vesta declared the Letter Agreements null and void. KMGA brought suit. The court held that Vesta had violated an obligation to negotiate in good faith and was liable for expectation damages in the form of cover. The court is persuaded that Vesta terminated the agreement because it was a bad business deal and it could not extricate itself otherwise. Its stated reasons for terminating were pretextual. . . . Following Vesta’s breach of the letter agreements, KMGA proceeded to purchase substitute gas from another supplier. Pursuant to [UCC Section 2-​712(1)], following a breach by a seller the buyer may “cover” by making in good faith and without unreasonable delay any reasonable purchase of or contract to purchase goods in substitution for those from the seller. The buyer is then entitled to recover from the seller as damages the difference between the cost of cover and the contract price.64

Of course, as Posner pointed out in Venture Associates even if both parties negotiated in good faith they might not have concluded a final contract. However, if one party’s failure to negotiate in good faith, where she was obliged to do so, made it impossible to determine what would have happened if she had negotiated in good faith, she should bear the burden of proving the deal would have broken down anyway. 60.  Venture Assocs. Corp. v. Zenith Data Syst. Corp., 96 F.3d 275, 278–​79 (7th Cir. 1996). 61.  843 F. Supp. 1401 (D. Kan. 1994). 62.  Id. at 1405. 63.  Id. 64.  Id. at 1408.

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If expectation damages are too uncertain, the court should award reliance damages measured by out-​of-​pocket costs or, where appropriate, by lost opportunities. As Posner also points out, “If, quite apart from any bad faith, the negotiations would have broken down, the party led on by the other party’s bad faith to persist in futile negotiations can recover only his reliance damages—​the expenses he incurred by being misled, in violation of the parties’ agreement to negotiate in good faith, into continuing to negotiate futilely.”65 Reliance damages are also appropriate where, as in the leading-​on cases, the promise to negotiate in good faith is enforceable on the ground that it has been relied upon rather than on the ground that it has been bargained-​for. For example, in the BMI case discussed below the court strongly suggested that if BMI was successful on its claim it might be limited to reliance damages. Similar cases have taken a comparable position.66

D.  CASES IN WHICH A RELIED-​UPON PROMISE TO NEGOTIATE IN GOOD FAITH IS IMPLIED FROM CONDUCT AND WORDS AMOUNTING TO LEADING-​ON In cases such as Itek and Channel Home the duty to negotiate in good faith arises from an explicit promise. In cases such as Tribune, OCCA, and Vespa the duty to negotiate in good faith arises from an implied-​in-​fact promise. The last and most difficult kind of case is that in which the duty to negotiate in good faith results from one party’s words and conduct during the course of negotiations for a contract, or after execution of an unenforceable agreement, in leading on or stringing along the other party after the execution of a preliminary agreement that does not involve an explicit or implicit promise to negotiate in good faith. The principle that should govern such cases is as follows: Where A and B have made an agreement that is unenforceable either because of its incompleteness or because the agreement disclaims any binding effect, A should not thereafter be allowed to lead on or string along B to take actions that involve significant costs in implementation of the agreement unless A is ready to negotiate in good faith to arrive at a final contract. Conversely put, if A leads on or strings B along in this way, A’s conduct comprises an implicit promise to negotiate in good faith to reach a final contract. If B reasonably relies on this promise, it should be enforceable to the extent of B’s reliance. As stated in Racine & Laramie Ltd. v. California Department of Parks & Recreation:67 . . . The fact that parties commence negotiations looking to a contract . . . does not by itself impose any duty on either party not to be unreasonable or not to break off negotiations, for any reason or for no reason. During the course of negotiations[, however,] things may be done which do then impose a duty of continued bargaining only in good faith.

65.  Venture Assocs., 96 F.3d at 278. 66.  See, e.g., Arcadian Phosphates, Inc. v. Arcadian Corp., 884 F.2d 69, 74 (2d Cir. 1989); Hoffman v. Red Owl Stores, Inc., 133 N.W.2d 267, 276 (Wis. 1965). 67.  14 Cal. Rptr. 2d 335, 340–​41 (Ct. App. 1992).

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For instance . . . in the course of negotiations it is possible for a party to so mislead another by promises or representations, upon which the second party detrimentally relies, as to bring into play the concept of promissory estoppel.

For example, in Budget Marketing, Inc. v.  Centronics Corp.,68 in April 1987 BMI and Centronics executed a letter of intent concerning a proposed merger. The letter stated a number of terms of the merger and certain conditions to the merger, including avoidance of a significant cash outlay for taxes that would result from a change in accounting methods that BMI planned to make. The letter also included a disclaimer that “this letter shall not be construed as a binding agreement on the part of BMI or Centronics.”69 Given the disclaimer, at the time of the letter neither party had made a promise to negotiate in good faith. However, throughout the summer and fall, Centronics gave BMI assurances that the deal was going forward to completion, and allegedly in reliance on these assurances, and with Centronic’s knowledge, BMI borrowed $750,000, opened additional branch offices, expanded existing branch operations, and purchased key-​man life insurance on its president. In November 1987 Centronics abruptly halted preparations for the merger on the ground that as a result of proposed tax legislation and a change in BMI’s accounting methods, the merger would lead to a cash outlay for taxes, thereby negating one of the conditions in the letter of intent. BMI brought suit, claiming that Centronics’ stated reasons for terminating negotiations were a pretext because the proposed tax legislation did not apply to the merger and the change of accounting methods would not have required Centronics to make a cash outlay for taxes. The court held that because of the disclaimer no binding commitment to negotiate in good faith could be implied from the letter of intent. Nevertheless, the court concluded, “the evidence of Centronics’ oral assurances, coupled with BMI’s alleged reliance and Centronics’ awareness of BMI’s reliance, is substantial enough to establish a triable claim under . . . promissory estoppel doctrine.”70

I I I .   S O M E R AM I F I CAT I ONS O F   T H E T R I BU NE R EGI M E: I N D E F I N I T E N ES S A ND  GA PS The Tribune analysis applies directly to instruments such as letters of intent, commitment letters, and memoranda of understanding. These applications are important in themselves, because these kinds of instruments are common in large commercial transactions such as mergers and acquisitions. However, the importance of the Tribune analysis goes much farther, because it radically shifts the legal regime that govern incomplete contracts. Consider the problem of gaps. All contracts have gaps because as a practical matter it is impossible to write a complete contingent contract, that is, a contract that covers every contingency that might arise. When faced with gaps, classical contract law adopted a binary rule. Either

68.  927 F.2d 421 (8th Cir. 1991). 69.  Id. at 423. 70.  Id. at 427.

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(1) the gaps in the contract were too large for the court to determine whether there had been a breach, and if so what should be the remedy, in which case there was no liability; or (2) the gaps in the contract could be filled by implication or the like, in which case there was full liability. Applying the Tribune regime to these cases, however, a different dynamic emerges. Where the agreement and the circumstances evidence that the parties believed they had concluded a deal, normally the parties should be deemed to have implicitly promised to fill any gaps by good faith negotiation. So, for example, one way to understand the situation in Cheever is that the parties implicitly agreed to negotiate in good faith to fill gaps in the contract on the number of pages and stories that would be included in the book. Mrs. Cheever would then be liable for breaking that promise because she withdrew without even offering to discuss this issue, and it is highly likely that she withdrew not because of these gaps but because as a result of Academy’s efforts she came to realize that she could get a bigger advance elsewhere. What should the remedy in Cheever have been? One possibility would be reliance damages to reimburse Academy for its time and other costs in locating Cheever’s uncollected stories. Another, better possibility would be to calculate expectation damages on the basis of either the sales of the book that was eventually published or the projected sales of a book with the least number of stories and pages Mrs. Cheever would have agreed to if she had negotiated in good faith, as she had implicitly promised to do. This last alternative may explain the decisions of the trial and intermediate appellate courts that the book had to contain at least ten to fifteen stories and 140 pages; that is, those courts must have concluded that if Mrs. Cheever had negotiated in good faith those numbers were the least that she would have agreed to. Of course, if those numbers are the least that she would have agreed to in good faith, the likelihood is that if she had actually negotiated in good faith she would have agreed to somewhat higher numbers. Nevertheless, where there are no objective guideposts to filling a gap the gap should be filled with the minimum terms that the party who broke off negotiations would likely have agreed to if she had negotiated in good faith. Somewhat comparably, one way to understand the usefulness of the UCC gap-​fillers, and more generally of default rules and judicial readiness to fill in gaps, is that these mechanisms provide an incentive for parties who have explicitly or implicitly agreed to negotiate in good faith to do so. For example, if an agreement for the sale of goods omits a price, UCC Section 2-​ 305 provides that normally the price is a reasonable price at the time for delivery—​a price that would be set by a judge or a jury. Where parties have made a deal even though they have not set a price, Section 2-​305 provides an incentive to negotiate the price in good faith rather than walk away, because a price negotiated by the parties will almost always be preferable to the parties than a price imposed by a judge or jury. Similarly, if the Illinois Supreme Court had adopted the trial court’s decision in Cheever, future parties in Mrs. Cheever’s position would not be so quick to walk away to get a better deal elsewhere.

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thirty-s ​ even

Form Contracts I .   I N G E NER A L This chapter concerns form contracts. To begin with it is necessary to distinguish between a contract and a form contract. As a matter of common legal usage the term contract refers to a type of agreement—​specifically, a legally enforceable agreement whose terms were based on prior negotiation, or at least discussion, between the parties to the agreement.1 In contrast, the term form contract refers to a writing that is in the form of a contract (hence the name), some of whose terms were negotiated, or at least discussed, by the parties, but most of whose terms were not. Instead, most terms of a form contract are prepared by one party, the form-​giver, without any negotiation, discussion, or even knowledge by the other party, the form-​taker. Moreover, a form contract, unlike a contract, is not designed to govern a transaction between the form-​giver and form-​taker, but instead is designed to govern transactions between the form-​giver and multiple form-​takers. Form contracts consist of two distinct elements. The first element is a real contract. That element is comprised of the terms of an agreement that were negotiated, or at least discussed and agreed upon, by the parties to the form contract prior to its finalization, and are intended to govern only a transaction between those parties. The second element consists of terms attached to the real contract that were prepared by the form-​giver, prior to the transaction between the parties, without either negotiation or discussion between the parties or knowledge by the form-​taker. Following conventional usage, this element will be referred to as boilerplate.2 In contrast to the terms of the real contract, the boilerplate terms are not the product of an agreement or discussion between the form-​giver and the form-​taker, and indeed are not even read by the form-​taker either before or after he signs the form contract. As stated by an American Bar Association task force, “preprinted boilerplate terms . . . cannot reasonably be expected to be read by the other party.”3 Here is why this is so: to 1.  For ease of exposition it is assumed in this chapter that a contract is made between only two parties. 2.  The term boilerplate is ambiguous, because it is also used to refer to provisions of a real contract, usually found at the end of the contract, that concern either minor terms, such as the addresses to be used for notices, or secondary terms, such as which state’s laws govern the contract, and are normally agreed upon by the lawyers for the parties rather than by the parties themselves. This meaning of boilerplate is not used in this chapter. 3.  [ABA Task Force] An Appraisal of the March 1, 1990, Preliminary Report of the Uniform Commercial Code Article 2 Study Group, 16 Del. J. Corp. L. 981, 1063–​64 (1991).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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make an optimal decision on contractual terms a party would carefully read each term and deliberate on its business and legal consequences. However, analyzing boilerplate in this way would usually be unduly costly. Form contracts often contain a lot of boilerplate—​sometimes as many as 50–​100 boilerplate terms, which run on for many pages. The meaning and legal effect of these terms will often be incomprehensible to laypersons, partly because they are often or usually written in highly technical language, and partly because even if written clearly the form-​taker will usually be unable to fully understand their effect since boilerplate terms characteristically vary the form-​taker’s baseline legal rights, and most form-​takers do not know their baseline legal rights. Because boilerplate is not negotiated, discussed, read, or understood by the form-​taker, and the form-​giver knows this is so, boilerplate is not contractual, although it is commonly treated as contractual.4 The verbal and legal obscurity of boilerplate makes the cost of deliberating on boilerplate exceptionally high. This is especially so because the length and complexity of a form contract is often not correlated to the dollar value of the transaction, so that a low-​value transaction may involve a lot of boilerplate. Moreover, boilerplate usually relates to the consequences of nonperformance, rather than to specifications of performance. Since most contracts are performed, in the case of most contracts most boilerplate never comes into play. Accordingly, the expected value of reading and deliberating on boilerplate must be heavily discounted. For example, if contracts are performed 95 percent of the time, most of the effort spent in reading and deliberating on boilerplate will be wasted. Often, therefore, and perhaps usually, the cost of thorough search and deliberation on boilerplate would be prohibitive in relation to the benefits. Therefore, in the case of form contracts a form-​taker faced with boilerplate, which she knows she will find difficult or impossible to fully understand, which involve contingencies that probably will never mature, whose discounted value is unlikely to be worth the cost of search and deliberation, and which aren’t subject to negotiation in any event, will typically and rationally decide to remain ignorant of most of the boilerplate terms.5 Omri Ben-​Shahar has put this very well in his article, “The Myth of the ‘Opportunity to Read’ in Contract Law”:6 Real people don’t read standard form contracts. Reading is boring, incomprehensible, alienating, time consuming, but most of all pointless. . . . And what if they did read? Surely, there is nothing they can do about the bad stuff they know they will find. . . . Dedicated readers can expect only heartache, which is a very poor reward for engaging in such time-​consuming endeavor. Apart from an exotic individual here or there, nobody reads. . . . Imagine a world in which individual consumers are shown the contract before buying the product, and make a deliberate decision that they want to read and acknowledge the terms before deciding whether or not to buy. . . . [E]‌ven if these consumers exist, they will likely fail in their attempt to read and comprehend the terms. First, even a simplified version of the legal terms . . . is too complicated a task for most consumers, given existing levels of literacy. Take, for example, 4.  For a comprehensive discussion of boilerplate, see Margaret Jane Radin, Boilerplate: The Fine Print, Vanishing Rights and the Rule of Law (2013). 5.  See Clayton P. Gillette, Rolling Contracts as an Agency Problem, 2004 Wis. L. Rev. 679, 680: “[F]‌ailure to read may be perfectly rational, especially given the inability to negotiate around terms, if the buyer accurately predicts that the costs of review exceed its benefits.” 6. 1 Eur. Rev. Contemp. L. 1 (2009).

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eBay’s User Agreement, which is one of the more impressive examples I found for a contract in lay language. . . . [E]ven with eBay’s heroic effort to simplify, would most people understand a term stating that “when you give us content, you grant us a nonexclusive, worldwide, perpetual, irrevocable, royalty-​free, sublicensable (through multiple tiers) right to exercise the copyright, publicity, and database rights (but no other rights) you have in the content, in any media known now or in the future?” Most contracts, [moreover], are not summarized in easy language. . . . Take a contract many of you surely did not read when clicking “I Agree” upon installing the software—​the Microsoft XP End User License Agreement (not a very inviting title for a 10 page single space text). The version installed on my (previous) computer was 4000 words long. If a user wanted to read, say, the remedies term—​the term that US regulators deemed important enough to require a mandatory appearance—​she must traverse through 16 previous paragraphs (all of which affect, in some way, the recovery of damages) to reach a provision that is drafted in one sentence, 186 words long! Maybe a few well-​paid contracts attorneys can read and understand, after years of experience, what it says. Others would be foolish to try. The limits of the ability to understand are not solely language comprehension. More fundamental is our limited ability to process the significance of the terms. . . . [T]o understand the effect and value of a boilerplate term the consumer has to know the default rule that this term trumps. This is most acute in the context of choice of regime clauses. Some jurisdictions might be better for the consumer if the case came before them, other are worse, but do people know the different substantive rules that these jurisdictions apply ex ante, so as to evaluate what they gain or lose through such clauses? Do they know if they will fare better in arbitration versus litigation, once a yet-​unknown dispute arises? . . . . . . The limited capacity to read is further aggravated by time constraints. . . . People want to surf the internet without even having to click “I agree” every time they enter a new site, surely they do not want to spend the time to read the text of the terms-​of-​service. The time-​to-​read problem arises from individuals’ desires to enter into many “small” transactions and the fact that each such transaction, while small in stakes, is big in contract text. There is not enough time to read all these texts.7

Moreover, there is a fundamental imbalance in this respect between form-​takers and form-​ givers. For a form-​giver a form contract is a high-​volume repeat transaction. Accordingly, a rational form-​giver will spend a significant amount of time and money, including money for legal services, to prepare boilerplate terms that are optimal from its perspective. For a form-​taker, in contrast, any given form contract is normally a one-​shot transaction. This is one reason why the costs of deliberating on the boilerplate terms or retaining a lawyer to evaluate the terms will normally far exceed the benefits of deliberation on the terms. These asymmetrical incentives allow form-​givers to heavily slant boilerplate in their favor. In short, the principle that bargain promises normally should be enforced according to their terms is based in significant part on the premise that actors are normally the best judges of their own utility. If actors regularly and rationally do not read boilerplate that premise does not apply to boilerplate, and there is no contractual reason, and therefore no reason, at all, to enforce boilerplate. Modern contract law adopts three approaches that go part of the way, but not all the way, to recognizing that form-​takers regularly and rationally don’t read boilerplate.

7.  Id. at 2, 13–​14.

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(1) One approach is to apply to form contracts a general principle of interpretation that is based on the protection of reasonable expectations. This principle, adopted in Restatement Second Section 211, is that where a form-​giver has reason to believe that a form-​taker who manifests assent to the form would not have done so if he knew that the form contained a given term, the term is not part of the contract. (2) A second approach is to treat a form-​giver’s inclusion of a term that is unfairly surprising to the form-​taker as a type of unconscionability. For example, in the leading case of Williams v.  Walker-​Thomas Furniture Co.,8 a buyer, Williams, regularly purchased furniture and home appliances from a seller, Walker-​Thomas, on installment credit. Walker-​Thomas’s form contract contained the following boilerplate term: [T]‌he amount of each periodical installment payment to be made by (purchaser) to the Company under this present lease shall be inclusive of and not in addition to the amount of each installment payment to be made by (purchaser) under such prior leases, bills, or accounts; and all payments now and hereafter made by (purchaser) shall be credited pro rata on all outstanding leases, bills and accounts due the Company by (purchaser) at the time each such payment is made [the pro-​rata provision].9

The immediate but obscure effect of this provision was that the seller retained title to each item purchased from it by a consumer under a contract until the buyer finished paying in full for all items purchased from Walker-​Thomas under a contract, even though the balance due on any particular item might be worked down to a few cents, as indeed it was in Williams.10 The effects of the provision on the buyer’s baseline legal rights were even more obscure, and undoubtedly were unknown to the buyer: Until the buyer brought her total unpaid balance to zero the seller could repossess any and every item purchased under every contract the consumer had entered with the seller until every contract was paid off, through summary process under the replevin statute, circumventing the normal process of a trial. Moreover, by virtue of the quoted provision no item the buyer purchased under any such contract would fall within the protection of statutes exempting defined classes of property from attachment to satisfy a judgment. Walker-​Thomas either knew or should have known that most and probably all of its buyers would be unfairly surprised by this term. Under classical contract law the term nevertheless would have bound Williams under the classical-​law principle that there is a duty to read.11 Indeed, this was just the result in Williams in the lower court.12 However, the Court of Appeals for the District of Columbia Circuit reversed and remanded on the ground that the lower court had failed to apply an unconscionability analysis: [W]‌hen a party of little bargaining power, and hence little real choice, signs a commercially unreasonable contract with little or no knowledge of its terms, it is hardly likely that his consent, or even an

8.  350 F.2d 445 (D.C. Cir. 1965). 9.  Id. at 447. 10.  Robert H. Skilton & Orrin L. Helstad, Protection of the Installment Buyer of Goods under the Uniform Commercial Code, 65 Mich. L. Rev. 1465, 1476–​77 (1967). 11.  See, e.g., Rossi v. Douglas, 100 A.2d 3, 7 (1953); Sardo v. Fidelity & Deposit Co., 134 A. 774 (N.J. 1926). 12.  Williams v. Walker-​Thomas Furniture Co., 198 A.2d 914 (D.C. 1964).

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objective manifestation of his consent, was ever given to all the terms. In such a case, the usual rule that the terms of the agreement are not to be questioned should be abandoned and the court should consider whether the terms of the contract are so unfair that enforcement should be withheld.13

Despite the significance of the pro-​rata provision few laymen would have understood all or even any of its implications. Even legal experts often can’t understand boilerplate terms. During the oral argument of Gerhardt v. Continental Insurance Cos.14 before the great New Jersey Supreme Court of the time, Chief Justice Weintraub looked at the insurance policy at issue and said, “I don’t know what it means. I am stumped. They say one thing in big type and in small type they take it away.” Justice Haneman added, “I can’t understand half of my insurance policies.” Justice Francis said, “I get the impression that insurance companies keep the language of their policies deliberately obscure.” If all this were not enough, most form contracts are tendered by agents who have no authority to vary the boilerplate terms, so that deliberating on those terms will usually be pointless. (3) Under a third approach, which is largely applicable to merchants who exchange forms, so that each party is both a form-​giver and a form-​taker, the courts knock out conflicting terms—​ which means all the boilerplate—​from both forms. This approach, which is based on Uniform Commercial Code Section 2-​207, will be discussed at the end of this chapter. All of this is based on common sense, experience, and reason. But there is more. Florencia Marotta-​Wurgler, Yanos Bakos, and David Trossen, in “Does Anyone Read the Fine Print? Consumer Attention to Standard Form Contracts,”15 report that: [W]‌e examine the extent to which potential buyers of software read end-​user license agreements (EULAs). . . . We tracked 48,154 visitors to the Web pages of 90 software companies over a period of 1 month and recorded their detailed browsing behavior. . . .Our main finding is that regardless of how strictly we define a shopper, only one or two in 1,000 shoppers access a product’s EULA for at least 1 second, which yields an informed minority of .2 percent.16 We find that very few consumers choose to become informed about standard-​form online contracts. In particular, we estimate that the fraction of retail software shoppers who access EULAs is between .05  percent and .22  percent, and most of the few shoppers who do access EULAs do not spend enough time doing so to have digest more than a fraction of their content.17

To summarize, it is rational for form-​takers not to read form contracts, and it would be irrational for them to do so. To put this differently, the appropriate response of form-​takers is to maintain a stance of rational ignorance. Therefore, making a form-​taker’s rights and liabilities turn on boilerplate terms that everyone knows he will not read is indefensible. Accordingly, boilerplate should normally be unenforceable.18 13.  Id. at 449–​50. 14.  48 N.J. 291, 225 A.2d 328 (1966). 15. 43 J. Legal Studies 1 (2014) (emphasis added). 16.  Id. at 3. 17.  Id. at 32. 18.  See Radin, supra note 4; Todd D. Rakoff, Contracts of Adhesion: An Essay in Reconstruction, 96 Harv. L. Rev. 1174, 1251 (1983).

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Although the reason for not enforcing boilerplate is compelling, a few arguments have been made in favor of enforcement. Usually, although not invariably, these arguments are made by Chicago law-​and-​economists, who picture a decision not to enforce boilerplate as a form of state intervention, which therefore violates their most deeply held convictions. In fact, however, that picture is fallacious. A  court that does not enforce a boilerplate term is not intervening; it is simply abstaining from intervention on one party’s behalf. Such a court does not tell the parties what to do; it only says that whatever the parties want to accomplish they must accomplish without state aid. Let us pass that issue by and focus directly on the three leading arguments for enforcing boilerplate terms. The most prominent argument, sometimes referred to as the informed-​minority argument, was developed by Alan Schwartz and Louis Wilde in their article, “Intervening in Markets on the Basis of Imperfect Information:  A Legal and Economic Analysis.”19 As just shown, the title—​and much of the reasoning—​of this article is ill-​conceived because a decision not to enforce a boilerplate term is not an intervention, it is an abstention. Passing that by, the informed-​minority argument, later picked up by other Chicago law-​and-​economists who followed Schwartz and Wilde the way the children followed the Pied Piper, is that if a sufficient number of consumers read and understand the boilerplate in a form contract the seller will write boilerplate that these reading consumers will accept, thereby benefiting even nonreading consumers. The fatal flaw in this argument is that Schwartz and Wilde never bothered to empirically determine what percentage of form-​takers is necessary to set their process in motion, and what percentage of form-​takers read and understand forms. As shown above, Marotta-​Wurgler et al., who did do the empirical work, found that less than .2 percent of consumers read form contracts, thereby sinking the informed-​consent argument to the bottom of the sea. Ted Cruz and Jeffrey Hinck have developedthree other devastating criticisms of the informed-minority agrument: [E]‌ven if the requisite number of informed consumers were present, one should nevertheless be wary of concluding that an efficient term equilibrium will occur. First, particularly in the absence of express disclaimers, it is seldom the case that there will be many consumers for whom the cost of becoming informed is less than the expected loss from the inefficient terms. Second, game theory suggests that the dominant strategy for consumers will be to remain uninformed, because they must choose whether to invest in information before they know the value of that information. Third, there is a very strong incentive for buyers to free ride on the information of others, and if everybody free rides, no informed minority will ever form.20

Another argument advanced in favor of enforcing boilerplate, sometimes referred to as the private-paternalism argument, is that form-​takers want boilerplate, because a seller will charge less for a commodity if it can write its contracts in boilerplate that favors it. This

19. 127 U. Pa. L Rev. 630 (1979). 20.  Not My Brother’s Keeper: The Inability of an Informed Minority to Correct for Imperfect Information, 47 Hastings L. Rev. 635, 675–​76 (1996).

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argument has been made in its strongest form by Omri Ben-​Shahar in “Regulation through Boilerplate: An Apologia.”21 The core of Ben-​Shahar’s argument is stated as follows: Let us begin by assuming that the rights that boilerplates delete are important. They are important because they affect, in an economically meaningful way, consumers’ surplus. If that were not the case, a book about boilerplate contracts would not be worth writing. The immediate implication of this assumption is that a product + boilerplate bundle that deletes these rights eliminates important fragments of value and thus saves the firms some of the costs of doing business. This cost savings allows firms that offer the depleted bundle to charge a lower price. Standard economics analysis shows that this implication holds regardless of the market power that firms have.22 It is possible that not all cost savings would accrue to consumers through lower prices. But it is hard to imagine that the savings due to, say, stingy warranties or restricted use of information products, would have no price effect.23

This argument fails for three reasons. First, Ben-​Shahar does not claim that saving some of a form-​giver’s costs by depriving form-​ takers of important rights without their knowledge is morally justified. He does not make that claim for good reason: it is not morally justified, and should not be the law for that reason alone. Second, he does not claim that if form-​givers are allowed to deprive form-​takers of important rights they will lower their prices; he claims only that depriving consumers of important rights will allow form-​givers to lower their prices. He provides no empirical evidence that this is what form-​givers do, and there is no reason to believe this is what they do, except for warranties. Third, he assumes that boilerplate terms are priced, so that if a term is included in the boilerplate the price of the commodity that is being sold is reduced by the amount of that price. With few exceptions, however, boilerplate terms aren’t priced. Boilerplate is written by young associates in law firms who lack the ability to price boilerplate and who simply draft all the terms they can think of that favor the firm’s client. Nor is boilerplate priced by the partner for whom the associate works, who also lacks the ability to price boilerplate terms, or by the client, who may have the ability to price boilerplate terms but usually doesn’t bother because it’s not worth his time to do so, since form-​takers won’t read the form and therefore will accept any terms the form includes. Ben-​Shahar argues that “If, in fact, the rights that boilerplates delete are pricey, many people would be happy to buy products and services stripped of the baseline entitlements the law provides, so long as they are rewarded with a significant price discount.”24 The problem with this argument lies in the introduction—​“If, in fact, the rights that boilerplate deletes are pricey . . .” That is a mighty big if, and Ben-​Shahar does not show and almost certainly cannot show (or he would have shown) that the rights that boilerplate deletes are pricey or even priced. Some are; most aren’t. There are a few terms in form contracts that are undoubtedly priced, principally warranties. But in the case of most terms what almost certainly happens is that the seller’s executives set the business terms, such as price, and then turn the drafting of the form contract over to the lawyers (usually law-​firm associates), whose 21. 112 Mich. L. Rev. 883 (2014). 22.  Id. at 895. 23.  Id. at 896. 24.  Id. at 896.

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major objective is to slant the remaining terms in favor of the seller and who are not asked to price, do not price, and cannot (for lack of ability) price the terms. In sum, as stated by James Gibson: Let us pause for a moment and consider the radical nature of the move that the private paternalism defense makes. . . . [T]‌he entire field of contract law is built on the proposition . . . that society is better off when we allow parties to actualize their own individual values through voluntary, legally binding transactions. This form of lawmaking produces bespoke rules, generated from the bottom up. . . . How odd, then, that this last defense of boilerplate engages in the very top-​down regulatory judgments that contract law is supposed to render irrelevant. . . .The world has gone topsy-​turvy when those who favor enforcement of contracts paternalistically purport to know what’s best for individuals without consulting them. . . . The longstanding assumption that boilerplate contracts are essential to the modern economy is provably wrong. Nothing about the complexity, content, or consequence of mass-​market transactions justifies reliance on private terms drafted by self-​interested parties and subject to no market discipline . . .25

Finally, UCC Section 2-​207(3) provides that “Conduct by both parties which recognizes the existence of a contract is sufficient to establish a contract for sale although the writings of the parties do not otherwise establish a contract. In such a case the terms of the particular contract consist of those terms on which the writings of the parties agree together with any supplementary terms incorporated under any other provisions of this Act.” Comment 6 to this Section provides that “ . . . Where clauses on confirming forms sent by both parties conflict each party must be assumed to object to a clause of the other conflicting with one on the confirmation sent by himself. As a result the conflicting terms do not become part of the contract. The contract then consists of the terms originally expressly agreed to and terms supplied by this Act. . . .” Pursuant to Section 2-​207(3) and Comment 6, and, perhaps more important, to arrive at a meaning of Section 2-​207(3) that is consistent with and effectuates the purpose of Section 2-​207 and produces a fair result, the courts have developed the knockout rule, under which conflicting terms in the form contracts of a buyer and a seller drop out. Since all boilerplate terms in a seller’s form sales order and a buyer’s form purchase will conflict, under the knockout rule in the case of commercial actors all the boilerplate terms of the purchase and sales orders will drop out. This is just as it should be, and shows that in all or almost all commercial form contracts the boilerplate terms drop out. This has not affected commerce by an ounce, which shows that the hand-​wringing over the prospect of making boilerplate unenforceable is no more than a Chicken Little view of the world. Although as a practical matter Section 2-​207 only applies to commercial form contracts because it only applies where the parties have exchanged forms, and that does not happen in consumer form contracts, there is no reason to treat consumer boilerplate better than commercial boilerplate. Although the critical reason that boilerplate should be unenforceable is that it is not contractual, there is another, which has been well-​put by Oren Bar-​Gill: Consumer contracts are characterized by an asymmetry between the two parties, the seller of a good or the provider of a service on the one hand and the consumer on the other. One party 25.  James Gibson, Boilerplate’s False Dichotomy, 106 Geo. L. J. 249, 261–​62 (2018).

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is usually a highly sophisticated corporation, the other—​an individual, prone to the behavioral flaws that make us human. Absent legal intervention, the sophisticated seller will often exploit the consumer’s behavioral biases. The contract itself, commonly designed by the seller, will be shaped around consumers’ systematic deviations from perfect rationality.26

The root fact is that there is no reason for a form-​giver to slant boilerplate in favor of the form-​ taker, and every reason to slant boilerplate in its own favor.

I I .   R O L L I N G CONT R A CT S A rolling contract is a special case of a form contract. As described by Robert Hillman: In a rolling contract, a consumer orders and pays for goods before seeing most of the terms, which are contained on or in the packaging of the goods. . . . Rolling contracts therefore involve the following contentious issue: Are terms that arrive after payment and shipment, such as an arbitration clause, enforceable?27

While it has become customary to purchase goods over the phone, via the Internet, or in a box without asking for the terms, if any, on which the goods are being sold, rolling contracts—​ sometimes described as pay now, terms later—​are somewhat controversial. As John Murray pointed out, they don’t seem to cohere with basic principles of contract law, which require agreement and consent. How can the concept of paying before you know what you are paying for make contractual sense?28 There has been a controversy in the scholarly literature, and to some extent in the courts, about the right answer to this question. However, two opinions by Judge Easterbrook that give qualified approval to the concept have more or less carried the day.29 The qualification is that although a buyer can be bound even without having seen the terms of the contract when he pays, he is only bound if he has had an opportunity to return the commodity within a reasonable time after has had an opportunity to see the terms. That makes a certain amount of sense, or would if the seller was required to compensate the buyer for his time, trouble, and expense in returning the commodity, a requirement that is rarely if ever taken on or imposed. But even if that requirement was imposed, boilerplate terms in a rolling contract should be unenforceable.

26.  Oren Bar-​Gill, Seduction by Plastic, 98 Nw. L. Rev. 1373, 1373 (2004). 27.  Rolling Contracts, 71 Fordham L. Rev. 743, 743 (2002–​2003). 28.  See John E. Murray, Jr., The Dubious Status of the Rolling Contract Formation Theory, 50 Duquesne L. Rev. 35 (2012). 29.  ProCD, Inc. v. Zeidenberg, 86 F.3d 1447 (3d. Cir. 1996); Hill v. Gateway 2000, 106 F. 3d 1147 (7th Cir. 1997).

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The Parol Evidence Rule I .   I N T R O DUCT I ON Assume that A and B make a contract. Call this the first contract or the parol agreement. Later, A and B make a second contract, in writing, which does not contradict but relates to the same subject matter as the first contract. Later still, A sues B for breach of the first contract and B defends on the ground that the second contract superseded or discharged the first contract, although it did not explicitly so provide. The validity of B’s defense seems to raise a simple, straightforward issue of fact:  Did the parties intend that the second agreement superseded or discharged the first? However, that is not the kind of position taken by contract law. Instead this kind of case is goverened by the parol evidence rule. It is a basic principle of American law that questions of fact are to be decided by the fact-​ finder—​normally, a jury. Under the parol evidence rule, however, where parties have made two agreements relating to the same subject matter, even if the second agreement is consistent with the first the question whether the second agreement superseded or discharged the first is treated as a question of law for the judge, not a question of fact for the jury. Since the issue whether the second agreement superseded or discharged the first is a question of fact, this treatment, and therefore the parol evidence rule, is unjustified.1 Discussion of the parol evidence rule is made difficult by three factors. (1)  The rule is formulated differently in the leading contract-​law authorities—​Williston and Restatement First; Corbin and Restatement Second, and the UCC. (2)  Two concepts—​integration and inconsistency—​that are at the heart of the rule are given diametrically opposed meanings by different courts. (3)  The rule is subject to a number of exceptions, and the most important exceptions are also often given diametrically opposed meanings. As a result, there is no single parol evidence rule. Instead, there are a number of competing rules that can be constructed by assembling alternative building blocks. Accordingly, rather than explicating and assessing the parol evidence rule, this chapter will explicate and assess the various building blocks that can be assembled to construct alternative rules.

1.  The parol evidence rule also applies to some other scenarios—​for example, where A and B make an oral and a written contract simultaneously, A sues B for breach of the oral contract, and B sets up the written contract as a defense. For ease of exposition, these other scenarios will not be treated separately.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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I I.   T H R E E F O R M U LAT I ONS OF   T HE PA R O L E V I D E N CE R UL E A ND THE   C O N C E P T O F  I NT EGR AT I ON A.  RESTATEMENT FIRST AND WILLISTON Restatement First Section 237, which largely follows Williston, provided that with certain exceptions: the integration of an agreement makes inoperative to add to or to vary the agreement all contemporaneous oral agreements relating to the same subject-​matter; and . . . all prior oral or written agreements relating thereto. . . .

This formulation of the rule is associated with classical contract law in general, and Williston in particular. As provided in Restatement First Section 237 and comparable formulations, the parol evidence rule applies if, but only if, the later contract is an integration.2 As a result, the definition of an integration is central to the meaning of the rule. Restatement First Section 228 provided that “An agreement is integrated where the parties adopt a writing . . . as the final and complete expression of the agreement.” On the surface, Section 228 requires a factual determination: What was the parties’ intent in adopting the second contract. However, the position of classical contract law was that whether the second contract is an integration instead turns on a purely formal test—​whether the later contract appears on its face to be complete. As stated by Williston: . . . Since it is only the intention of the parties to adopt a writing as a memorial which makes that writing an integration of the contract, and makes the parol evidence rule applicable, any expression of their intention in the writing in regard to the matter will be given effect. . . . The parties, however, rarely express their intention upon this point in the writing, and if the court may seek this intention from extrinsic circumstances, the very fact that parties made a contemporaneous oral agreement will of itself prove that they did not intend the writing to be a complete memorial. The only question open would be whether such a contemporaneous oral agreement was in fact made. . . . [T]‌he practical value of the [parol evidence] rule would be much impaired if either party to a writing were allowed to rebut the presumption by proof of any contemporaneous oral agreement. Certainly the law does not permit this. . . . It is generally held that the contract must appear on its face to be incomplete in order to permit parol evidence of additional terms. Frequently, it is not a necessary inference from the writing itself either that it is a statement of the whole agreement, or that it is not. In such a case it has been held that parol evidence is admissible to show which is the fact. The difficulty with such a principle lies in its application. No written contract which does not in terms state that it contains the whole agreement (and few do so provide . . .) precludes the possible supposition of additional parol clauses, not inconsistent with the writing. The matter has been well summed up Finch, J. [in Eighmie v. Taylor, 98 N.Y. 288, 294]: “. . . [I]‌f we may go outside of the instrument to prove that there was a stipulation not contained in it, and so that only part of the contract was put in writing, 2.  This term integration is based on the concept that the parol evidence rule applies where the parties’ agreement is integrated into—​we might say, swallowed by—​the later contract.

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and then, because of that fact, enforce the oral stipulation, there will be little of value left in the rule itself.”3

Mitchell v.  Lath4 illustrates the operation of the Willistonian, formal version of the parol evidence rule. In fall 1923 the Laths owned a farm that they wanted to sell. Across the road, on land belonging to a third party, the Laths had an ice house, which they could remove. Catherine Mitchell looked over the Lath farm with a view to its purchase. She found the ice house objectionable. Mitchell and the Laths then orally agreed that in consideration of her purchase of the Lath farm the Laths would remove the ice house in spring 1924. Relying on this promise, Mitchell made a written contract to buy the farm for $8,400. After receiving a deed, Mitchell entered into possession of the farm and spent considerable amounts to improve it. When the time came, however, the Laths did not tear down the ice house and did not intend to do so. Mitchell sued for specific performance. There was no question that the Laths had agreed to tear down the ice house: the trial court so found, the Court of Appeals wrote its opinion on that basis, and Mitchell won in both the trial court and the intermediate appellate court. Nevertheless, the Court of Appeals held for the Laths on the ground that the ice house agreement was unenforceable under the parol evidence rule because the contract to purchase the farm appeared complete and made no provision concerning the ice house. “An inspection of this contract shows a full and complete agreement, setting forth in detail the obligations of each party. On reading it, one would conclude that the reciprocal obligations of the parties were fully detailed.”5

B.  RESTATEMENT SECOND AND CORBIN (AND MODERN CONTRACT LAW) An alternative formulation of the parol evidence rule and the definition of an integration, associated with modern contract law in general and Corbin in particular, is whether the parties actually intended the second contract to supersede or discharge the first. As set out in Restatement Second, this test is substantive rather than formal. Restatement Second Section 213 formulates the rule as follows:

(1) A binding integrated agreement discharges prior agreements to the extent that it is inconsistent with them. (2) A binding completely integrated agreement discharges prior agreements to the extent that they are within its scope. (Emphasis added.)

The definition of integration in Restatement Second is set out in Section 209. In contrast to Restatement First, the Comment to this Section gives only a brief nod to a formal test, and then goes on to adopt a substantive test: Where the parties reduce an agreement to a writing which in view of its completeness and specificity reasonably appears to be a complete agreement, it is taken to be an integrated agreement unless it is established by other evidence that the writing did not constitute a final expression. 3. 2 Samuel Williston, The Law of Contracts at 1226–​27 (emphasis added). 4.  160 N.E. 646 (N.Y. 1928). 5.  Id. at 647 (emphasis added).

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The substantive nature of the test under Section 209(3) is reinforced by Comment c to that section: Proof of integration. Whether a writing has been adopted as an integrated agreement is a question of fact to be determined in accordance with all relevant evidence. (Emphasis added.)

and also by Comment b to Section 210: That a writing was or was not adopted as a completely integrated agreement may be proved by any relevant evidence. A document in the form of a written contract, signed by both parties and apparently complete on its face, may be decisive of the issue in the absence of credible contrary evidence. But a writing cannot of itself prove its own completeness, and wide latitude must be allowed for inquiry into circumstances bearing on the intention of the parties. (Emphasis added.)

C.  UCC SECTION 2-​202 UCC Section 2-​202 adopts still a third formulation of the parol evidence rule: Terms . . . set forth in a writing intended by the parties as a final expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented. . . . (b) by evidence of consistent additional terms unless the court finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement.

Similarly, Comment 3 to Section 2-​202 provides: Under [Section 2-​202(b)], consistent additional terms, not reduced to writing, may be proved unless the court finds that the writing was intended by both parties as a complete and exclusive statement of all the terms. (Emphasis added.)

The Comment adds: If the additional terms are such that, if agreed upon, they would certainly have been included in the document in the view of the court, then evidence of their alleged making must be kept from the trier of fact. (Emphasis added.)

The difference between the formal test of Restatement First and Williston and the substantive tests of Restatement Second, Corbin, and UCC Section 2-​202 was summarized as follows by Judge Sneed, writing for the Ninth Circuit in Interform Co. v. Mitchell Construction Co.:6 Williston requires the judge to ascertain the legal relations between the parties by reference to those associated with the “forms” (that is, the natural and normal integration practices and the 6.  575 F.2d 1270 (9th Cir. 1978).

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meaning of words that reasonably intelligent people would employ) to which they should adhere and from which they depart at their peril. . . . Corbin, on the other hand, directs the judge to fix the legal relations between the parties in accordance with their intention even when the “forms” they employed suggest otherwise. . . . A  judge, guided by Williston . . . would impose upon the parties the terms of the [contractual documents] as understood by the reasonably intelligent person if [those documents] appear complete . . . A  judge, guided by Corbin, would impose upon the parties the agreement that the evidence indicates they in fact reached. . . .7

Judge Sneed then described the present status of the competing formulations: It is unlikely that any jurisdiction will inflexibly adopt one approach to the exclusion of the other; each is likely to influence the conduct of judges and the disposition of cases. However, it must be acknowledged that the influence of Corbin’s way is stronger now . . . than when he and Williston grappled during the drafting of [Restatement First]. . . .8

Judge Sneed further observed: . . . [UCC § 2-​ 202] reflects Corbin’s influence. It precludes contradiction of “confirmatory memoranda” by prior or contemporaneous oral agreements when the writing was “intended by the parties as a final expression of their agreement” and permits the introduction of consistent additional terms “unless the court finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement.” The focus plainly is on the intention of the parties, not the integration practices of reasonable persons acting normally and naturally . . .9 (Emphasis added.)

I I I .  T H E MI G H T-​N AT UR A L LY-​B E-​ M A D E -​A S -​A -​S E PA R AT E-​A GR EEM ENT, OR W O U L D -​C E RTA I NLY-​H AVE-​B EEN-​ I N C L U D E D , E X CEPT I ON T O  T HE PA R O L E V I DENCE  R UL E The parol evidence rule is subject to a number of exceptions. These exceptions are formulated in divergent ways. The most important exception, as formulated in Restatement First Section 240, applies where the parol agreement was “such an agreement as might naturally be made as a separate agreement by parties situated as were the parties to the written contract.” Under classical contract law this exception was applicable only if reasonable persons in the positions of the

7.  Id. at 1276. 8.  Id. 9.  Id. at 1277.

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parties would naturally have made the parol agreement as a separate agreement, as opposed to whether the actual parties would naturally have made the parol agreement as a separate agreement. As stated by Williston: . . . [T]‌he test of admissibility is much affected by the inherent probability of parties who contract under the circumstances in question, simultaneously making the agreement in writing which is before the court, and also the alleged parol agreement. The point is not merely whether the court is convinced that the parties before it did in fact do this, but whether parties so situated generally would or might do so.10

This approach is a dramatic feature of Mitchell v.  Lath. There the court held that the ice-​house agreement was discharged under the parol evidence rule because reasonable persons in the position of the parties would not have made that agreement as a separate agreement, despite the fact that the actual parties did make the ice house agreement as a separate agreement. The might-​naturally-​be-​omitted exception is often very difficult to apply. For example, Illustration 2 to Restatement First Section 240 provides: A and B in an integrated contract respectively promise to sell and to buy Blackacre for $3000. A contemporaneous oral agreement between them that the price shall be paid partly by discharge of a judgment which B has against A is operative.

And Illustration 3 provides: A and B in an integrated contract respectively promise to sell and to buy Blackacre for $3,000. A contemporaneous oral agreement that B shall be allowed to pay the price by work taken at a stated rate of compensation is inoperative.

There is not a dime’s worth of difference between the two Illustrations.11 In contrast to Restatement First, Restatement Second Section 216 provides that:

(1) Evidence of a consistent additional term is admissible to supplement an integrated agreement unless the court finds that the agreement was completely integrated. (2) An agreement is not completely integrated if the writing omits a consistent additional agreed term which is . . . (b) such a term as in the circumstances might naturally be omitted from the writing.

10. 2 Williston, supra note 3, § 638, at 1235. 11.  Similarly, the first part of Illustration  7 provides:  “A and B in an integrated contract respectively promise to sell and to buy a specific automobile. A contemporaneous oral undertaking on the part of A to warrant the quality of the machine beyond the warranties that the law would otherwise impose is inoperative . . .” However, the second part states: “Oral representations by A of the quality of the machine which induce B to enter into the written contract are . . . operative to create a warranty. The representations are independent of the contract through an inducement to its formation, and the obligation of a warranty is imposed by law not from a promise but from an assertion of fact.” Locating the difference between the first and second parts of Illustration 7 is no easy task.

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Comment d explains: d. Terms omitted naturally. If it is claimed that a consistent additional term was omitted from an integrated agreement and the omission seems natural in the circumstances, it is not necessary to consider further the questions whether the agreement is completely integrated and whether the omitted term is within its scope. . . . Moreover, there is no rule or policy penalizing a party merely because his mode of agreement does not seem natural to others. Even though the omission does not seem natural, evidence of the consistent additional terms is admissible unless the court finds that the writing was intended as a complete and exclusive statement of the terms of the agreement.12

UCC Section 2-​202, Comment 3, provides: Under paragraph (b) consistent additional terms, not reduced to writing, may be proved unless the court finds that the writing was intended by both parties as a complete and exclusive statement of all the terms. If the additional terms are such that, if agreed upon, they would certainly have been included in the document in the view of the court, then evidence of their alleged making must be kept from the trier of fact.

The would-​certainly-​have-​been-​included test in Restatement Second is much easier for the proponent to satisfy than the might-​naturally-​be-​omitted exception set out in Restatement First and applied in Mitchell v. Lath. Case law also has loosened up this exception. A leading example is Masterson v. Sine.13 Dallas Masterson and his wife Rebecca owned a ranch as tenants in common. On February 25, 1958, they conveyed the ranch to Medora and Lu Sine by a deed, “Reserving unto the Grantors herein an option to purchase the above described property on or before February 25, 1968 [for the] same consideration as being paid heretofore plus their depreciation value of any improvements Grantees may add to the property from and after two and a half years from this date.”14 Medora was Dallas’s sister and Lu’s wife. Sometime after this conveyance Dallas was adjudged bankrupt and Rebecca and Dallas’s trustee in bankruptcy then brought a suit against Medora and Lu for declaratory relief to establish their 12.  Here are three Illustrations to Section 216: 4. A owes B $1,000. They agree orally that A will sell B Blackacre for $3,000 and that the $1,000 will be credited against the price, and then sign a written agreement, complete on its face, which does not mention the $1,000 debt or the credit. The written agreement is not completely integrated, and the oral agreement for credit is admissible in evidence to supplement the written agreement. 7. A and B sign a written agreement, complete on its face, for the sale of goods to be shipped by A from Chicago to New York. It is claimed that the written agreement was signed on the oral understanding that the shipment would be made by a specified route. Under Uniform Commercial Code §§ 2-​311 and 2-​504, unless otherwise agreed, A could properly ship by any reasonable route. The written agreement is not completely integrated, and the oral understanding is admissible in evidence to supplement its terms. 8. A and B orally agree that A shall work for B in specified employment for $3,000. B delivers to A an absolute written promise to pay $3,000 in six months. The terms of the oral agreement are admissible in evidence to supplement the written promise and to qualify B’s duty to pay $3,000.

13.  436 P.2d 561 (Cal. 1968). 14.  Id. at 562.

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right to enforce the option. Medora and Lu defended on the ground that the parties wanted the prop­erty kept in the Masterson family and the option was therefore personal to Dallas and Rebecca and could not be exercised by the trustee in bankruptcy. The trial court excluded this evidence under the parol evidence rule. The California Supreme Court, in an opinion by Justice Traynor, reversed, focusing on how, in the circumstances, the actual parties could reasonably be expected to behave rather than on how similarly situated parties could reasonably be expected to behave: Evidence of oral collateral agreements should be excluded only when the fact finder is likely to be misled. The rule must therefore be based on the credibility of the evidence. One such standard, adopted by section 240(1)(b) of the Restatement [First] of Contracts, permits proof of a collateral agreement if it “is such an agreement as might naturally be made as a separate agreement by parties situated as were the parties to the written contract.” . . . The draftsmen of the Uniform Commercial Code would exclude the evidence in still fewer instances: “If the additional terms are such that if agreed upon, they would certainly have been included in the document in the view of the court, then evidence of their alleged making must be kept from the trier of fact.” The option clause in the deed in the present case does not explicitly provide that it contains the complete agreement, and the deed is silent on the question of assignability. Moreover, the difficulty of accommodating the formalized structure of a deed to the insertion of collateral agreements makes it less likely that all the terms of such an agreement were included. . . . The statement of the reservation of the option might well have been placed in the recorded deed solely to preserve the grantors’ rights against any possible future purchasers and this function could well be served without any mention of the parties’ agreement that the option was personal. There is nothing in the record to indicate that the parties to this family transaction, through experience in land transactions or otherwise, had any warning of the disadvantages of failing to put the whole agreement in the deed. This case is one, therefore, in which it can be said that a collateral agreement such as that alleged “might naturally be made as a separate agreement.” A fortiori, the case is not one in which the parties “would certainly” have included the collateral agreement in the deed.15

IV.   CON T R A D I C T I O N O R I NCONS I S T ENCY Even if an exception to the parol evidence rule would otherwise apply, a parol agreement normally will be discharged if it is contradicted by the later contract. Thus Restatement Second Section 215 provides: Except as stated in [Section 214],16 where there is a binding agreement, either completely or partially integrated, evidence of prior or contemporaneous agreements or negotiations is not admissible in evidence to contradict a term of the writing. 15.  Id. at 564–​65. 16.  Section 214 provides: Agreements and negotiations prior to or contemporaneous with the adoption of a writing are admissible in evidence to establish (a)  that the writing is or is not an integrated agreement;

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Similarly, recall that UCC Section 2-​202 provides that: Terms [which are] otherwise set forth in a writing intended by the parties as a final expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented . . . (b) by evidence of consistent additional terms unless the court finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement. (Emphasis added.)17

This rule is justified because except in the context of form contracts (see Chapter 37) it is so unlikely that parties who make a second contract that is inconsistent with the parol agreement would not intend the second contract to supersede or discharge the parol agreement that it is not worth putting the issue to the jury. However, the term contradict, like every other important term of the parol evidence rule, is subject to two radically divergent interpretations. The natural interpretation, which might be called the negation or logical-​inconsistency interpretation, is brought out in Hunt Foods and Industries, Inc. v. Doliner.18 Hunt Foods entered into negotiations to acquire the assets of Eastern Can Company through an agreement with George Doliner, members of Doliner’s family, and one or more of Doliner’s associates (the Doliner Group), who together owned the great majority of Eastern Can stock. At an early stage of the negotiations agreement was reached on price, but several other important items were not agreed upon. At this point it was found necessary to adjourn the negotiations for several weeks. The Hunt negotiators expressed concern over an adjournment, stating that they feared that the Doliner Group would use the Hunt offer as a basis for soliciting a higher bid from a third party. To protect themselves the Hunt negotiators demanded an option to purchase all of the Doliner Group’s stock at $5.50 per share. Such an option was prepared and signed by George Doliner, the members of his family, and at least one of his associates. On resumption of negotiations the parties failed to reach agreement and Hunt exercised the option. However, the Doliner Group refused to deliver the stock on the ground that it had obtained a contemporaneous understanding from Hunt that the option was to be exercised only if Doliner solicited an outside offer. Hunt moved for summary judgment for specific performance, arguing that the claimed condition was inconsistent with the option and therefore was unenforceable under the parol evidence rule. The court held for the Doliner Group: We believe the proffered evidence to be inadmissible only where the writing contradicts the existence of the claimed additional term. . . . It is not sufficient that the existence of the condition is implausible. It must be impossible. . . .19

(b)  that the integrated agreement, if any, is completely or partially integrated; (c)  the meaning of the writing, whether or not integrated; (d)  illegality, fraud, duress, mistake, lack of consideration, or other invalidating clause; (e)  ground for granting or denying rescission, reformation, specific performance, or other remedy.

17.  The introductory paragraph of Section 2-​202 uses the term may not be contradicted, whereas subsection 2-​202(2) uses the term consistent. It seems unlikely that anything is to be made out of this difference: contradict and not consistent are essentially two peas from the same pod. 18.  270 N.Y.S.2d 937 (App. Div. 1966). 19.  Id. at 940.

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The meaning of the term contradict utilized in Hunt embodies the ordinary meaning of that term, and makes it very easy to formulate a test for determining whether the parol agreement contradicts or is inconsistent with the later contract. This test is as follows: if the parol agreement was combined with the later contract would the combined agreement make sense? In Hunt the answer is yes, because if the combined agreement had set out the option but provided that it could be exercised only if the Doliner Group shopped the Hunt offer the agreement would be perfectly sensible and not internally inconsistent. A diametrically opposed definition of contradiction or inconsistency is expressed in other cases, such as Alaska Northern Development, Inc. v. Alyeska Pipeline Service Co.20 There the court defined inconsistency under UCC Section 2-​202(b) to mean “the absence of reasonable harmony in terms of the language and respective obligations of the parties.”21 This is a bizarre and unjustified meaning of the terms inconsistency or contradict. It is also a meaning that is close to meaningless, because what constitutes reasonable harmony between two passages will inevitably vary from judge to judge. It is ironic that under this approach a rule intended to promote certainty would do just the opposite. In contrast, assigning these terms their ordinary meaning makes it extremely easy to formulate a test to determine whether a parol agreement is inconsistent with or contradicts the later agreement.

V.   PA RT I A L I N T EGR AT I ON Another building block of the parol evidence rule is the concept of partial integration. This concept is set out as follows in Restatement Second Section 210:

(1) A completely integrated agreement is an integrated agreement adopted by the parties as a complete and exclusive statement of the terms of the agreement. (2) A partially integrated agreement is an integrated agreement other than a completely integrated agreement.

Even if the parol evidence rule was justified, the rule concerning partially integrated agreements would not be. By hypothesis a partial integration is a fraction of an agreement. There is no reason why a fraction of an agreement should be considered an integration, partial or otherwise. Furthermore, it is simply too difficult to determine that a fraction of an agreement is an integration under either the Willistonian formal test or the Corbin substantive test. If a document signed by the parties contains a warranty term but nothing else, is it an integration? And if so, of what? The warranty provisions of an agreement between the parties? The remedy provisions of an agreement between the parties? If the parties have executed a writing that neither appears to be nor is intended to be a complete contract, the writing should not supersede or discharge a parol agreement or any portion of such an agreement. 20.  666 P.2d 33 (Alaska 1983). 21.  Id. at 40.

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V I .   M E R G E R CL A US ES Many written contracts contain a clause stating that the written contract is the entire contract between the parties. These clauses are known as merger or integration clauses because they say, in effect, that all agreements between the parties have been merged or integrated into the writing. Typically these terms are boilerplate—​that is, they are standardized clauses that are routinely inserted by the drafting lawyer into every contract the lawyer writes even when the principals have not specifically negotiated such a clause. These terms usually appear at the end of the contract alongside other standardized terms, such as provisions that set out the addresses to which notices should be sent. The law on what effect should be given to merger clauses is messy. This messiness is reflected in the muddiness of Restatement Second Section 216, Commente: Written agreements often contain clauses stating that there are no representations, promises or agreements between the parties except those found in the writing. Such a clause may negate the apparent authority of an agent to vary orally the written terms, and if agreed to is likely to conclude the issue whether the agreement is completely integrated. Consistent additional terms may then be excluded even though their omission would have been natural in the absence of such a clause. But such a clause does not control the question whether the writing was assented to as an integrated agreement, the scope of the writing if completely integrated, or the interpretation of the written terms. (Emphasis added.)

In some cases the courts have given a merger clause a great deal of weight; in others, the clause has been given little if any weight. For example, in Seibel v. Layne & Bowler, Inc.,22 decided under the UCC, the defendant argued that the contract at issue could not be supplemented by a parol agreement because the contract included a merger clause. The court rejected this argument: [UCC § 2-​202] requires . . . that the parties intend for the agreement to be their complete expression. Because the merger clause is . . . inconspicuous . . . it provides little or no evidence of the parties’ intentions, regardless of the defendant’s intentions. Moreover, under the UCC, courts are to limit the application of contract provisions so as to avoid any unconscionable result. [UCC § 2-​302, Official Comment 1] indicates that a principle underlying unconscionability is the prevention of unfair surprise. . . . We think that it would be unconscionable to permit an inconspicuous merger clause to exclude evidence of an express oral warranty especially in light of the policy expressed by [UCC § 2-​316]. That is, a disclaimer of the implied warranties of fitness and merchantability must be conspicuous to prevent surprise. We think that a merger clause which would deny effect to an express warranty must be conspicuous to prevent an even greater surprise.23

22.  641 P.2d 668 (Or. Ct. App. 1982). 23.  Id. at 671.

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V I I .   P R O MI S S O RY  F R A UD Under a well-​established exception to the parol evidence rule a parol agreement is admissible if the later contract is subject to an “invalidating cause” such as lack of consideration, duress, mistake, illegality, or fraud.24 A very significant element in this cluster is fraud, and more particularly the doctrine of promissory fraud. Although fraud normally involves statements of fact, under the doctrine of promissory fraud a promise is fraudulent if the promisor makes the promise with a present intent not to perform it. Under the fraud exception to the parol evidence rule, therefore, a parol agreement that would otherwise fall within the rule is enforceable if the promisor made the later contract with an intent not to perform it. For example, in Sabo v. Delman25 Sabo had assigned to Delman applications for letters patent on a machine that Sabo had invented, and had entered into written contracts with Delman concerning the assignment and the sharing of proceeds. Thereafter, Sabo brought an action to rescind these transactions on the ground that Delman had induced Sabo to enter into the transactions by fraudulently promising that he would finance the manufacture of the machine and use his best efforts to promote its sale or lease, when in fact he had no intention to do either. The Court of Appeals held that evidence of these promises was admissible under the fraud exception. Accordingly, a promisee may be able to avoid the bite of the parol evidence rule if the circumstances support a plausible claim that a promisor made the parol agreement with an intent not to perform it. Lusk Corp. v. Burgess26 is a good example. Plaintiffs, as buyers, entered into a written contract with defendants, as sellers, for the construction and purchase of a house and lot. Prior to the execution of the contract the defendants’ agent represented to plaintiffs that a lot across an alley at the back of the plaintiffs’ residence (the lot) would be used for the purpose of constructing a Texaco burnt-​adobe service station with a gravel-​covered roof, the plans had already been drawn up, the service station would be the latest thing in the west, Texaco was all for it, a patio wall would be built on the portion of the service-​station lot between the service station and plaintiffs’ proposed house, the service station would have a low roof, and its architecture would conform to that of the houses in the Highland Vista subdivision in which plaintiff ’s house was located. After making these representations, defendants conveyed the lot, without restrictions, to third persons, who erected a red-​brick service station painted white. This service station neither conformed neither to the defendant’s representations nor to the architecture of the houses in the Highland Vista subdivision. Furthermore, in addition to the service station, a square cement block building containing a barber shop and beauty parlor was built on a portion of the service-​ station lot immediately adjoining the lot sold to the plaintiffs by defendants. Plaintiffs were not informed that any buildings other than the service-​station building were to be constructed on the service-​station lot. The trial judge found that the representations made by the defendants or their agents were false, and known to be false when made, and held that the parol evidence rule did not apply: The representations concerning the service station were made to plaintiffs between June 2, 1954 and June 9, 1954. Subsequent to these representations plaintiffs on June 9, 1954, entered

24.  See Restatement (Second) of Contracts § 214(d) (Am. Law Inst. 1979). 25.  143 N.E.2d 906, 908–​09 (N.Y. 1957). 26.  332 P.2d 493 (Ariz. 1958).

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into a written contract for construction and purchase of the house and lot from defendants. The testimony indicates that as early as the first part of May, 1954 the defendants were negotiating to sell the service station lot to third persons, the successful conclusion of which depended upon whether the purchasers could lease said property to the Texas company. Other evidence bearing upon this matter is that pursuant to these negotiations defendants thereafter on June 15, 1954, only six days after the execution of the contract of purchase with plaintiffs, conveyed by deed the service station lot to the person with whom they had been negotiating for its sale. . . . [W]‌e believe the inference is clear that defendants divested themselves of control of the serv­ice station lot prior to the time the representations claimed by plaintiffs to be false were made to them. This inference is strengthened by the fact that within six days after conveying the lot to plaintiffs defendants conveyed the service station lot to the purchaser without incorporating in the deed restrictions in conformity with the representations made to plaintiffs. These two circumstances considered together, we believe, are sufficient evidence to support a finding by the court that defendants made said representations with the intent then formed to not perform them. This being true said representations constitute actionable fraud. The further fact that plaintiffs’ agent represented as an existing fact that Texaco had already drawn the service station plans and were all for it when considered in connection with all of the other evidence, seems to us to make the representations actionable fraud.27

The promissory fraud exception is especially complex when the later contract includes a merger clause. As in the case of merger clauses generally, the judicial reaction to merger clauses in the context of promissory fraud cases has been mixed. In Sabo v.  Delman28 the New York Court of Appeals held that a generalized merger clause did not bar rescission for promissory fraud: . . . [Just as the parol evidence] rule is ineffectual to exclude evidence of fraudulent representations, so [the merger clause in this contract] may not be invoked to keep out such proof. Indeed, if it were otherwise, a defendant would have it in his power to perpetrate a fraud with immunity, depriving the victim of all redress, if he simply has the foresight to include a merger clause in the agreement.29

However, the New  York Court took a different position in Danann Realty Corp. v. Harris,30 where the merger clause related much more specifically to the parol evidence sought to be introduced. The purchaser of a lease on a building brought an action for damages against the seller, claiming that the seller had orally misrepresented the building’s operating expenses and the profits to be derived from the purchaser’s investment. The contract of sale provided that: The Purchaser has examined the premises agreed to be sold and is familiar with the physical condition thereof. The Seller has not made and does not make any representations as to the 27.  Id. at 494–​95. 28.  143 N.E.2d 906 (N.Y. 1957). 29.  Id. at 909. 30.  157 N.E.2d 597, 598 (1959).

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physical condition, rents, leases, expenses, operation or any other matter or thing affecting or related to the aforesaid premises, except as herein specifically set forth, and the Purchaser hereby expressly acknowledges that no such representations have been made, and the Purchaser further acknowledges that it has inspected the premises and agrees to take the premises “as is”. . . . It is understood and agreed that all understandings and agreements heretofore had between the parties hereto are merged in this contract, which alone fully and completely expresses their agreement, and that the same is entered into after full investigation, neither party relying upon any statement or representation, not embodied in this contract, made by the other. The Purchaser has inspected the buildings standing on said premises and is thoroughly acquainted with their condition.

The court said: Plaintiff has in the plainest language announced and stipulated that it is not relying on any representations as to the very matter as to which it now claims it was defrauded. Such a specific disclaimer destroys the allegations in plaintiff ’s complaint that the agreement was executed in reliance upon these contrary oral representations. . . . The Sabo case . . . dealt with the usual merger clause. The present case . . . additionally, includes a disclaimer as to specific representation. . . .31

V II I .  T H E C O N D I T ION-​T O-​L EGA L -​ E F F E C T I V E N E S S EXCEPT I ON Another exception to the parol evidence rule is that the rule does not apply to an agreement that provides that the occurrence or nonoccurrence of some state of affairs is a condition to the effectiveness of a later contract. The exception is illustrated as follows in Restatement Second Section 217, Illustration 5: A and B make and sign an elaborate written agreement for the merger of their corporate holdings into a single new company. The writing provides that all obligations under it will terminate unless agreed subscriptions to the stock of the new company are accepted within twenty days. It is also orally agreed that the project is not to be operative unless the parties raise $600,000 additional capital. If the additional capital is not raised, there is no contract.

The condition-​to-​legal-​effectiveness exception is inconsistent with the parol evidence rule for two reasons: First, the exception turns on form, rather than substance. If the parties characterize an earlier agreement as a condition to the performance of a later contract, the earlier agreement will be inadmissible under the parol evidence rule, because the later contract is then admittedly a binding contract and the condition concerns only its performance. However, if the parties characterize their parol agreement as a condition to the legal effectiveness of the written agreement, under the condition-​ to-​ legal effectiveness exception the parol 31.  Id. at 599.

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agreement is not subject to the parol evidence rule even though the parties clearly had concluded a deal and therefore had made a contract. Second, in practice it is not easy to reconcile the exception and the rule. The rationale of exception is that (1) the parol evidence rule only applies where a writing is a contract, and (2) if there was a parol agreement that a writing was not to be legally effective as a contract unless and until some condition is fulfilled, then the writing is not a contract prior to that time, so the parol evidence rule does not apply. The problem with this rationale is that in most cases where the exception is applied it is clear that the writing is a contract, and that the parol agreement was a condition to the obligation of performance under the contract, not a condition to the legal effectiveness of the—​contract. For example, in Illustration 5 to Restatement Second Section 217, supra, despite the phrasing of the oral agreement it is likely that A would be in breach of contract if A walked away from the deal before B had a chance to raise $600,000 additional capital.

I X .   C O N CL US I ON All versions of the parol evidence rule are unjustified because they give the judge rather than the jury the power to make critical factual determinations. There is no good reason to take this issue out of the hands of the jury. The parol evidence rule is frequently defended on the ground that juries are likely to be biased in favor of the little guy. However, there is no evidence that this is so, and if it was so then many other issues should also be taken from the jury. The law properly does not take that path in non-​contracts cases and it should not take that path in contract law. Therefore, the parol evidence rule should be dropped. Unfortunately, that will not happen very soon, if at all, because dropping the rule would be perceived as a loss for the defense bar, and given the phenomenon of loss aversion the strength of the opposition to dropping the rule would be much stronger than the strength of any movement to drop the rule. If, for political reasons, the rule is retained it should be formulated in the best possible way. This means, among other things, that: (1) Whether a contract is an integration should depend on all available evidence concerning the parties’ intentions. (2) Whether a parol agreement is such as might naturally be made as an agreement separate from the later contract should turn on the facts and circumstances concerning the actual parties, not on what hypothetical reasonable parties would have been likely to do. (3) The concept of partial integration should be dropped, so that a later contract supersedes a parol agreement only if it is a complete integration. (4) A parol agreement should not be deemed inconsistent with a later agreement unless putting the parol agreement and the later contract into one instrument would produce an instrument that was self-​contradictory. (5) A later agreement should not supersede or discharge an earlier agreement if the later agreement was subject to a recognized contract defense, including the defense of promissory fraud. (6) A merger clause should not bar evidence of a parol agreement unless there is no room for doubt that giving the merger clause that effect reflects both parties’ actual intentions.

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PA R T S I X T E E N

MISTAKE, DISCLOSURE, AND UNEXPECTED CIRCUMSTANCES

50

51

t h i r t y - ​n i n e

Introduction to Mistake in Contract Law Supp ose that A and B enter into a c on tr act that i s based on or

reflects a mistake made by A or by A and B jointly. Later, A claims that because of the mistake the contract should be unenforceable if it has not been performed, or reversible if it has been. The problems raised by claims of this kind have been a source of persistent difficulty in contract law. In part, this difficulty results from the complex nature of the underlying issues. Intuitively there seems to be a serious tension between the concept that a mistake may be a ground for relief in contractual transactions, on the one hand, and basic ideas of contract law such as risk-​shifting, the security of transactions, and rewards for knowledge, skill, and diligence, on the other. However, a good part of the difficulty results not so much from this tension as from the use of legal categories and doctrinal rules that are not based on a functional analysis. Traditionally, contract law has recognized four categories of mistake, each with its own body of rules: mutual mistake, unilateral mistake, mistranscription, and misunderstanding. The names of the categories generally fail to describe contractual mistakes according to their functional characteristics, and many of the rules that govern these categories turn on elements that are either of only limited functional significance, easy to manipulate, or both. The first step in developing a functional analysis of mistake is to describe contractual mistakes on the basis of their character. The second step is to develop the rules that should govern each type of mistake based on policy, morality, and experience. In succeeding chapters the basic types of contractual mistakes will be analyzed in light of these two steps. This chapter sets out the general parameter of the analyses.

I .   E F F I CI ENCY From an efficiency perspective, whether relief should be granted to a contracting party on the basis of a given type of mistake principally turns on three overlapping questions: • Would furnishing relief based on the given type of mistake provide efficient or inefficient incentives? On the surface it might appear that furnishing relief for mistake would inefficiently provide a disincentive to take precautions. That disincentive, however, will Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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often be swamped by countervailing incentives to be careful. Furthermore, maximum precautions are not always or even normally efficient. For example, a legal regime that provided an incentive for triple and quadruple checking might inefficiently lead to an unduly high amount of precaution. • Was the risk of the mistake explicitly or implicitly allocated by the contract? Bargains are instruments of efficiency: they increase wealth through trade, allocate commodities to higher-​valued uses, and facilitate private planning by allowing actors to allocate risks, to coordinate and stabilize planning through the acquisition of control over inputs and outputs, and to reliably make investments that will increase the value of the exchange. Accordingly, if a contract allocates to one party the risk of a given kind of mistake, normally that allocation should be deemed efficient. Moreover, if a contract allocates the risk of a mistake to the mistaken party any advantage that the nonmistaken party derives from the mistake will normally be an advantage that she has earned. • If the risk of the mistake was not explicitly or implicitly allocated by the contract, can we be reasonably confident how the parties would have allocated the risk if they had addressed that question? If we can, then allocating the risk that way is at least presumptively fair and efficient.

I I .   MO R AL I T Y From a moral perspective, whether relief should be granted for any given type of mistake also principally turns on three overlapping questions:





(1) Is it morally proper for a mistaken promisor to assert that the given type of mistake is an excuse for not keeping her promise? Some types of mistake provide a moral justification for not keeping a promise; some don’t. Similarly, is it morally proper for the nonmistaken promisee to take advantage of the mistake by insisting on full performance even after he has been made aware of the mistake? (2) Would a legal rule that furnished relief for a given type of mistake improperly leave the nonmistaken party with an unredressed injury caused by the mistaken promisee’s fault? Almost invariably a mistake results from fault. Where a mistake by a promisor results in a decrease in the promisee’s wealth typically it would be inappropriate to excuse the mistaken promisor from making good that decrease or, to put it differently, from reliance damages. However, certain types of mistake should excuse a mistaken promisor from making good the promisee’s expectation. (3) Would a legal rule that allowed a nonmistaken party to enforce her promise, or retain a benefit that was based on a given type of mistake, undesirably confer upon that party an unearned and ungifted advantage? The law typically protects advantages and benefits that have been earned or gifted, but it is not as solicitous to protect advantages and benefits that are unearned and ungifted. Of course, an advantage or benefit that one actor gains through another’s mistake may be earned, as where the mistaken actor contracted to take the risk of the mistake. However, where one party’s advantage or benefit is gained by another party’s mistake and not earned or gifted, the retention of the advantage or benefit may be exploitive.

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I I I .   E X P ER I ENCE The most salient type of experiential propositions that concern mistake involve administrability. For example, a rule concerning mistake that would be desirable if it would be easy and not too costly to acquire the information needed to apply the rule may be undesirable if it would be difficult or costly to acquire the information. Other kinds of experiential propositions that concern mistake will be considered throughout this Part.

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Evaluative Mistakes A bargain promise requ ires and em b odi es t wo choi ces b y the

promisor. First, the promisor must choose to achieve a certain objective. Second, she must choose to achieve that objective by making a bargain. Like other choices, bargain promises entail evaluations of various kinds. In particular, a bargain promisor must explicitly or implicitly evaluate the relation between her own preferences (including her values and tastes) and the performances due from and to her under the contract. Those evaluations consist of the personal or subjective value to her of those performances, and the expected market or objective value of those performance at the time they are due. Suppose that before making a bargain a promisor knew all the material information relevant to her choice and was capable of processing the information, but the bargain turned out badly for her. In one important sense the promisor has made no mistake: the bargain may have turned out badly because her preferences have changed or because of the occurrence of unexpected circumstances or events that fell on the unlucky tail of a probability distribution. Making a prudent bet need not be characterized as a mistake even if the bet loses. Nevertheless, in everyday language if a person has made a choice, including a choice to make a bargain, that turned out badly, it is common to characterize the choice as a mistake. A few examples: • A, who has two weeks of vacation each year, enters into a contract with the X cruise line to take a cruise in the Caribbean during that period. A later develops a passion for skiing, and comes to believe that her choice to make the contract with X was a mistake. • B, the general manager of a basketball team, signs Y to a five-​year contract. B later comes to believe her choice to make a contract with Y was a mistake because K, another player already on the team, develops much more quickly than expected and renders Y expendable. • C, a toymaker, makes a contract with Z, a film studio, under which C obtains a license to manufacture and sell toys based on characters in Z’s forthcoming movie, Rapunzel. Everyone expects Rapunzel to be a blockbuster, and C pays a large nonrefundable advance for the license. Rapunzel turns out to be a flop, the license is worthless, and C comes to believe that her decision to make a contract for the license was a mistake. In this book, where a well-​informed and capable actor chose to make a contract, and later comes to believe that her choice was a mistake as a result of a change in her preferences, a change in the subjective or objective value of the performances due under the contract, or

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the occurrence of unexpected circumstances or events that fall on the unlucky trail of a probability distribution but did not give rise and a defense of impossibility for frustration (see Chapter 45), the mistake will be referred to as an evaluative mistake. Some types of mistakes should provide relief to a mistaken promisor. Evaluative mistakes are not one of these types. Begin with efficiency considerations. Many bargains are motivated by the parties’ differing evaluations of the objective value of the performances that will be due under their contract. To put this differently, in many cases the risk that one contracting party has made an evaluative mistake is exactly what the other party has bargained for. In effect such contracts are fair bets, and to allow evaluative mistakes to provide a basis for relief would undercut both the purpose of such contracts and the efficiency goals they serve. Even when bargains are motivated by factors other than the value of what is to be exchanged, such as a party’s desire to coordinate and stabilize his economic enterprise through the acquisition of control over inputs and outputs, or to reliably make investments that will increase the value of an exchange, a rule that allowed an evaluative mistake to provide a basis for relief would inefficiently render wholly insecure contracts whose very objective was to achieve security. Moral considerations point in the same direction. If a promisor is capable and well-​informed and does not act under a transient defect of cognition, then the choice reflected in her promise is what Thomas Scanlon has called a demonstrative choice—​a choice that reflects, and therefore demonstrates, the actor’s intelligence and skill and, not incidentally, symbolizes the actor’s view that she is competent to make a choice of this kind.1 Accordingly, the value of a demonstrative choice to an actor is not limited to promoting an outcome the actor wishes to achieve, but also includes the significance to the actor of the fact that she is capable of making and has made such a choice.2 A promisor may come to regret that she made the choice embodied in her promise, but considerations of self-​respect argue that this is the kind of choice that she should stand behind if her only reason for regret is that she made an evaluative mistake. Even more fundamentally, it is a basic principle of morality that promises should be kept, and the whole point of a promise is to commit an actor to take a given action in the future even if, all things considered, when the action is due to be taken the actor does not wish to take it. A rule under which an evaluative mistake provided a basis for not keeping a promise would negate the very point and meaning of a promise, and therefore the moral principle of promise-​ keeping, because to say that a person is not obliged to keep a promise on the ground that she made an evaluative mistake is equivalent to saying that a person not need keep a promise if, all things considered, she wishes not to do so. Finally, in the case of an evaluative mistake the promisee has entered into the bargain on the basis of his evaluations made through the use of his knowledge, skill, and diligence. If a capable and well-​informed promisor could back out of a contract because it turned out that the promisee’s evaluation was better than hers, the promisor would be depriving the promisee of an earned advantage. Accordingly, an evaluative mistake should not and does not provide a basis for relief from a contract that a promisor no longer wishes to perform. Whether and when non-​evaluative mistakes should and do provide such relief—​or more accurately, the extent to which various types of non-​evaluative mistakes should and do provide such relief—​will be explored in the next few chapters. 1.  See T.M. Scanlon, Jr., The Significance of Choice, in 8 The Tanner Lectures on Human Values 149, 179–​80 (Sterling M. McMurrin ed., 1988). 2.  Id.

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Mechanical Errors (“Unilateral Mistakes”) I .   I N T R O DUCT I ON A common kind of mistake in everyday life consists of physical blunders, such as spilling coffee. This kind of mistake, although manifested externally, normally results from errors in the mechanics of an actor’s physical machinery, such as a lapse of concentration, a loss of balance, or an error in hand-​eye coordination. Such errors are almost invariably transient. If an actor spilled every cup of coffee he handled we would not characterize his spills as mistakes, but instead would say that he had some type of disability. A counterpart to transient physical blunders consists of transient mental blunders that result from errors in the mechanics of an actor’s mental machinery. For example, as a result of a transient error in the mechanics of an actor’s mental machinery the actor may write “65” when he intends to write “56,” or may incorrectly add a column of figures. Mistakes of these kinds—​ that is, blunders that result from transient mental errors in the mechanics of an actor’s internal machinery, are usually referred to as unilateral mistakes, that is, a mistake made by one party. This terminology is misleading, because some kinds of mistakes made by one party, such as evaluative mistakes, are not a ground for relief, while others are. In this book, transient mental blunders will be referred to as mechanical errors. Mechanical errors resemble the kind of mistake sometimes made in the transcription of DNA. Almost invariably, that transcription is correct. Every once in a while, it goes transiently awry. Mechanical errors differ from evaluative mistakes in several critical respects. For one thing, promises that are a product of mechanical errors are not based on, and do not reflect, the promisor’s preferences. On the contrary, such promises are based on and reflect a transient and non-​deliberate departure from those preferences—​a departure that would not have been made if the promisor’s internal machinery had not temporarily gone awry. Also unlike evaluative mistakes, the prospect that a counterparty will make a mechanical error normally is not a risk that is bargained for. Finally, unlike relief for evaluative mistakes, relief for mechanical errors would not undermine the very idea of promise. A promisor who seeks relief on the ground of mechanical error does not assert that all things considered she doesn’t wish to perform. Rather, she asserts that she has a morally acceptable excuse that is well within the systemics of promise.

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Providing relief from contracts on the basis of mechanical errors is normally efficient. It is inevitable that actors will make a certain number of mechanical errors even if they take optimal precautions, just as it is inevitable that a certain number of DNA transcriptions will go wrong even though the body’s cellular machinery has mechanisms to prevent and cure such mistranscriptions. Generally speaking, actors will take optimal precautions against mechanical errors as a matter of self-​interest even under a regime in which they will not be subject to expectation damages. As stated in S.T.S. Transport Service, Inc. v. Volvo White Truck Corp.:1 The reason for the special treatment [of errors that are mathematical or “clerical”] is that they are difficult to prevent, and that no useful social purpose is served by enforcing the mistaken term. No incentives exist to make such mistakes; all the existing incentives work, in fact, in the opposite direction. There is every reason for a contractor to use ordinary care, and, if errors of this sort—​clerical or mathematical—​slip through anyway, the courts will generally find it more useful to allow the contract to be changed or rescinded than to enforce it as it is.2

In contrast, a regime that provided no relief for mechanical errors would give actors an incentive to take an inefficiently high level of precaution—​triple-​and quadruple-​checking. A regime that provides relief for mechanical errors will also be efficient in the sense that it will reflect the preferences that most actors would express if they were choosing a legal regime from behind the veil. The phenomenon of loss-​aversion is relevant here. Behavioral economics has shown that actors are loss-​averse: that is, the disutility of losing what one has is greater than the utility of acquiring an equal amount of what one doesn’t have.3 To put this differently, an actor perceives the loss of existing endowments as a greater harm than a failed opportunity to augment his endowments by an equal amount. Accordingly, perceived losses, such as out-​of-​pocket costs, are more painful than forgone gains, such as potential profits.4 As

1.  766 F.2d 1089 (7th Cir. 1985). 2.  Id. at 1093. 3.  See, e.g., Richard H. Thaler, The Winner’s Curse:  Paradoxes and Anomalies of Economic Life 63–​78 (1992); Daniel Kahneman, Jack L. Knetsch & Richard H. Thaler, Experimental Tests of the Endowment Effect and the Coase Theorem, 98 J. Pol. Econ. 1325, 1345–​46 (1990); Amos Tversky & Daniel Kahneman, Rational Choice and the Framing of Decisions, in The Limits of Rationality 60, 70–​72 (Karen Schweers Cook & Margaret Levi eds., 1990). 4.  Loss-​aversion, the endowment effect (on which loss-​aversion is partly based), and some of the evidence for loss-​aversion, are nicely summarized by Jeffrey Evans Stake: The endowment effect is a pattern of behavior in which people demand more to give up an object than they would offer to acquire it. This difference between the amount a person is willing to pay . . . and the amount she is willing to accept . . . has been explained by reference to the theory of loss-​aversion. According to the theory of loss-​aversion, losses have greater subjective impact than objectively commensurate gains. In graphical terms, utility curves are asymmetrical in that the disutility of giving up an object is greater than the utility of acquiring it. . . . In one experiment, subjects were given either a lottery ticket or $2.00 cash. When they were given the chance to trade their initial endowment for the other endowment, somewhat surprisingly, very few subjects chose to switch. Almost everyone preferred what they were initially given. In a test for endowment effects reported by Professors Kahneman, Knetsch, and Thaler, subjects were randomly assigned to one of three groups: sellers, buyers, or choosers. Sellers were given a coffee mug and a chance to sell it at various prices. Buyers were given a chance to buy a mug at various prices. Choosers were given an opportunity to get either a mug or cash. Put another way, choosers were given an option to get a mug (without paying anything) and given the chance to sell the mug-​option at various prices. The only difference between choosers and sellers was that choosers were not actually endowed with a mug before they were put

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Daniel Kahneman explains it, “There is an asymmetry between gains and losses, and it really is very dramatic and very easy to see. . . . People really discriminate sharply between gaining and losing and they don’t like losing.”5 Given the phenomenon of loss-​aversion, if contracting parties addressed the issue whether one party could take advantage of the other’s mechanical error, they would probably agree that she could not, except to the extent that she has justifiably relied. Providing relief for mechanical errors also comports with morality. It is morally proper for an actor who has made a promise based on a blunder resulting from a transient error in her mental machinery to request relief, provided she stands willing to compensate the promisee in such a way that he is not worse off than he would have been if the promise had not been made. Correspondingly, if the promisor stands ready to make such compensation for any loss the promisee has suffered as a result of the mistake, it would be morally exploitive for the promisee to insist on full performance or expectation damages even after he knows that the promise was based on a mechanical error. Furthermore, the advantage that a promisee would derive from a promisor’s mechanical error would be unearned and ungifted—​obtained not through the promisee’s skill and diligence, but only as a result of chance. Accordingly, the legal principle that should govern mechanical errors is this:  Mechanical errors should provide a basis for relief to a promisor except to the extent that the promisee has suffered a loss as a result of her justifiable reliance on the promise. This principle might be undesirable if it was very difficult to determine whether a mechanical error has been made. Typically, however, it is very easy to make that determination. For example, many mechanical-​error cases involve mistaken payments. In most cases it is very easy to establish that a payment was mistaken—​because, for example, the payment was sent to the wrong person, or the payor either owed nothing to the payee or indisputably owed a smaller sum than was paid. Many other mechanical-​error cases involve computational errors in construction bids by contractors or subcontractors. Typically in these cases either the contractor’s work papers, the surrounding circumstances, or both, clearly demonstrate that a computational error was made.6 Much the same is true in other kinds of mechanical-​error cases.7 In any event a party seeking relief on the basis of a mechanical error should have the burden of proving that

to the task of deciding their selling price. The major difference between choosers and buyers was that buyers were already endowed with the cash they would have to spend to get a mug whereas the cash was merely a prospect for choosers. The prices at which trades, or choices, could take place were varied across a range, and the results—​how many subjects in each group would trade—​were recorded. In this way, a median valuation (or reservation price) was determined for each group: sellers, $7.12; choosers, $3.12; buyers, $2.87. In a replication of the experiment, in which the price tags were left on the mugs, the results were: sellers, $7.00; choosers, $3.50; buyers, $2.00. These results confirmed conclusions from other loss-​aversion experiments. People are biased toward the status quo. Losses have a subjectively larger impact than equivalent financial gains, and the difference is greater than would be predicted from declining marginal utility alone.

Jeffrey Evans Stake, The Uneasy Case for Adverse Possession, 89 Geo. L.J. 2419, 2459–​62 (2001). 5.  Erica Goode, A Conversation with Daniel Kahneman: On Profit, Loss and the Mysteries of Mind, N.Y. Times, Nov. 5, 2002, at F1. 6.  See, e.g., Elsinore Union Elementary Sch. Dist. v.  Kastorff, 353  P.2d 713, 718 (Cal. 1960); Balaban-​ Gordon Co. v. Brighton Sewer Dist. No. 2, 342 N.Y.S.2d 435, 437 (1973). 7.  See, e.g., the Nolan Ryan Baseball Card case and Donovan v. RRL Corp., 27 P.3d 702 (Cal. 2001) (both discussed infra Part III.E).

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the error was made, and if there is significant doubt on that issue the benefit of the doubt should be given to the party who denies that an error was made. The remainder of this chapter will consider several recurring mechanical-​error cases, such as mistaken payments, mistaken computations, and mislabeled prices, as well as the classical and modern positions on mechanical errors.

I I .   MI S TA K E N PAYM ENT S A recurring type of mechanical error involves mistaken payments. Such payments may occur in either a contractual or noncontractual context, and may result from a factor other than a mechanical error, such as a mistake of law. This chapter will consider only cash payments, made in a contractual setting, that result from mechanical errors. (The term “contractual setting” is used here broadly to include, for example, insurance and banking transactions.)8 For ease of exposition, payments of this sort will be referred to as mistaken payments. The issues raised by mistaken payments are usually addressed by the law of restitution rather than the law of contracts, because a suit to recover a mistaken payment is not a suit to enforce a contract. Mistaken payments are considered in this chapter both because of the contractual setting and, more, because an examination of this relatively straightforward case is useful in examining more difficult mechanical-​error cases.

A.  THE PARADIGM CASE In the paradigm mistaken-​payment case it is undisputed that the payment is not owed by the payor to the payee, and the payee knows that the payment is mistaken. For example, Debtor, who owes $1,000 to Creditor C1, sends that amount to C2, a stranger, in the mistaken belief that C2 is C1. Or Buyer sends $5,000 to Seller in the mistaken belief that she owes Seller that amount, when in fact it is undisputed that she owes only $500. Or as a result of a clerical oversight Insurer pays the proceeds of a life-​insurance policy to the deceased’s surviving spouse, when both Insurer and the surviving spouse knew that a former spouse was entitled to the policy proceeds. As a legal matter there is no doubt that in the paradigm case the payee is obliged to return the mistaken payment.9 But why should this be so when the payor was at fault in making the mistaken payment and the payee did not obtain the payment through a breach of contract, a tort, or any other wrongful act? The issues arising out of mistaken payments are sometimes analyzed in terms of autonomy, voluntariness, and free choice.10 This analysis is not very productive. Hanoch Dagan has said

8.  The analysis in this chapter is confined to cash payments made in a contractual setting because other kinds of benefits conferred by mistake, such as mistaken payments of taxes and mistaken improvements on another’s land, tend to raise issues of valuation and liquidity that are not as salient for contract law as they are for the law of restitution. See Hanoch Dagan, Mistakes, 79 Tex. L. Rev. 1795, 1826–​27 (2001). 9.  See, e.g., Metro. Life Ins. Co. v. Solomon, 996 F. Supp. 1473, 1475 (M.D. Fla. 1998). 10.  See, e.g., Dagan, supra note 8, at 1797–​802.

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that “the autonomy interest of a potentially mistaken party is the ability to act without fear that a mistake will irrevocably frustrate her intentions and threaten the integrity of her self.”11 But surely it would not be an invasion of the autonomy interest to hold an actor responsible for his own uncoerced mistakes. Respect for autonomy may require that actors not be held responsible for involuntary actions, but an actor who made a mistaken payment has acted voluntarily. By way of comparison, if A, who is in the demolition business, tears down B’s building in the mistaken belief that the building belonged to C, holding A responsible for the destruction of B’s building could not reasonably be thought to interfere with A’s autonomy or free choice, or to make A liable for an involuntary action. Accordingly, it is much more fruitful to examine the issues raised by mistaken payments through the lens of efficiency and moral considerations. Call a legal regime in which payors are entitled to recover mistaken payments (minus the payee’s transaction costs for voluntarily returning the payment and the amount of the payee’s justifiable reliance, if any) a restoration regime. Under such a regime a mistaken payor fully internalizes the costs of the mistaken payment—​both his own costs and those of the payee.12 It might be thought that a restoration regime is inefficient because it fails to give payors an incentive to take optimal precautions against making mistaken payments.13 In fact, however, a restoration regime is more efficient than a nonrestoration regime. Even under a restoration regime a mistaken payor bears a number of risks and costs. She bears the risk that she may not discover that she made a mistaken payment. She bears the risk that the payee will be judgment-​proof. And even if the mistake is discovered and the payee is not judgment-​ proof, she bears the risk that she will have to incur costs, possibly including the costs of litigation, to recover the payment. Given these risks and costs it is highly unlikely that a restoration regime will lead payors to take less-​than-​optimal precautions against making mistaken payments. In contrast, under a nonrestoration regime payors would forfeit the amount of mistaken payments. Such a regime would cause payors to take excessive precautions, such as triple-​or quadruple-​checking, and delaying payments because of the time needed to perform such checking. These excessive precautions would not only constitute a social cost but would often harm payees as a class, because payors whose business entails a large number of payments, such as large financial or commercial enterprises, would pass the increased costs of such excess precautions on to consumers in the form of higher prices and delays. The power to retain a mistaken payment would constitute a windfall to the payee. Most consumers would probably prefer a legal regime that produces lower present prices and faster payments, but no windfall, over a regime that produces higher present prices and slower payments coupled with the chance of a highly improbable windfall of an uncertain amount in the remote future. It might be thought that a restoration regime fails to give payees incentives to take an efficient amount of precaution against receiving mistaken payments. But why should the law encourage actors to take precautions against receiving mistaken payments? We want actors to take precautions against being injured, but do we really care whether actors take precautions 11.  Id. at 1806. 12.  There appears to be little or no law on the permissibility of a deduction by the payee for transaction costs of voluntarily returning a mistaken payment, presumably because those costs are almost always trivial. 13.  See J. Beatson, Mistaken Payments in the Law of Restitution, in The Use and Abuse of Unjust Enrichment: Essays on the Law of Restitution 137, 160–​62 (1991).

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against being mistakenly benefited? In any event, even under a restoration regime actors will take precautions to determine whether payments they receive are correct. Payees have an incentive to check for mistakes that are not in their favor. The process of checking for mistakes not in one’s favor is usually identical to the process of checking for mistakes in one’s favor. For example, to determine whether a credit to an actor’s bank account is less than it should be the actor must compare the amount that was credited with the amount he expected. In the process the actor will also discover whether the credit is more than it should be. In general, in the process of looking for adverse mistakes actors will also uncover favorable mistakes. A restoration regime is also efficient because it reflects actors’ preferences. Such a regime can be analogized to a mutual-​insurance scheme: under a restoration regime all actors insure each other against the casualty loss of making mistaken payments by taking on a legal obligation to return any mistaken payment that falls to their lot. Given loss-​aversion and the cost of taking super-​high precautions under a nonrestoration regime, if actors addressed from behind the veil the issue what should be the rule when one actor makes a mistaken payment to another, it is highly likely they would agree that the payment should be restored. To put this differently, most actors would probably prefer a restoration regime, in which random mistaken payments can be recaptured by the payor, to a nonrestoration regime, in which a party who makes a mistaken payment completely loses out. Thus at least in contractual contexts a restoration regime is more efficient than a nonrestoration regime because it is the regime that parties would choose if they addressed the issue. A restoration regime is also supported by considerations of morality. In mistaken-​payment cases the payee has obtained possession of money that belongs to the payor and has done so not through skill or diligence, but by accident—​by chance. It is morally improper for an actor to retain money of another that has come into his possession simply through chance without his having either earned or been gifted the property. It might be argued that even though a mistaken payment is neither earned nor gifted an actor should be entitled to a benefit that she luckily obtains. It is true that in some cases it is acceptable for an actor to retain an unearned and ungifted benefit. If the golden pheasant flies over your backyard and drops a golden egg, the egg is yours. In such cases the actor who benefits is said to be lucky. Normally, however, an actor is not morally entitled to retain an unearned and ungifted benefit at another’s expense. In such cases, the actor is not said to be lucky. What constitutes luck is largely a matter of social morality and policy, which may change over time, and law, which will normally follow social morality and policy. For example, before the 1960s an actor who knowingly received inside information that bore on the value of corporate stock was lucky because he could make money by trading on the basis of the information. Today such an actor is not lucky; if he trades on the basis of the information, he is considered a kind of thief and is subject to moral and legal sanctions.14 Similarly, if A loses property that B finds, and B knows or could determine by a reasonable effort that the property belongs to A, B must take steps to restore the property to A; therefore, B is not lucky except in the very attenuated sense that she may come in for a reward from A. (A finder who doesn’t know or have reason to know the loser’s identity may be somewhat luckier, because she may be able to claim ownership if the owner doesn’t appear.) Of course, a finder may wrongfully keep the lost property, and in such a case she may count herself lucky, just as a thief may 14.  See, e.g., United States v. O’Hagan, 521 U.S. 642, 675–​76 (1997); SEC Rule 10b-​5, 17 C.F.R. § 240.10b-​5 (2017).

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count himself lucky to find a lot of money in a house that he has broken into. As a matter of social morality, however, both the finder and the thief would be regarded not as lucky, but as immoral. Indeed, a finder’s appropriation of the property, without having made reasonable efforts to restore the property to the owner, will constitute theft not only morally but under the criminal law.15 From a moral perspective there is no significant difference between keeping lost property that you know belongs to an identifiable person and keeping a payment that you know has been sent to you by mistake. An actor who receives such a payment is no more morally entitled to retain the payment than a finder of lost property who knows or could easily determine the owner’s identity is morally entitled to retain the property. And although it is true that in the paradigm mistaken-​payment case the payor is typically at fault, his fault causes no harm to the payee as long as the payee is entitled to deduct his reliance and any transaction costs from the repayment. 16

B.  LACK OF ACTUAL KNOWLEDGE BY THE PAYEE Suppose the paradigm case is varied by assuming that the payee did not know the payment was mistaken at the time it was made, but she learns of the mistake later, before she has taken action on the basis of the payment. The efficiency reasons for a restoration regime in the paradigm case also generally apply here. So do the reasons of morality. The payee’s moral obligation to return the payment if she learns of the mistake before she has relied is the same as it would have been if she had known the payment was mistaken when she received it—​just as a finder of lost prop­ erty who originally believed that the property was abandoned has a moral obligation to make reasonable efforts to restore the property to its owner if she learns that the property was not abandoned, but lost.

C. RELIANCE Next, suppose the paradigm case is varied by assuming that the payee has relied on the mistaken payment. Reliance counts in morality and law only if it is justified. In the paradigm case, in which the payee knew the payment was mistaken when she received it, she could not have justifiably relied upon the payment. Suppose next that a payee relies upon a mistaken payment at a time when she did not actually know, but had reason to know, that the payment was mistaken. In this case, too, reliance is unjustified, because by hypothesis the payee was unreasonable in not knowing that the payment was mistaken. Now suppose that a payee relies on a mistaken payment by engaging in an adverse change of position at a time when she neither knew nor had reason to know that the payment was 15.  See, e.g., Model Penal Code § 223.5 (Am. Law Inst. 1962) [hereinafter Model Penal Code]; N.Y. Penal Law § 155.05 (McKinney 2010); 18 Pa. Cons. Stat. Ann. § 3924 (West 2015); Ray Andrews Brown, The Law of Personal Property § 3.5 (Walter B. Raushenbush ed., 3d ed. 1975). 16.  See Model Penal Code § 223.5; N.Y. Penal Law § 155.05 (McKinney 2010); 18 Pa. Cons. Stat. Ann. § 3924 (West 2015).

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mistaken. In such a case the payee should be entitled to deduct the amount of her reliance from the amount of the repayment, because the payee’s reliance is justifiable and caused by the payor’s fault, and the payee would be injured if she was not allowed to retain the amount of her reliance.17 Restatement Third of Restitution and Unjust Enrichment Section 65, Illustration 9, exemplifies such a case: Insurer pays a $5,000 death benefit to Widow when the face amount of the policy is only $500. On discovery of the mistake, Insurer has a prima facie claim to restitution in the amount of $4,500. . . . Acting before she has notice of Insurer’s mistake, Widow spends $3,500 of the insurance money on an expensive funeral for her husband. Had it not been for Insurer’s mistake, Widow would not have spent more than $500 on her husband’s funeral. . . . Widow is entitled to a defense with respect to her additional expenditure of $3,000. Insurer is entitled to restitution from Widow in the amount of $1,500.18

In practice, justifiable reliance on a mistaken payment will not often occur. Normally, a payee who receives a mistaken payment will either know or have reason to know of the mistake. Even where that is not the case it is unlikely that payees will often justifiably rely upon mistaken payments. Reliance on a mistaken payment can only occur if the payee engages, to her prejudice, in conduct that she would not have engaged in if the mistaken payment had not been made. If the payment is not very large in relation to the payee’s wealth, receipt of the payment is unlikely to cause the payee to take an action that she would not otherwise have taken. Accordingly, relatively small mistaken payments are unlikely to be relied upon. Thus if in the Restatement Illustration, C had a net worth of $12 million, it is unlikely that she could show that she relied upon the mistaken $5,000 payment. At the other end of the wealth scale, where a mistaken payment is very large in relation to the payee’s wealth, the payee will almost invariably know or have reason to know that the payment was mistaken. Of course, justifiable reliance on a mistaken payment can occur, as in the Illustration to the Restatement, or where an institution, such as a clearing bank, bureaucratically passes on a mistaken payment to a third party from whom it cannot recover the payment easily or at all. Where justifiable reliance does occur, the payee should be entitled to retain the amount required to put it in the position it would have been in if it had not relied, as well as the transaction costs of voluntarily repaying the balance to the payor.19

17.  Jack Beatson and Hanoch Dagan argued that actors who receive and justifiably rely upon mistaken payments should not routinely be allowed to retain the amount of their justified reliance. Beatson, supra note 13; Dagan, supra note 8. Beatson’s and Dagan’s arguments are critiqued in Melvin Aron Eisenberg, Mistake in Contract Law, 91 Cal. L. Rev. 1573, 1589–​93, 1593 n.26 (2003). 18.  Restatement (Third) of Restitution and Unjust Enrichment § 65  cmt. c, illus. 9 (Am. Law Inst. 2011). 19.  How to measure the payee’s reliance may sometimes be a very difficult question. For a masterly analysis of that question, see Beatson, supra note 13, at 139–​41.

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D. ADMINISTRABILITY Finally, administrability is normally not a problem in the case of mistaken payments. It is usually clear that a payment was mistaken, because, for example, it was sent to the wrong person or was indisputably in excess of any obligation the payor owed to the payee. True, in some cases a payor may claim that payment was mistaken when it was really a compromise of a disputed amount, so that the only possible mistake was evaluative. However, such false claims normally should be easy to see through.

I I I .   C O MP U TATI ONA L   ER R OR S Another recurring type of mechanical error consists of computational errors, such as errors in addition. This kind of error is most often found in bids on construction projects. Although a computational error may occur in performance, for ease of exposition only computational errors that occur prior to contract-​formation will be considered here.

A.  THE NONMISTAKEN PARTY KNEW OF THE ERROR In the paradigm case of a computational error the nonmistaken party knew of the error at the time of contract-​formation. Unlike mistaken payments, which are largely governed by the law of restitution, computational errors fall squarely within contract law, because normally an actor who has made a computational error seeks to be relieved from contractual liability, rather than to recover a benefit conferred. However, the issues raised by computational errors are comparable to those raised by mistaken payments—​indeed, computational errors constitute one source of mistaken payments—​and the analysis is also substantially the same. As in the case of mistaken payments, actors have strong incentives to use care in making computations even under a regime in which computational errors provide a basis for relief. The error might never be caught; if the error is caught it might be costly to obtain relief; and so forth. And as in the case of mistaken payments, failure to allow computational errors to provide a basis for relief could lead to an inefficiently high level of precaution—​triple-​and quadruple-​checking. Partly for this reason, and partly because of loss-​aversion, it is highly likely that actors making rules from behind the veil would prefer a regime in which a contracting party could not take advantage of his counterparty’s known computational errors. Moral considerations point in the same direction. Unlike a bargain promise based on an evaluative mistake, a bargain promise based on a computational error does not embody a demonstrative choice by the promisor, which he could be expected to stand behind as a matter of self-​respect. Few actors regard computation as a process that demonstrates their intelligence and skill and symbolizes their capability to make a choice of the relevant kind. Everyone makes computational errors from time to time, and expects to do so. Accordingly, when a computational error is called to an actor’s attention in everyday life the reaction is usually limited to “Oh, you’re right,” or the like, rather than regret or even significant embarrassment.

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Similarly, allowing computational errors to provide a basis for relief would neither drain the moral content from promises nor undercut the institution of contract—​as is shown by the fact that such errors have long been recognized as a basis for relief with little if any protest from the profession, and indeed with the general endorsement of the judicial and academic sides of the profession. Furthermore, in the paradigm case the mistaken party does not seek to back out of a contract because his knowledge, skill, and diligence in evaluation were less than that of the nonmistaken party. Therefore, a regime in which computational errors provided a basis for relief in the paradigm case would not deprive the promisee of an advantage earned by his knowledge, skill, and diligence in evaluation. Judge Posner’s analysis of an analogous case, in which a party seeks to take opportunistic advantage of a counterparty’s mistake about the contents of a contract, is applicable here: [I]‌t is one thing to say that you can exploit your superior knowledge of the market—​for if you cannot, you will not be able to recoup the investment you made in obtaining that knowledge. . . . It is another thing to say that you can take deliberate advantage of an oversight by your contract partner concerning his rights under the contract. Such taking advantage is not the exploitation of superior knowledge or the avoidance of unbargained-​for expense; it is sharp dealing. Like theft, it has no social product, and also like theft it induces costly defensive expenditures, in the form of overelaborate disclaimers or investigations into the trustworthiness of a prospective contract partner, just as the prospect of theft induces expenditures on locks.20

It is true that in the case of a computational error, as in the case of a mistaken payment, normally the mistaken party is at fault. So, for example, if an engineer had miscomputed the strength of a girder, and as a result a building collapsed, he would almost certainly be deemed negligent and therefore responsible for resulting injuries to person and property. In the paradigm contracts case, however, A’s fault does not harm B, because B knew of the mistake when she tried to conclude a contract based on the mistake. Of course, B might have formed an intention to benefit from A’s mistake by purporting to conclude a contract. As a matter of morality, however, if that was B’s intention she would be viewed as improperly taking advantage of A, so that her expectation would be unjustified, like the expectation of a person who finds lost property and knows who the owner is, but thinks that she is entitled to benefit from the owner’s carelessness.

B.  THE NONMISTAKEN PARTY HAD REASON TO KNOW OF THE ERROR Suppose that the nonmistaken party does not know of the computational error, but has reason to know. For example, suppose that A is one of six contractors bidding on a construction job for B. A’s bid is $500,000, and the remaining five contractors bid between $1,200,000 and $1,400,000. A reasonable person in B’s position would have had reason to know that A made some sort of computational error in assembling his bid, but B did not actually know that A made an error. The efficiency considerations here are roughly the same as in the paradigm case. If the nonmistaken party is allowed to take advantage of a computational error when she had reason to know that such an error was made, actors might engage in too much precaution; actors have the 20.  Mkt. St. Assocs. v. Frey, 941 F.2d 588, 594 (7th Cir. 1991).

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same economic incentives to avoid making computational errors in this kind of case as they do in the paradigm case, and actors deciding from behind the veil would be highly likely to prefer a relief regime in such cases as a kind of mutual insurance against the impact of computational errors. The moral analysis is not as clear. In the paradigm case B knowingly attempts to take advantage of A’s mistake. In this variation, she does not. Nevertheless, although A is at fault for making the mistake, B is at fault for failing to realize that a mistake was made when a reasonable person would have done so. Furthermore, only the nonmistaken party knows with certainty whether she actually knew of a computational error. Therefore, proving actual knowledge by the nonmistaken party may be too difficult a burden for the mistaken party to shoulder. Where the nonmistaken party had reason to know of a computational mistake, she probably did know. Accordingly, the reason-​to-​know case should be treated like the actual-​knowledge case to protect the integrity of the rule that governs the actual-​knowledge case.

C.  THE NONMISTAKEN PARTY NEITHER KNEW NOR HAD REASON TO KNOW OF THE ERROR Suppose the nonmistaken party, B, neither knew nor had reason to know of a computational error. This kind of case presents two issues: First, should A be liable for B’s reliance damages? Second, should A be liable for B’s expectation damages? In the paradigm case, in which B knows that A  made a computational error, B’s reliance is unjustified. Reliance should also be treated as unjustified where B had reason to know that A made a computational error. However, if B relies when he neither knows nor has reason to know that A made a computational error then B’s reliance is justified: A’s fault has caused an injury to B and A should compensate B for that injury, that is, for the amount of B’s reliance. Whether A should be liable for expectation damages in such a case is a more difficult issue. Classical contract law took the position that a mechanical error (or, in the traditional nomenclature, a unilateral mistake) was not a defense against expectation damages unless the nonmistaken party either knew or had reason to know of the mistake. Thus Illustration 1 to Restatement First of Contracts Section 503 stated: A, in answer to an advertisement of B for bids for the construction of a building according to stated specifications, sends B a bid of $50,000. B accepts the bid. A, in the calculations that he makes prior to submitting his bid, fails to take into account an item of construction that will cost $5000. If B knows or, because of the amount of the bid or otherwise, has reason to know that A is acting under a mistake, the contract is voidable by A; otherwise not.21

In contrast, modern contract law takes the position that a computational error (and more generally, a mechanical error) is a defense to expectation damages, at least where expectation damages would be “unconscionable”22 —​a term that in this context effectively means that

21.  Restatement (First) of Contracts § 503, illus. 1 (Am. Law Inst. 1932). 22.  See, e.g., Restatement Second of Contracts § 153 (Am. Law Inst. 1981) [hereinafter Restatement Second].

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expectation damages based on the mistake would have a severe impact on the mistaken party.23 Thus Illustration 1 to Restatement Second of Contracts Section 153 states: In response to B’s invitation for bids on the construction of a building according to stated specifications, A submits an offer to do the work for $150,000. A believes that this is the total of a column of figures, but he has made an error by inadvertently omitting a $50,000 item, and in fact the total is $200,000. B, having no reason to know of A’s mistake, accepts A’s bid. If A performs for $150,000, he will sustain a loss of $20,000, instead of making an expected profit of $30,000. If the court determines that enforcement of the contract would be unconscionable, it is voidable by A.24

The modern rule that the nonmistaken party cannot recover expectation damages for a bargain based on a mechanical error even when the nonmistaken party neither knows nor should know of the error is preferable to the classical-​contract-​law rule. Actors who addressed the issue from behind the veil would be highly likely to prefer the modern rule, because it provides a kind of mutual insurance policy against casualty losses while protecting the nonmistaken party from losses through reliance. Furthermore, allowing relief for computational errors does not undermine the integrity of contract. In the case of a computational error, the mistaken party is not attempting to withdraw from a contract because he made an evaluative error, nor is he attempting to redistribute a bargained-​for risk, such as a price shift. Indeed, if prices shift against the nonmistaken party between the time the contract was made and the time the mistaken party discovers and communicates that she has made a computational error, the mistaken party should be liable for the amount of that shift, because the amount of the shift is an opportunity cost that the nonmistaken party incurred as a result of the mistaken party’s fault. It is true that where B neither knows nor should know of the mistake A is at fault, and B has formed a justified expectation as a result of A’s fault. That, however, is not dispositive. For example, where an actor negligently makes a mistaken payment, and the payee neither knows nor has reason to know that a payment is mistaken, then as a result of the payor’s fault the payee will form a justified expectation that the payment is hers to keep. That expectation, however, is not protected by law.25 Similarly, where an owner has negligently lost property and the person who finds the property reasonably believes that it was abandoned, the finder forms a justified expectation that the property is now his, but that expectation is not protected. As in those cases, the fact that the nonmistaken party in a computational-​error case formed a justified expectation does not mean that he acts fairly in insisting on full enforcement of the contract after he understands that his counterparty had made such an error. On the contrary, just as a payee is morally obliged to return a mistaken payment once he learns it was mistaken, and a finder is morally obliged to make reasonable efforts to return property once he knows that it was lost rather than abandoned, so too a party to a contract that is based on a mistaken computation is morally obliged not to insist on full enforcement after she learns of the computational error.

23.  See infra Section III. 24.  Restatement Second § 153, illus. 2. 25.  See, e.g., Glover v. Metro. Life Ins. Co., 664 F.2d 1101, 1105 (8th Cir. 1981): In all the circumstances, it would be unjust, in our view, for [an unknowing mistaken payee] to keep the money. This result disappoints an expectation on her part that she had every reason to believe, at one time, to be legitimate, but to decide otherwise would be intolerably unfair to [the mistaken payor]. Id.

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The rules that govern mistaken payments and computational errors are instantiations of the principle that should and largely does govern mechanical errors as a class: a party who makes a mechanical error should not be liable, except to the extent that the nonmistaken party has been injured by justified reliance on the contract. The balance of this chapter explores some other recurring cases, and develops the present legal framework.

D.  OFFERS THAT ARE TOO GOOD TO BE TRUE Another recurring type of mechanical error involves offers that are too good to be true.26 For the reasons considered above, the rule should be and is that an offeree cannot snap up such an offer.27 Speckel v. Perkins28 is a good example. Speckel had been injured in a collision between a car driven by Perkins and a truck in which Speckel was a passenger. Perkins’s attorney Wheat, wrote to Speckel’s attorney, Eckman, as follows: In reviewing my file concerning this claim and the upcoming trial, I note that we have a demand in our file [from you for a settlement at the] policy limits of $50,000.00. While I agree that the case has some value, I cannot agree that this is a limits case. At this point in time I have authority to offer you $50,000.00 in settlement of your claim against my client. . . . I  would appreciate hearing from you at your earliest convenience and would be pleased to carry any offer you may wish to make back to my client’s insurance company for their consideration.29

Eckman replied, “Your offer of $50,000 to settle this case . . . is hereby ACCEPTED.”30 Perkins and the insurance company claimed that no contract had been formed by Eckman’s acceptance, because Eckman knew from the first paragraph of Wheat’s letter that the insurer would not pay $50,000. Wheat explained that the reason “$50,000” was in the second paragraph is that he was engaged in a trial in another matter at the time and dictated the letter to his assistant, who misheard the term that Wheat dictated, “$15,000,” as “$50,000.” Wheat didn’t notice the mistake because the assistant signed the letter on his behalf. The court properly held that no contract had been formed, because Eckman should have known that it was not Wheat’s intention to settle for $50,000: Several aspects of the offer . . . negate its validity. A duty to inquire may be imposed on the person receiving the offer when there are factors that reasonably raise a presumption of error. An offeree “will not be permitted to snap up an offer that is too good to be true; no agreement based on such an offer . . . can be enforced by the acceptor.”

26.  See 1 Samuel Williston & George J. Thompson, A Treatise on the Law of Contracts § 94 (2d ed. 1936); see also United States v. Braunstein, 75 F. Supp. 137, 139 (S.D.N.Y. 1947) (quoting Williston, supra). 27. 1 Williston, supra note 26, § 94. 28.  364 N.W.2d 890 (Minn. Ct. App. 1985). 29.  Id. at 891. 30.  Id. at 892.

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Mistake, Disclosure, and Unexpected Circumstances In this case Wheat’s letter is internally inconsistent. After stating that the case is not worth the policy limits, it proceeds to offer precisely that amount. We find that this internal inconsistency raises a presumption of error and imposed upon Eckman a consequent duty to inquire, particularly in this context—​the policy limits, requested when negotiations began, were offered on the eve of trial when the parties were presumably prepared and circumstances had not changed. Finally, the letter expressly states that Wheat “would be pleased to carry any offer [Eckman] may wish to make back to [Wheat’s] client’s insurance company for their consideration.” Despite offering the full amount of the demand, the language does not indicate that an acceptance is anticipated, but rather calls for a counter-​offer. We cannot agree that it is an offer enforceable upon acceptance.31

E.  RETAIL MISPRICING In another recurring pattern a retail product is mispriced as a result of a mechanical error. The most well-​known case of this kind is the Nolan Ryan Baseball Card case.32 In April 1990, Joe Irmen opened a baseball-​card store named Ball-​Mart. One of the cards Ball-​Mart offered for sale was a 1968 Jerry Koosman/​Nolan Ryan rookie card in almost perfect condition. A rookie card is the first published baseball card featuring a given player. The rookie card of a player who later becomes a superstar, such as Nolan Ryan, normally commands a very high price. Irmen did not own the card. He had obtained it on consignment from its owner and was required to pay the owner $1,000 if the card was sold. A subsequent issue of a monthly price guide listed the price of a Nolan Ryan rookie card as $800–​$1,200. It was uncontroverted that Ball-​Mart’s Nolan Ryan card was marked with the number 1200, but there was a dispute whether the number contained other marks such as a comma, a decimal, or a dollar sign.”33 A few days after Ball-​Mart had opened for business, Bryan Wrzensinski came into the store. Bryan was a twelve-​year-​old boy who had a collection of 40,000–​50,000 baseball cards. At that point, Irmen had more customers in Ball-​Mart than he could serve. Irmen owned a jewelry store next door to Ball-​Mart, and he asked a salesperson in that store, Kathleen Braker, to help out. Braker had no knowledge of baseball cards. Bryan saw the Nolan Ryan card, showed it to Braker and said, “Is this card worth twelve dollars?” Braker said yes, and Bryan bought the card for that amount. When Irmen found out what had happened he offered Bryan $100 for return of the card. Bryan declined, and Irmen sued to recover either the card or damages. The case was settled in mid-​trial. Because of the notoriety the card had acquired, by the time of the settlement the card was worth $3,000–​$5,000 and possibly more. In addition, by this time Bryan had sued Irmen for 31.  Id. at 893. 32.  This case drew much notoriety, but was settled rather than decided and therefore was not reported. The following account of the case is drawn largely from media reports. See Lisa Twyman Bessone, What a Card, Sports Illustrated, Mar. 18, 1991, at 9; Mark Hansen, Major League Dispute, ABA J., June 1991, at 24; John Leptich, Boy Sued over Baseball Card, Chi. Trib., Nov. 10, 1990, § 1, at 1; John Leptich, Charity Delivers Winning Pitch in Baseball-​Card Suit, Chi. Trib., Apr. 23, 1991, § 3, at 1; John Leptich, Finally, It’s Bottom of 9th in Baseball Card Case, Chi. Trib., Apr. 5, 1991, § 3, at 2 [hereinafter Leptich, Finally, It’s Bottom of 9th]. These reports vary in certain details. Where that has occurred, the version that seems most plausible has been adopted. 33.  John Leptich, 13-​Year-​Old Throws Judge a Curve, Chi. Trib., Mar. 6, 1991, § 1, at 1; Norm Cohen, $12 Ryan Shuffled in Court, Newsday, Mar. 10, 1991, at 15.

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libel on the ground that Irmen had stated publicly that Bryan had stolen the card. The settlement provided that the card would be auctioned off, each party would donate his half of the proceeds to charity, and Bryan would dismiss his libel action.34 Because the case was settled it did not result in an opinion. However, the case has been widely discussed35 and is a good launching pad for discussion of mispricing due to a mechanical error. Consider various possible scenarios: Suppose first that the Nolan Ryan card was marked “$1,200” or “1,200.” The case is then pretty easy: By asking Braker “Is this card worth twelve dollars?” Bryan would have actively misled Braker about the price and should not have been entitled to retain the card. Suppose next that the card was marked “$1200” or “1200.” As the owner of 40,000–​50,000 baseball cards Bryan almost certainly would have known that in this context “1200” or “$1200” did not mean “12.00.” On these facts too, therefore, Bryan would have actively misled Braker and should not have been entitled to retain the card. Suppose finally that the card was marked “$12.00” or “12.00.” Given the size of Bryan’s collection and the true value of the card, here too Bryan almost certainly would have known that the $12.00 price was based on a mechanical error, and should not have been able to retain the card.

I V.   T H E M O D ER N POS I T I ON In sum, in the case of a mechanical error by a mistaken party, under classical contract law the nonmistaken party was entitled to expectation damages if he neither knew nor had reason to know of the error, and Restatement First so provided. However, the better rule is that the nonmistaken party should be limited to reliance damages even if he neither knew nor had reason to know of the error. This rule is adopted in Restatement Second Section 153: Where a mistake of one party at the time a contract was made as to a basic assumption on which he made the contract has a material effect on the agreed exchange of performances that is adverse to him, the contract is voidable by him if he does not bear the risk of the mistake under the rule stated in § 154,36 and (a) the effect of the mistake is such that enforcement of the contract would be unconscionable, or (b) the other party had reason to know of the mistake or his fault caused the mistake.

34. Leptich, Charity Delivers Winning Pitch in Baseball-​Card Suit, supra note 32. Leptich reports the following sequel: “Kathleen Braker, the clerk from Irmen’s jewelry store who sold Wrzesinski the disputed card and quit two weeks later because she was ‘humiliated,’ is back on the job. One of her projects is a T-​shirt which bears Ryan’s likeness on front and a Topps 40th anniversary logo on back. Below the Topps logo, the shirt reads: “Home of the Nolan Ryan Rookie Card 1200 Ball Mart Baseball Cards & Coins” and gives the store’s telephone number. The price? You guessed it, $12.” Leptich, Finally, It’s Bottom of 9th, supra note 32. 35.  See, e.g., Andrew Kull, Unilateral Mistake: The Baseball Card Case, 70 Wash. U. L.Q. 57 (1992). 36.  Section 154 provides: When A Party Bears The Risk Of A Mistake A party bears the risk of a mistake when (a) the risk is allocated to him by agreement of the parties, or (b) he is aware, at the time the contract is made, that he has only limited knowledge with respect to the facts

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The rule embodied in Section 153 is also adopted in modern case law. Donovan v. RRL Corp.,37 decided by the California Supreme Court in 2001, is a prominent example of the modern trend. Lexus of Westminster placed an ad in a local newspaper, the Daily Pilot, for a “PRE-​OWNED COUP-​A-​RAMA SALE!/​2-​DAY PRE-​OWNED SALES EVENT.” The ad listed sixteen used cars, including a 1995 Jaguar XJ6 Vanden Plas. The advertisement described the color of this car, included the vehicle identification number, and stated a price of $25,995.38 The next day Brian Donovan saw the ad, drove with his wife to Lexus of Westminster, found the advertised 1995 Jaguar, test-​drove it, and told the salesperson, “Okay. We will take it at your price, $26,000.”39 When the salesperson did not respond, Donovan showed him the advertisement. The salesperson immediately said, “That’s a mistake.”40 Westminster’s sales manager then also told Donovan that the price listed in the advertisement was a mistake, apologized, and offered to pay for Donovan’s fuel, time, and effort in traveling to the dealership to examine the automobile. Donovan declined and asked what price the sales manager wanted. Westminster had paid $35,000 for the car. Based on that price, the sales manager said he would sell the car to Donovan for $37,016. Donovan responded, “No, I want to buy it at your advertised price, and I will write you a check right now.”41 The sales manager again said that he would not sell the car at the advertised price. Donovan brought suit. Westminster later sold the car to a third party for $38,399.42 At the trial it was shown that Westminster’s advertising manager regularly compiled information for advertisements in various local newspapers, including the Daily Pilot.43 As originally prepared by the advertising manager the advertisement in question listed a 1995 Jaguar XJ6 Vanden Plas but did not specify a price. Instead, the word “Save”—​that is, save for later specification—​appeared in the space where the price would ordinarily be specified. Thereafter, Westminster’s sales manager instructed the advertising manager to delete the 1995 Jaguar from all the advertisements and to substitute in its place a 1994 Jaguar XJ6 at a price of $25,995. The advertising manager gave this information to the Daily Pilot. However, because of typographical and proofreading errors made by Daily Pilot employees the newspaper inserted the price of $25,995 in place of the word Save but failed to change the description of the car from a 1995 Jaguar to a 1994 Jaguar, so that the Daily Pilot mistakenly advertised a 1995 Jaguar XJ6 Vanden Plas at a price of $25,995. No Westminster employee reviewed a proof sheet of the revised advertisement before it was published, and Westminster was unaware of the mistake until Donovan attempted to purchase the Jaguar.

to which the mistake relates but treats his limited knowledge as sufficient, or (c) the risk is allocated to him by the court on the ground that it is reasonable in the circumstances to do so.

The exceptions stated in this section are apposite in mistaken shared factual assumption cases (discussed in Chapter 43, infra), but are rarely if ever in mechanical-​error cases. 37.  27 P.3d 702 (Cal. 2001). 38.  Id. at 707. 39.  Id. 40.  Id. 41.  Id. 42.  Id. at 708. 43.  Id.

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The day before he went to Lexus of Westminster, Donovan had shopped for a Jaguar at a Jaguar dealer, whose prices were $8,000–​$10,000 higher than the price Westminster listed in the advertisement. However, Westminster’s Jaguar had some visible defects. Furthermore, Donovan remarked to the Westminster salesperson that the price in the Daily Pilot advertisement looked “really good,” and the salesperson responded that because Westminster was a Lexus dealer it might offer better prices for a Jaguar than a Jaguar dealer would. Accordingly, the court treated it as given that Donovan neither knew nor should have known that the price in the advertisement was incorrect. Nevertheless, the court held that Westminster was not liable to Donovan for expectation damages. The court’s opinion emphasized the way in which contract law on this issue had changed over time: Under the first Restatement of Contracts, unilateral mistake did not render a contract voidable unless the other party knew of or caused the mistake. . . . . . . [I]‌n M.F. Kemper Const. Co. v.  City of L.A. (1951) [and Elsinore Union etc. Sch. Dist. v. Kastorff (1960)], we acknowledged but rejected a strict application of the foregoing Restatement rule regarding unilateral mistake of fact. . . . . . . . The decisions in Kemper and Elsinore establish that California law does not adhere to the original Restatement’s requirements for rescission based upon unilateral mistake of fact—​i.e., only in circumstances where the other party knew of the mistake or caused the mistake. Consistent with the decisions in Kemper and Elsinore, the Restatement Second of Contracts authorizes rescission for a unilateral mistake of fact where “the effect of the mistake is such that enforcement of the contract would be unconscionable.” . . . Although the most common types of mistakes falling within this category occur in bids on construction contracts, § 153 of the Restatement Second of Contracts is not limited to such cases. . . . Because the rule in . . . the Restatement Second of Contracts, authorizing rescission for unilateral mistake of fact where enforcement would be unconscionable, is consistent with our previous decisions, we adopt the rule as California law. As the author of one treatise recognized more than 40  years ago, the decisions that are inconsistent with the traditional rule “are too numerous and too appealing to the sense of justice to be disregarded.” (3 Corbin, Contracts (1960) § 608  . . . ) We reject Donovan’s contention . . . that, because [Donovan] was unaware of [Westminster’s] unilateral mistake, the mistake does not provide a ground to avoid enforcement of the contract.44

Other modern cases take the same position. For example, in Colvin v.  Baskett,45 Baskett listed with Colvin, for sale by Colvin, three bags of uncirculated coins. One of these bags was owned by Jess Crow, on whose behalf Baskett was acting. On the same day, Baskett’s son-​in-​law

44.  Id. at 715–​16. There is a traditional rule of offer-​and-​acceptance law that an advertisement is not an offer. See supra Chapter 31. Under that rule Westminster Lexus would have prevailed even if there had been no mistake. However, the status of the traditional rule is in serious doubt. Id. In its opinion the California Supreme Court acknowledged both the traditional rule and its doubtful status, but finessed the issue by holding that under the California Vehicle Code an advertisement by an automobile dealer to sell a car is an offer. Accordingly, Westminster could not win on the basis of the traditional advertisement rule; it could win only if it could establish a defense of mistake. Donovan, 27 P.3d at 709–​13. 45.  407 S.W.2d 19 (Tex. Civ. App. 1966).

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also listed a bag of uncirculated coins with Colvin. This was the same bag of Jess Crow’s coins that Baskett had listed. Apparently, neither Baskett nor his son-​in-​law realized that the other was listing this bag. Apparently too, Colvin knew only that Baskett had listed three bags of uncirculated coins and that Baskett’s son-​in-​law had listed one bag, and didn’t know that both had listed the same bag. When Baskett realized that he and his son-​in-​law had inadvertently both listed the same bag of uncirculated coins, he asked Colvin to sell only two bags of coins, not three. Colvin sued, and the court held that Baskett had a right to rescind his contract with Colvin. Similarly, in Hall v.  United States,46 the Air Force had a jet-​engine part worth $167,553 that it intended to send to a repair depot. Instead, the engine part was mistakenly put up for auction, where Hall purchased it for $15. The court held that the auction contract was unenforceable. In general, this position is correct. However, there is a problem with the formulation employed in Donovan, in other modern cases, and in Restatement Second. Under these formulations, if the nonmistaken party neither knew nor had reason to know of a mechanical error the error will serve as a defense to expectation damages only if such damages would be “unconscionable.” Traditionally, unconscionability refers to fault by a promisee at the time of contract formation. Obviously, the concept of unconscionability, as it is used in Restatement Second Section 153 and cases such as Donovan, means something other than fault at the time of contract-​formation. By hypothesis, we are dealing with cases in which at that time the nonmistaken party neither knew nor had reason to know of the mechanical error, and therefore was not at fault in making the contract. Accordingly, unconscionability in the context of mechanical errors can only refer to the idea that it is unconscientious47 or exploitive to attempt to hold a party to expectation damages on the basis of a promise that was based on the product of a mechanical error that resulted in a significant difference between the promised price and the price that the adversely affected party would have agreed to if the mistake had not been made. But that being so, there is no need to determine whether enforcement would be unconscionable: the only need is to determine whether the impact of the error was significant. In reality, therefore, in the context of mechanical errors unconscionable is a code word for economic significance. This is reflected in Donovan: . . . [The general rule governing unconscionability] is inapplicable here, because unconscionability resulting from mistake does not appear at the time the contract is made. . . . In the present case, enforcing the contract with the mistaken price of $25,995 would require [Westminster] to sell the vehicle to [Donovan] for $12,000 less than the intended advertised price of $37,995—​an error amounting to 32 percent of the price [Westminster] intended. [Westminster] subsequently sold the automobile for slightly more than the intended advertised price, suggesting that that price reflected its actual market value. [Westminster] had paid $35,000 for the 1995 Jaguar and incurred costs in advertising, preparing, displaying, and attempting to sell the vehicle. Therefore, [if Westminster is required to sell the Jaguar to Donovan for $25,995, Westminster]

46.  19 Cl. Ct. 558 (1990). 47.  See Stepps Invs., Ltd. v. Sec. Capital Corp., (1976) 73 D.L.R.3d 351, 362–​64 (Can.).

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would lose more than $9,000 of its original investment in the automobile. [Donovan], on the other hand, would obtain a $12,000 windfall if the contract were enforced, simply because he traveled to the dealership and stated that he was prepared to pay the advertised price.48

In short, despite the language of unconscionability, whether a mechanical error that is unknown to the mistaken party is a defense to expectation damages should and does depend solely on whether the impact of the error is significant.49

48.  Donovan v. RRL Corp., 27 P.3d 702, 723–​24 (Cal. 2001). 49.  Another recurring kind of case in which a nonmistaken party normally neither knew nor should have known that a mechanical error was made concerns promotional contests. For example, in one common type of promotional contest a seller promises to award prizes to persons who either find a winning game piece inside a package in which the seller’s product is contained, or find matching game pieces inside two or more packages. See generally Mark B. Wessman, Is “Contract” the Name of the Game? Promotional Games as Test Cases for Contract Theory, 34 Ariz. L. Rev. 635 (1992). Inevitably, some of these promotional contests go awry as a result of a mechanical error and too many game pieces are produced, so that if the seller sticks by the rules of the contest the total payoff would be much greater than was planned. See, e.g., id. at 640–​43 (mechanical error in a contest exposed Kraft Food to potential liability of over $11 billion when the total value of all prizes but for the error would have been only $63,000).   When mechanical errors occur in a promotional contest, normally contestants believe they were entitled to prizes before the mistake was discovered and publicized, so that they neither knew nor should have known of the mistake. It might seem that an error of this sort should provide a defense to expectation damages for much the same reasons that apply to computational errors. However, the promotional-​contest case is more complex than other mechanical-​error cases. Because a seller promotes a contest to get the benefit of increased sales, a mistaken seller must have originally calculated that the profits generated by the increased sales would equal or exceed the cost of the contest. By the time the mistake is discovered and made known to the public the seller may have received much or even most of the expected increased sales. Accordingly, a mistaken seller should be obliged to distribute in prizes at least as much as it planned to distribute. Most sellers will probably do even more, either to retain good will, by way of a settlement, or both.   Still another recurring mechanical-​error case occurs when a machine makes an error. One possible error of this type is an error in a calculator or computer program that causes a bid to be mistakenly computed. There is no reason such an error should be treated differently than a human computational error. Similarly, a transient error in a gambling device—​usually a slot machine—​may cause the device to mistakenly show a huge win. Mistaken jackpots have reached millions of dollars. Normally, the casino refuses to pay in such cases. See Sengal v. IGT, 2 P.3d 258, 259–​60 (Nev. 2000). However, Harrah’s paid a mistaken $330,000 jackpot after the winner retained a lawyer who generated a barrage of critical media coverage, and showed that Harrah’s had improperly failed to immediately call in the state gambling commission. See Christina Binkley, Bad Luck: Glitches Can Make One-​Armed Jackpots Evaporate, Wall St. J., July 22, 1998, at B1.

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Mistranscriptions Supp ose that A  and B enter into a n or a l c on tr act a n d ag ree

that A will transcribe the agreement into writing. Due to A’s negligence the writing mistranscribes the parties’ contract. Both parties then sign the writing mistakenly believing that it accurately reflects the contract. What rule should govern this kind of case? Mistranscriptions are a special case of mechanical errors. A  intends the writing to incorporate the contract, but by virtue of a mechanical error it does not. If we stopped there, mistranscriptions, like other mechanical errors, would be fairly easy to deal with. Indeed, they would be even easier to deal with than most mechanical errors, because unlike an ordinary mechanical error a mistranscription does not affect the terms of the contract:  in ordinary mechanical-​error cases the error occurs before or at the time of contract-​formation, whereas in mistranscription cases the error occurs after the contract has been made: The mistranscription is not a contract. The only contract the parties have made is the oral contract. Accordingly, the principle that should govern mistranscriptions is the same as the principle that should govern other mechanical errors—a mistranscription should provide a basis for relief to the adversely affected party. However, the precise nature of the relief needs to reflect the special characteristics of mistranscriptions. To begin with, the appropriate relief for most mechanical errors is to give the mistaken party a defense, either in whole or in part, against a suit for reliance or expectation damages, as the case may be. In mistranscriptions, however, the appropriate relief is to amend the writing so that it correctly embodies the contract. Next, mistranscription cases tend to give rise to a special evidentiary problem. Unlike most other mechanical errors, mistranscriptions often are not discovered quickly. Typically the parties assume that the writing is an accurate transcription of their contract and file it away. Only much later do one or both parties realize that a mistranscription has occurred. This time lag can cause significant problems of proof. Furthermore, if a written instrument can be defeated on the ground that it mistakenly mistranscribed an oral contract, there is a danger that a party to a losing written contract might avoid liability by perjuriously convincing a jury that a mistranscription has occurred when in fact it has not. The law addresses these evidentiary concerns in two ways. First, a person who claims that a mistranscription has occurred must request the remedy of reformation to make the writing conform to the contract. Because reformation is an equitable remedy, jury trial is not permitted, and many lawyers believe that judges may be better and more objective fact-​finders than juries.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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Second, reformation is granted only if the party who requests that remedy proves his case by clear and convincing evidence or by satisfying a comparable standard, rather than merely satisfying the usual civil standard by showing a preponderance of the evidence. As summarized by Judge Posner, “since reformation is an equitable doctrine and . . . requires ‘clear and satisfactory proof ’ . . . the danger of facile invocations . . . is limited. The party [seeking reformation] must convince the judge, and convince him clearly.”1 What if A intentionally, rather than negligently, mistranscribes the parties’ contract? In that case we have only one mistaken party and only one mistake—​B’s mistake concerning the content of the writing—​rather than two. However, the result should be the same. If B can obtain reformation in the case of a negligent mistranscription by A surely B can also do so in the case of a deliberate mistranscription.

1.  Patton v. Mid-​Continent Sys., Inc., 841 F.2d 742, 746 (7th Cir. 1988).

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Shared Mistaken Factual Assumptions (“Mutual Mistakes”) An imp ortant t ype of mistake i n c on tr act l aw c on si sts of

mistaken factual (that is non-​evaluative) assumptions about the present state of the world. Mistaken factual assumptions differ from evaluative mistakes because they do not concern evaluations of future states of the world and are made by actors who are not fully informed. They differ from mechanical errors because they do not involve blunders that result from transient errors in an actor’s mental machinery. They differ from mistranscriptions because they do not turn on whether a writing is erroneous. A mistaken factual assumption may either be shared by both parties to a contract or held by only one of the parties. These two categories raise very different issues. Shared mistaken factual assumptions are considered in this chapter. Unshared mistaken factual assumptions are considered in the next. Traditionally, the law has treated shared mistaken factual assumptions under the terminology mutual mistake, meaning a mistake shared by both parties. This terminology is misleading. Some kinds of shared mistakes should provide a basis for relief but others should not, and even shared mistakes that should provide a basis for relief fall into different functional categories that require differing treatment. For example, in mistranscription cases the parties share the mistaken belief that the writing properly transcribes the contract, but the appropriate relief in these cases differs significantly from the appropriate relief in shared mistaken-​factual-​assumption cases. In short, that a mistake is shared is a necessary but not sufficient condition for relief based on mistaken assumptions. What makes a shared mistake sufficient for relief is the character of the mistake. Section I develops the general principle that should govern such mistakes. Section II develops four important exceptions to the general principle.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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I .   T H E G E N E R AL PR I NCI PL E In analyzing shared mistaken factual assumptions it is useful to begin with shared factual assumptions that are made explicit in a contract. If a contract is explicitly based on a shared factual assumption that turns out to have been mistaken, normally the mistake should furnish a basis for relief as a matter of interpretation. This point can be illustrated by hypothetical variations of two leading cases, Griffith v. Brymer and Lenawee County Board of Health v. Messerly. In Griffith v. Brymer,1 Edward VII was to be crowned in Westminster Abbey on June 26, 1902, following a coronation procession from Buckingham Palace to the Abbey.2 Brymer had a room that overlooked the proposed route of the procession. On June 24, Griffith entered into an oral agreement with Brymer’s agents to take the room for the purpose of viewing the procession, at the price of £100, and handed over a check for that amount. Unbeknown to either party, that morning Edward’s physicians had decided that Edward required surgery, and as a result the coronation and procession had been postponed. Griffith sued to recover the £100. The contract did not spell out the parties’ assumption that the coronation and procession were still on. But suppose it did. In particular, suppose that the contract explicitly stated, “This agreement is made on the assumption that the coronation and procession are still on as of this moment.” It could then be concluded, under a relatively straightforward interpretation of the contract, that if the assumption was incorrect Griffith would recover his payment. In Lenawee County Board of Health v. Messerly,3 the Messerlys owned a three-​unit apartment building that they used as an income-​producing investment. The building was located on a 600-​square-​foot property. The Messerlys offered the building for sale, and Carl and Nancy Pickles bought it for $25,500, under an installment contract, as an income-​producing investment. Five or six days later, when the Pickleses went to introduce themselves to their tenants, they discovered raw sewage seeping out of the ground. Unbeknown to the Messerlys, a predecessor in interest had installed a septic tank on the property without a permit and in violation of the applicable health code. Tests conducted by a sanitation expert indicated that the sewage system was inadequate. Subsequently the County Board of Health condemned the property and obtained a permanent injunction proscribing habitation until the property was brought into conformance with the County sanitation code. Under that code 750 square feet of property was mandated for a septic system for a one-​family home, and 2,500 square feet was mandated for a three-​family dwelling. Therefore, it was impossible to remedy the illegal septic system within the confines of the 600-​square-​foot parcel on which the apartment building was located. As a result the only way the apartment building could be put to residential use was to pump and haul the sewage, which would have cost twice the income that the property generated. Accordingly, the value of the supposed income-​producing property was negative: the property could not possibly produce income in excess of costs. When the Pickleses learned these facts they stopped making payments under the installment contract. The Messerlys then sought foreclosure, sale of the property, and a deficiency judgment. The Pickleses countersued for rescission. The contract in this case did not explicitly state that 1.  [1903] 19 TLR 434 (KB) (Eng.). 2.  John D. Wladis, Common Law and Uncommon Events: The Development of the Doctrine of Impossibility of Performance in English Contract Law, 75 Geo. L.J. 1575, 1609, 1618 n.199 (1987). 3.  331 N.W.2d 203 (Mich. 1982).

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the apartment building could legally be used as an income-​producing property. But suppose it did. Specifically, suppose that the contract had explicitly provided that “This agreement is based on the assumption that the apartment building is a lawful income-​producing property.” Again, relief would have been justified under a relatively straightforward interpretation of the contract. Now suppose a shared mistaken factual assumption is tacit rather than explicit. The concept of a tacit assumption has been explicated as follows by Lon Fuller: Words like “intention,” “assumption,” “expectation” and “understanding” all seem to imply a conscious state involving an awareness of alternatives and a deliberate choice among them. It is, however, plain that there is a psychological state that can be described as a “tacit assumption”, which does not involve a consciousness of alternatives. The absent-​minded professor stepping from his office into the hall as he reads a book “assumes” that the floor of the hall will be there to receive him. His conduct is conditioned and directed by this assumption, even though the possibility that the floor has been removed does not “occur” to him, that is, is not present in his conscious mental processes.4

Or as Randy Barnett has put it: As computer researchers struggling to develop “artificial intelligence” have painfully realized, beginning in infancy every person learns far more about the world than she could possibly articulate—​even to herself. Any parent can testify to the untold number of questions that children ask eliciting information that adults unconsciously take for granted. Until subjected to the barrage, one cannot fully appreciate the immense store of knowledge one possesses. One is also struck by one’s inability to articulate what one knows perfectly well. Each of us brings [virtually infinite] knowledge and skill to every interpersonal interaction and much, perhaps most, of this knowledge we hold in common. For example, even persons who have never conceived of the concept of gravity know that to build a tower out of toy blocks we have to begin at the bottom, not at the top. (An elaborately programmed computer used for one artificial intelligence experiment did not “realize” this basic fact and responded to a command to stack blocks by starting at the top. It then had to be reprogrammed with this basic assumption.) This vast repository of shared knowledge about the world and how it works is often referred to as “common sense.” Common sense makes communication by means of a common language possible.5

A more colloquial expression to capture the concept of tacit assumptions is the phrase “taken for granted.”6 As this expression indicates, tacit assumptions are as real as explicit assumptions. Tacit assumptions are not made explicit, even where they are the basis of a contract, just because they are taken for granted and therefore don’t need to be expressed. They are so deeply embedded that it simply doesn’t occur to the parties to make them explicit—​any more than it

4.  Lon L. Fuller, Melvin Aron Eisenberg & Mark Gergen, Basic Contract Law 819–​20 (10th ed. 2018). 5.  Randy E. Barnett & Nathan B. Oman, Contracts: Cases and Doctrine 1065 (6th ed. 2017). 6.  Cf. Lee B. McTurnan, An Approach to Common Mistake in English Law, 41 Can. B. Rev. 1, 51 (1963) (employing the formulation, “an unquestioning faith in the existence of a fact”). The term presupposition also captures this concept.

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occurs to Fuller’s professor to think to himself, every time he is about to walk through a door, “Remember to check my assumption that the floor is still in place.” For ease of exposition, in this book the term shared mistaken factual assumptions will be used to mean shared mistaken tacit factual assumptions. Such a mistake is unlike a mechanical error not only in the character of the mistake but in the way the mistake plays out. In the case of a mechanical error the adversely affected party wants to be excused from an agreement that he has actually made. In the case of a shared mistaken assumption, the adversely affected party wants only to depart from the literal words of a text, not from the agreement itself, which includes the tacit assumption.7 To take an example from everyday life, suppose that Jesse is an Orthodox Jew who keeps strictly kosher, and Rebecca is a Reform Jew who does not. Rebecca knows that Jesse keeps strictly kosher. Jesse and Rebecca meet periodically for dinner at the Star Delicatessen, a kosher restaurant. On Monday they agree to meet for dinner at the Star on Wednesday night. Unbeknown to either of them, on the previous Thursday the local rabbinate had declared that the Star’s method of preparing food did not satisfy kosher rules. Jesse learns of this development on Tuesday, calls Rebecca, explains the situation, and says, “I can’t have dinner with you at the Star because it’s now not kosher. Let’s have dinner somewhere else.” Rebecca replies, “No, you agreed to have dinner at the Star; if you don’t meet me there tomorrow you will be breaking your promise.” Rebecca’s position is untenable. Jesse has not broken his promise because his promise and the agreement were based on the shared mistaken factual assumption that the Star was still kosher. Similarly, it is pretty clear that the parties in Griffith v. Brymer operated on the shared tacit assumption—​took for granted—​that the coronation and procession were still on when they made their contract. Accordingly, if relief would be justified had the parties made this assumption explicit, so too would it be justified where the assumption was tacit. And indeed the court held that Griffith was entitled to a return of his money on the ground that “the agreement was made on the supposition by both parties that nothing had happened which made performance impossible. This was a missupposition of the state of facts which went to the whole root of the matter.”8 So too in Lenawee it is pretty clear that the parties operated on the shared tacit assumption that the apartment building could be used for income-​producing purposes. Therefore, if relief would have been justified where the parties had made this assumption explicit, so too would relief have been justified where the assumption was tacit. As a result, in Lenawee the court held that but for a provision in the contract that, as the court saw it, put the relevant risk on the Pickleses,9 rescission would have been appropriate.10

7.  It is sometimes suggested that shared mistaken assumptions that are not explicitly spelled out in the contract should not justify legal relief because contracts should be interpreted literally. Cf. Michael J. Trebilcock, The Limits of Freedom of Contract 144 (1993) (“I would propose that in frustration cases, a very austere rule of literal contract enforcement should in most cases obtain. . . .”); George G. Triantis, Contractual Allocations of Unknown Risks:  A Critique of the Doctrine of Commercial Impracticability, 42 U. Toronto L.J. 450 (1992). This argument is critiqued in Chapter 45, infra. 8.  [1903] 19 T.L.R. 434 (KB). 9. Lenawee Cty. Bd. of Health v.  Messerly, 331 N.W.2d 203, 211 (Mich. 1982). The provision stated, “Purchaser has examined this property and agrees to accept same in its present condition.” 10.  Lenawee is representative of a number of real estate cases in which courts have granted relief on the basis of a shared mistaken factual assumption that the relevant property could be lawfully used, either in the way it was then being used or in the way both parties understood the buyer intended to use it.

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In short, every contract includes, among other elements, explicit terms, implied terms, usages, and tacit assumptions. Where a tacit assumption is material, the contract also includes an implied understanding that, subject to the exceptions discussed in Section II, the risk that the assumption is mistaken is allocated away from the adversely affected party. Accordingly, the general principle that should govern such cases is as follows: Where a shared mistaken factual assumption would provide a basis for relief to the adversely affected party if the assumption was made explicit, so too should the assumption provide a basis for relief to the adversely affected party if the assumption was tacit. (The term material has been well defined for this purpose, as “an underlying assumption without which the parties would not have made the contract they in fact made.”11 A party is adversely affected if she would suffer a loss if the contract was enforced because due to the mistake, for this purpose, either (1) the performance she was to receive is worth much less than she agreed to pay and reasonably expected the performance would be worth, or (2) her own performance would cost much more to produce than the price she is to be paid and the costs that she reasonably expected to incur.) This principle does not undercut the agreement of the parties:  rather, if properly applied this principle carries out the agreement of the parties. So in Griffith v. Brymer if the agreement is construed to include the parties’ shared tacit assumption that the coronation was on, then the agreement itself justifies relief for Griffith. If, in Lenawee, or cases like it, the agreement is construed to include the parties’ shared tacit assumption that there was no existing legal barrier to using the property to produce income, then the agreement itself justifies relief for the purchaser. It might be argued that if parties have made an explicit agreement and they wanted the accuracy of a shared assumption to be a condition to the obligation to perform the agreement, they would have made the assumption explicit. However, it is both natural and rational to leave tacit assumptions out of an agreement. Jesse acts naturally and rationally when he doesn’t add to his date with Rebecca, “unless even as we speak the Star is no longer kosher.” Of course, if actors had infinite time to think about proposed contracts and no costs for making tacit assumptions explicit then they could ransack their minds to think through every one of their tacit assumptions and make each of those assumptions explicit. But actors do not have infinite time, and they do have costs. It would be irrational to take the time and incur the costs to determine and make explicit every tacit assumption, because the time and costs of doing so would often approach or exceed the expected profit from the contract. Moreover, normally it would be impossible to make such a determination and write such a contract. As Randy Barnett points out: [When we add] to the infinity of knowledge about the present world the inherent uncertainty of future events . . . we immediately can see that the seductive idea that a contract can . . . articulate every contingency that might arise before . . . performance is sheer fantasy. For this reason, contracts must be silent on an untold number of items. And many of these silent assumptions that underlie every agreement are as basic as the assumption that the sun will rise tomorrow. They are simply too basic to merit mention.12

11.  Bell v. Lever Bros., Ltd., [1932] AC 161 at 208 (Eng.) (Lord Warrington). 12.  Barnett & Oman, supra note 5, at 1065.

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In short, in contracting, as in other parts of life, some things go without saying. And a central characteristic of things that go without saying is—​they aren’t said. All of this can be put more generally. If a contract includes a promise that is expressly conditioned, the contract should not be enforced if the condition has come into play. The same is true if a contract includes a promise that is implicitly conditioned. One way to determine whether a promise is implicitly conditioned is to ask, if the promisor does not perform according to the literal words of the promise, and the promisee requests an explanation, what answer would the promisor give? If the promisor’s only answer is, “My preferences have changed,” or “My valuations of the performances due under the contract have changed,” he has not offered an adequate justification. If the promisor thinks these are sufficient reasons not to perform she doesn’t understand what a promise is. But if the promisor’s answer is, “My promise was implicitly conditioned on the tacit assumption, which we shared, that the present state of the world was X, and in fact the state of the world was Not-​X,” most people would think this was at least prima facie an adequate justification. Indeed, most people would go further, and say that the person who is acting improperly in such a case is not the promisor, but the promisee, by trying to hold the promisor to the literal words of a promise when, under a tacit assumption shared by both parties, the literal words were not the whole promise. To think differently is to approach the world in the totemic way that children sometimes do, looking only at the literal meaning of words. A popular children’s book series from the 1960s, Amelia Bedelia, draws on children’s literalist approach to language. Amelia Bedelia goes to work for Mr. and Mrs. Rogers. When Amelia is asked to dust the furniture, she sprinkles dust on the furniture. When she is asked to draw the curtains, she sketches the curtains. When she is asked to measure two cups of rice, she reports that two cups of rice measure 4 inches. Amelia has now grown up, married, and given birth to the literalist school of contract interpretation, discussed in Chapter 28.13 Or as stated by Charles Fried: [A]‌set of confused attitudes lurks behind the notion that if an agreement is expressed in general words, and if those general words appear to cover a surprising specific case, then the burden of this surprise should lie where it will fall as a result of taking those general words as covering that specific case, even when neither party meant them to. . . . [W]hy should we take those words to include the unintended, surprising, specific result? The general words might usually imply this specific result. But in the instance of this contract and these parties, by hypothesis neither party meant or foresaw that these general words should cover this specific case.14

I I .   F O U R E X C E P T I ONS T O  T HE G E N E R A L P RI NCI PL E There are four important exceptions to the general principle that if a mistake concerning a shared factual assumption would provide a basis for relief to the adversely affected party if the assumption was explicit, so too should it provide a basis for relief to that party if the 13.  Peggy Parrish, Amelia Bedelia (1963). I owe this reference to Debra Krauss. 14.  Charles Fried, Contract as Promise 66 (1981).

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assumption was tacit. In large part these exceptions are implicit in the general principle itself. They concern cases in which the adversely affected party is either aware of the risk that the relevant assumption is mistaken or recklessly disregards facts that put her on notice of the risk; the risk that the assumption is mistaken is contractually allocated to the adversely affected party; one contracting party is in a position to have clearly superior information about the risk that the assumption is mistaken; or the result of the mistake would be a windfall rather than a loss.

A.  THE ADVERSELY AFFECTED PARTY IS CONSCIOUSLY AWARE OF THE RISK THAT THE ASSUMPTION IS MISTAKEN OR RECKLESSLY DISREGARDS FACTS THAT PUT HER ON NOTICE OF THAT RISK In some cases a party who would be adversely affected by the risk that a shared factual assumption is mistaken is consciously aware of that risk. In a subcategory of such cases a party is consciously aware that she has only limited knowledge with respect to a fact, but treats her limited knowledge as sufficient. In both such cases the actor is characterized as being consciously ignorant. The general principle that governs shared mistaken factual assumptions does not justify relief in such cases. First, the assumption is conscious, not tacit. Second, under the circumstances the adversely affected party impliedly assumes the risk that the assumption is mistaken. As put in Comment c to Restatement Second § 154: Even though the mistaken party did not agree to bear the risk, he may have been aware when he made the contract that his knowledge with respect to the facts to which the mistake relates was limited. If he was not only so aware that his knowledge was limited but undertook to perform in the face of that awareness, he bears the risk of the mistake.15

Or, as stated by Lee McTurnan, “when parties contract aware of an uncertainty, the natural inference is that they estimated the probabilities and fixed the price accordingly.”16 The conscious-​ignorance exception should not be carried too far. In most and perhaps almost all cases involving shared mistaken assumptions the adversely affected party could have determined that she was mistaken if she had undertaken an unbounded search. In Lenawee, for example, an unbounded search, including an inspection by a sewage engineer, probably would have revealed the defect in the sewage system. In Griffith v. Brymer an unbounded search would have included sending a runner to the Palace just before finalizing the agreement, to make sure that the coronation was still on. In these and many other cases the courts have held that a shared mistaken assumption justified relief to the adversely affected party even though an unbounded search would have disabused both parties of their mistake. 15.  Restatement (Second) of Contracts § 154 cmt. c (Am. Law Inst. 1981) [hereinafter Restatement Second]; see also McTurnan, supra note 6, at 15–​16 (“contracting while consciously ignorant of a fact tends to show an intention to assume the risk of non-​existence [of the fact] and to be bound irrespective of that possibility”). 16. McTurnan, supra note 6, at 16.

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For example, in Dover Pool & Racquet Club v. Brooking,17 Dover had contracted to purchase from Brooking a fifty-​acre parcel of land, located partly in the Town of Medfield, to use as a tennis and swim club. The parties had previously inquired into the relevant zoning laws, which allowed such a use. Unbeknown to the parties, after Dover made its inquiries, but just before the contract was signed, the Town of Medfield published a notice of public hearing on a zoning-​law amendment that would require a special permit for Dover’s planned use. If the special-​permit amendment was adopted (as it subsequently was) it would be effective retroactively to the time of publication—​and therefore to a time before the contract was signed—​with the result that the parcel might lose most of its value to Dover. An unbounded search would have included sending an agent to be at the Medfield Town Hall one minute before the contract was signed, to ensure that no notice of a proposed zoning-​law amendment had been published at the very last moment. Such a search would have revealed that the parties’ shared assumption, that the property could freely be used for a tennis and swim club, was mistaken. Such a search was not conducted. Nevertheless, the court properly held that Dover could rescind the contract. In Bar-​Del, Inc. v. Oz, Inc.,18 the buyer had contracted to purchase a tavern from the seller. Unbeknown to the parties, the property was not zoned for tavern use even though the seller had operated the tavern for many years. An unbounded search would have found zoning laws and maps that showed that the parties’ shared assumption that the property could lawfully be used as it had long been used was mistaken. Such a search was not conducted. Nevertheless, the court properly held that the buyer could rescind. In In re Macrose Industries,19 the buyer had contracted to purchase a parcel of real estate from the seller subject to obtaining all the municipal approvals that were necessary to realize the buyer’s plans for the property. The contract gave the buyer one year to secure these approvals. Subsequently the buyer discovered that the process of obtaining one of the required permits could take up to two years. An unbounded search of the relevant law and practice before the contract was signed would have shown that the parties’ shared assumption, that one year would suffice to acquire the necessary permits, was mistaken. Such a search was not conducted. Nevertheless, the court properly held that the buyer could rescind. In Reilly v.  Richards,20 the buyer had contracted to purchase a parcel of real estate upon which to build a house. Subsequently, the buyer discovered that part of the property was located in a flood-​hazard area and as a result was unfit for construction. An unbounded search of flood-​ plain records would have shown that the parties’ shared assumption, that a house could be built on the property, was mistaken. Such a search was not conducted. Nevertheless, the court properly held that the buyer could rescind. These holdings are proper because it is often or usually rational for actors not to conduct an unbounded search to verify a tacit assumption. If the costs of searching for information were zero then every actor contemplating a decision would make an unbounded search for all relevant information. In reality, however, searching for information does involve costs, in the form of time, energy, and often money. Most actors either do not want to expend the resources required for an unbounded search or recognize that an unbounded search could not be achieved at any realistic cost. Accordingly, decision-​making is always bounded by limited search and information, and actors regularly make decisions in 17.  322 N.E.2d 168, 169–​71 (Mass. 1975). 18.  850 S.W.2d 855, 856–​57 (Ky. Ct. App. 1993). 19.  186 B.R. 789, 793 (E.D.N.Y. 1995). 20.  632 N.E.2d 507, 508–​09 (Ohio 1994).

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rational ignorance of alternatives and consequences they could have discovered and considered if they had engaged in unbounded search. However, even if the adversely affected party is not actually conscious of a risk that a shared mistaken assumption is mistaken, she should bear that risk if she recklessly disregards facts that would put a reasonable person on notice of the risk or she otherwise fails to conduct an investigation that is reasonable under the circumstances, such as a termite inspection in an area where such inspections are customary. For example, if the purchasers in Lenawee had seen raw sewage seeping up before they made the contract they would have been reckless in assuming that the property was being lawfully used for purposes of habitation without investigating further.

B.  THE RISK THAT THE ASSUMPTION IS MISTAKEN IS CONTRACTUALLY ALLOCATED TO THE ADVERSELY AFFECTED PARTY Next, the risk that a shared assumption is mistaken will not justify legal relief where the contract allocates that risk to the adversely affected party. This requirement was developed in a notable article by Edward Rabin21 and then embodied in Restatement Second Section 154, which provides that “A party bears the risk of a mistake when . . . the risk is allocated to him by agreement of the parties. . . .”22 This is not really a limitation of the general principle that governs shared mistaken assumptions, but merely a corollary. The general principle applies where the risk of a shared mistaken assumption is implicitly allocated by the contract away from the adversely affected party. That implication is overridden, however, if the risk is allocated by the contract to the adversely affected party. Indeed, in such a case the parties did not have a shared mistaken tacit assumption. Instead, they had an assumption they realized might be mistaken, and they allocated the risk of that mistake to the adversely affected party. In this kind of case giving relief to that party on the basis of the mistake would defeat rather than effectuate the parties’ agreement. The rule that should and does govern cases in which the risk of a mistaken assumption is contractually allocated to the adversely affected party is straightforward, but its application can sometimes be difficult, because the contract may allocate the risk to the adversely affected party implicitly rather than explicitly. This is exemplified by Illustration 1 to Restatement Second § 154: A contracts to sell and B to buy a tract of land. A and B both believe that A has good title, but neither has made a title search. The contract provides that A will convey only such title as he has, and A makes no representation with respect to title. In fact, A’s title is defective. The contract is not voidable by B, because the risk of the mistake is allocated to B by agreement of the parties.

Here the provision concerning title does not explicitly allocate to B the risk of a defect in title, but it does allocate that risk implicitly. The Illustration involves, not a tacit assumption that A has title, but an explicit recognition that there is a risk that A does not have title and an implicit allocation of that risk to B. 21. Edward H. Rabin, A Proposed Black-​ Letter Rule concerning Mistaken Assumptions in Bargain Transactions, 45 Tex. L. Rev. 1273, 1276–​77, 1292–​94 (1967). 22.  Restatement Second § 154.

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Furthermore, a determination that the risk of the mistake is contractually allocated to the adversely affected party is often based not on the language of the contract but on the background of the contract and the circumstances surrounding its formation. This is exemplified by two further illustrations in the Restatement Second. Here is the first: A contracts to sell and B to buy a tract of land, on the basis of the report of a surveyor whom A has employed to determine the acreage. The price is, however, a lump sum not calculated from the acreage. Because of an error in computation by the surveyor, the tract contains ten per cent more acreage than he reports. The contract is voidable by A. . . . 23

Here is the second: The facts being otherwise as stated in [the above illustration], A proposes to B during the negotiations the inclusion of a provision under which the adversely affected party can cancel the contract in the event of a material error in the surveyor’s report, but B refuses to agree to such a provision. The contract is not voidable by A, because A bears the risk of the mistake.24

Even if a contract does not explicitly allocate to the adversely affected party the risk that a shared assumption is mistaken, and such an allocation cannot clearly be inferred from the language of the contract or the circumstances surrounding its formation, the risk should be deemed to have been contractually allocated to that party if either the risk was clearly impounded into the price paid to the adversely affected party or the risk clearly induced the other party to enter into the contract, as the adversely affected party either knew or should have known. (The second test may seem odd. Why would a risk induce a party to enter into a contract? The answer is that a risk may be either downside or upside, and the prospect that an upside risk will pay off may induce a party to enter into a contract.) Take, for example, the famous case of Sherwood v. Walker.25 Sherwood was a banker and also had a farm where he raised the best breeds of livestock. He wanted to buy some polled Angus cattle. The Walkers were importers and breeders of such cattle. They told Sherwood they had a few polled Angus cows at one of their farms, but that in all probability the cows were sterile and would not breed.26 Sherwood went to the farm, saw the cows, and expressed his interest in purchasing one of them, Rose 2d of Aberlone. Two days later it was agreed that Sherwood would buy Rose for 5 1/​2¢ per pound. Before the date on which Sherwood was scheduled to pick up Rose the Walkers found out that she was with calf. The Walkers then claimed that the contract was voidable because it was based on the mistaken assumption that Rose was barren. The court

23.  Id. § 152 cmt. b, illus. 2. 24.  Id. § 154 cmt. c, illus. 2. 25.  33 N.W. 919 (Mich. 1887). 26.  Id. at 924 (Sherwood, J., dissenting). The facts are taken from the dissenting opinion, but are consistent with, although a bit more expansive than, the facts stated by the majority. Although Sherwood v. Walker is often treated as Michigan (and even national) law, it was effectively disavowed by the Michigan Supreme Court in Nester v. Michigan Land & Iron Co., 66 Mich. 568, 33 N.W. 919 (Mich. 1887).

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held for the Walkers on the ground that there was a mistake “as to the substance of the things bargained for”—​a mistake that went to “the very nature of the thing.”27 The result in Sherwood was unjustified for two related reasons. First, there was no mistaken assumption in this case. The Walkers thought that the cow was probably barren. That was not a mistake. She was probably barren. “Probably barren” is not the same as “barren.” On the contrary, “probably barren” strongly implies “possibly not barren.” Second, it seems highly likely that Sherwood entered into the contract because of the upside risk that Rose was fertile. To put this differently, it seems highly likely that Sherwood did not take it for granted that Rose was barren, and that the Walkers knew or had reason to know that. It is true that Sherwood paid a price calculated in cents per pound, which is presumably the way a beef cow is priced; and it is likely that the 5 1/​2¢ per-​pound price was the market price for beef at the time. Accordingly, the upside risk that Rose might be fertile may not have affected the contract price. However, this upside risk almost certainly induced Sherwood to enter into the contract, as the Walkers either knew or had reason to know. Sherwood was a banker and a gentleman farmer, not a butcher. He originally went to Walkersville to purchase breeding cattle. Almost certainly he figured that he would purchase Rose for her upside value, and if she did not prove fertile he could resell her for approximately the beef value that he paid, so that he would lose only the cost of maintaining her in the interim. The Walkers, for their part, almost certainly sold Rose at her beef value because no one would pay more than that and the Walkers were no longer willing, as Sherwood was, to pay the cost of maintaining her. Accordingly, Sherwood v. Walker is a good illustration of a case in which the upside risk that an assumption was mistaken induced a party to make a contract, as the other party knew or should have known.28 An even easier case is City of Everett v. Estate of Sumstad.29 The Mitchells owned a small secondhand store. They frequently shopped at Alexander’s Auction to obtain merchandise for their personal use and for inventory in their store. In August 1978, the Mitchells purchased at the auction, for $50, a used safe with a locked inner door. According to the Mitchells: [W]‌e saw that the top outer-​most door with a combination lock was open, and that the inner door was locked shut. That inner door required a key to open, and we learned that the safe would have to be taken to a locksmith to get the inner door opened because no key was available. We also learned that the combination for the outer lock was unknown. The auctioneer told the bidders that both this and [another] safe had come from an estate, that both were still locked, that neither had been opened, and that the required combinations and key were unavailable for either.30

Several days after the auction the Mitchells took the safe to a locksmith to have the inner door unlocked. The locksmith found $32,207 inside the safe, and Alexander’s Auction sued the Mitchells for that amount. The court correctly held for the Mitchells. As Alexander’s Auction knew or should have known anyone in the position of the Mitchells would have been induced to

27.  Id. at 923. 28. The substance/​accident test is now widely discredited, and Sherwood itself was overruled by the Michigan Supreme Court in Lenawee Cty. Bd. of Health v. Messerly, 331 N.W.2d 203 (Mich. 1982), discussed above, supra notes 9–​10. 29.  631 P.2d 366 (Wash. 1981). 30.  Id. at 368.

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enter into the contract partly by the upside risk that there was something of value in the locked safe, and that risk was probably impounded into the price that the Mitchells paid. Here is another, hypothetical, example. Buyer agrees to purchase a still-​life painting from Seller, who runs a secondhand shop, for $100. Buyer has the painting reframed, and when he does so he discovers that the painting is an Old Master worth $100,000. Seller hears the news, and seeks to rescind. On these facts the upside risk that the painting was an Old Master may not have been impounded into the $100 price, but was likely to have been a factor that induced Buyer to make the purchase. People who buy paintings in secondhand shops often have in the back of their minds a hope that the painting will turn out to be very valuable. As in Sherwood v. Walker Buyer was likely induced to buy the painting in part because at the least she would get a painting for $100 that she valued at that price, and at best she would get a painting worth much more.31

C.  ONE CONTRACTING PARTY IS IN A POSITION TO HAVE CLEARLY SUPERIOR INFORMATION ABOUT THE RISK THAT THE ASSUMPTION IS MISTAKEN A further limitation on the general principle that should govern shared mistaken factual assumptions is that where one contracting party is in a position to have clearly superior information concerning the risk that the assumption is mistaken, that party should be deemed to take the risk in the absence of an agreement to the contrary. In part this is an information-​forcing rule, because it forces the party, A, who is in a position to have clearly superior information about the risk that the assumption is mistaken, to either say nothing and accept the risk or point out the risk to the other party, B. At that point, B, now conscious of the risk, can demand that A explicitly accept the risk, agree to accept the risk himself, or propose some intermediate solution. Restatement Second Section 154, Illustration 6, presents a case of this kind: A contracts with B to build a house on B’s land. A and B believe that subsoil conditions are normal, but in fact some of the land must be drained at an expense that will leave A no profit under the contract. The contract is not voidable by A.

The result in the Illustration is justified. Although the parties share the mistaken assumption that subsoil conditions are normal, A, as a contractor, is clearly more knowledgeable about the risk of unexpected subsoil conditions than B. If A does not want to take that risk he should bring the risk to B’s attention and deal with it contractually. If A does not do that, he should bear the risk. In some cases the clearly-​superior-​informational exception can be justified on the alternative but overlapping ground that in appropriate circumstances a party who is in a clearly superior informational position may be deemed to make an implied representation concerning the

31.  See, e.g., Peter Maller, Flower Power: Painting Transcends Garage-​Sale Past, Brings $882,500 at Auction, Milwaukee J. Sentinel, May 27, 1999, at B1 (describing how a painting purchased for $29 at an estate sale turned out to be a valuable painting by American painter Martin Johnson Heade).

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subject matter of the shared assumption. This aspect of the exception is illustrated by McRae v.  Commonwealth Disposals Commission.32 The Disposals Commission, an instrumentality of the Australian government, believed that a tanker it owned was wrecked on the Jourmaund Reef. It tendered for offers to buy the tanker and sold it to the highest bidder, McRae, who then set out to salvage the tanker. In fact, the tanker did not exist and McRae sued the Commission for breach of contract. The Commission defended on the ground that both parties were mistaken. The court properly held for McRae. The Commission was in a position to know, as McRae was not, whether the wrecked tanker existed. Because of the Commission’s clearly superior informational position the Commission’s tender for bids impliedly represented that the tanker existed. If the Commission was not confident the tanker existed it should have made that clear.

D. WINDFALLS In most shared mistaken-factual assumption cases if the contract was enforced the adversely affected party would suffer a loss, in the sense that he would be less well off than he had reasonably expected to be under the contract. In contrast, in some shared mistaken factual assumption cases the issue is how to allocate a windfall—​that is, a surprising and unlikely element of value whose allocation to either party will not leave the other party less well off than he had expected to be under the contract. For example, in In re Seizure of $82,000 More or Less33 the Missouri State Highway police had stopped and searched a 1995 Volkswagen for speeding and following too closely. The search indicated that there was fresh silicone on the car’s undercarriage. This raised suspicions, and the car was brought to the police garage. There, agents of the United States Drug Enforcement Agency (DEA) found $25,000 in drug proceeds contained in plastic bags in the battery case. As a result, the car was forfeited to the United States under statute. Subsequently, the United States advertised the car for bids. The successful bidders were Helen and Jeffrey Chappell, mother and son. After they purchased the car the Chappells noticed that it had a fuel problem. Jeffrey took the car to a mechanic to have the problem fixed. While working on the car the mechanic found more bundles of money wrapped in plastic and floating in the fuel tank. He reported his find to the DEA. The DEA seized the money, around $82,000, and the parties disputed its ownership. This was a windfall case: there was an element of value to the Volkswagen that was surprising and unlikely, and whose allocation to either party would not make the other party less well off than it had expected to be under the contract. If the money was allocated to the government the Chappells would still have the Volkswagen at the price they thought it was worth. If the money was allocated to the Chappells the government would still have the money it expected to get for the Volkswagen. In another kind of windfall case, often discussed by commentators,34 Farmer A sells his farm to Farmer B and after the sale oil is found under the farm. Such a case is of no special interest if oil is common in the area, because in that case the possibility of an oil strike would probably

32.  (1951) 84 CLR 377 (Austl.). 33.  119 F. Supp. 2d 1013 (W.D. Mo. 2000). 34.  See, e.g., E. Allan Farnsworth, Contracts 612 (4th ed. 2004); Rabin, supra note 21, at 1295. For an actual case along these lines, see Tetenman v. Epstein, 226 P. 966 (Cal. Dist. Ct. App. 1924).

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be impounded into the market price of local farmland. Assume, however, that oil deposits had never been found or suspected in the area. At first glance, these hypotheticals and Seizure of $82,000 may look like Sumstead, the locked-​safe case, but actually they are very different. Sumstead is an easy case, because the upside risk that there was something valuable in the safe is very likely to have induced the buyers to purchase the safe, and the expected value of that risk was probably impounded into the price the buyers paid. In contrast, it is highly unlikely that the upside risk of a windfall such as cash secreted in a used car or oil beneath a farm in an area where oil deposits are unknown and unsuspected, would be impounded into the price the buyer pays. There are several good reasons why in shared-​mistaken, factual-​assumption cases the law should treat windfalls differently than losses, assuming that the windfall is not contractually allocated to one of the parties. Begin with loss-​aversion. Actors disvalue losses more than they value forgone gains of an equal amount. As stated by Michael Trebilcock, “Treating wipe-​outs differently from windfalls may be justifiable on the grounds either that risk aversion . . . is more apposite to prospective losses than prospective gains or, on a related Rawlsian difference principle, that people generally would prefer a legal regime that shields them from catastrophic losses.”35 There is also a structural difference in the way that cases involving losses and windfalls tend to arise. In loss cases, such as Lenawee, typically it is the buyer who wants relief, because the value of the seller’s performance is unexpectedly much less than it would have been if the mistaken assumption had been true. In contrast, in windfall cases, such as Seizure of $82,000, typically it is the seller who wants relief, because the value of the seller’s performance is unexpectedly much greater than the price that the buyer contracted to pay. With that background, one of four possible rules could be adopted to govern windfalls in shared-​mistaken-​assumption cases. One possible rule is that windfalls should always be allocated to the seller. An argument for this rule is that the seller sold something different than he “intended” to sell. That argument and rule, however, would substitute, for a functional analysis, an argument about essences—​the kind of approach used in Sherwood v. Walker and now discredited. Furthermore, an analysis based on intention can equally well be put in terms of what the buyer intended to purchase. In the farm hypothetical, for example, Farmer A might not have intended to sell oil-​bearing land, but Farmer B intended to purchase Farmer A’s farm. A rule that windfalls should always be allocated to the seller would raise other significant problems. Often such a rule would raise a problem of reliance. Losses tend to become apparent almost immediately, as in Griffith v. Brymer and Lenawee. In contrast, windfalls may not become apparent for some time after possession has shifted, as in the oil-​under-​the-​farm hypothetical.36 During that time, the buyer may have integrated the relevant property into his business or lifestyle in a way that is hard to unwind. Moreover, such a rule would often involve a kind of infinite 35.  Trebilcock, supra note 7, at 146. 36.  Cf. Carol Vogel, Inside Art—​Rembrandt Face to Face, N.Y. Times, July 11, 2003, at E29. Vogel describes how a Rembrandt self-​portrait dated 1634 was hidden for more than 300 years under layers of paint applied by one of Rembrandt’s pupils, who transformed the painting into “a study of a flamboyantly dressed Russian aristocrat with a tall red hat, long hair, earrings, and a mustache.” In the mid-​1900s, the then-​ owner had the painting cleaned and much of the overpainting came off. Successive cleanings over time revealed the entire underpainted self-​portrait. On July 11, 2003, the self-​portrait was sold for $11.3 million.

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regression, because if the seller can recover a windfall from the buyer, then the seller’s seller can recover the windfall from the seller, and so on down the line. Finally, often the buyer makes a significant contribution to unearthing a windfall, which is discovered as a result of the buyer’s knowledge, skill, and diligence in examining the relevant asset after he has acquired it.37 For these or other reasons, a rule that a windfall should always be allocated to the seller would not find much modern support. For example, the general consensus on the farm hypothetical is that the buyer, not the seller, should get the benefit of oil found after the farm is sold,38 and in Seizure of $82,000 the court allowed the Chappells to keep the money found in the gas tank (albeit partly on the quirky theory that the Chappells were the finders of abandoned property).39 Another possible rule to govern windfalls is that they should always be allocated to the buyer. Such a rule could be supported by the argument that because there is no strong reason to give a windfall to the seller, this may be one of those rare cases in which luck is decisive and the person who is lucky is the buyer. This argument is unpersuasive because it is simply conclusory. Still a third possible rule is that a windfall should always be shared equally between the seller and the buyer. A sharing rule, however, would threaten the security of possession, because in many cases (such as the farm hypothetical), under this rule the buyer would have to either give the seller a half-​interest in the relevant commodity or sell the commodity to pay off the seller’s half-​interest. Furthermore, a sharing rule would involve the same infinite regression as a rule that always allocated windfalls to sellers: if the buyer should be entitled to share with the seller, then the seller should be requested to share with his seller, and so on up the line. Finally, a sharing rule does not take into account which party discovered the windfall. A fourth possible rule is that a windfall normally should be allocated to the party who is in possession when the windfall is discovered, unless the upside risk of the windfall has been explicitly or implicitly allocated to the other party. This rule is not perfect, but it is preferable to the other possible rules on several grounds. To begin with, this rule would not involve the problem of infinite regression. More important, in the general run of cases a discovery of the windfall is likely to result in large or small part from some action of the party in possession. For example, in Seizure of $82,000, the United States could have taken the car to a mechanic, who would have discovered the money in the gas tank. It did not. The Chappells did. As the court pointed out: [T]‌he Chappells would never have acquired an interest in this $82,000 if the Government had found the currency during the years that the Volkswagen Golf was in its possession. The reason the car was seized in the first place was the recent work that had been done on the undercarriage. This, plus the fact that the gas gauge always registered empty, might have inspired a search of the gas tank before the car was sold at auction. As early as the 1970s when “Easy Rider” was aired, the Government was on notice that drug dealers use gas tanks to hide their contraband. . . .40

37.  In some cases before the contract is made a buyer uses his knowledge, skill, and diligence to determine that there is an element of value in the seller’s property of which the seller is unaware. Such cases, which will be considered in infra Chapter 44, on disclosure in contract law, do not involve windfalls, but do raise other problems. 38.  Farnsworth, supra note 34, at 242. 39.  In re Seizure of $82,000 More or Less, 119 F. Supp. 2d 1013, 1019–​21 (W.D. Mo. 2000). 40.  Id. at 1021.

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Similarly, in the case of the oil beneath the farm, the windfall is discovered on the buyer’s watch, and the discovery is probably due, if only in very small part, to action by the buyer. A possession rule would normally favor the buyer, but would not invariably do so. For example, suppose that in Sherwood v. Walker Sherwood was a butcher whose only interest in Rose was her value as beef. If the fact that Rose was fertile was discovered before possession had changed, then under a possession rule the Walkers could keep Rose, although they would be obliged to pay the butcher market-​price damages if the market price for beef cattle at the time Rose was to be delivered exceeded the contract price.

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Disclosure in Contract Law I .   T H E D I S C L O SUR E PR I NCI PL E Suppose that A and B propose to make a contract for the purchase and sale of a commodity. A knows a material fact, F, concerning the commodity, and also knows or has reason to know that B does not know F.1 The problem raised by such a case is whether A must disclose fact F to B. This will be referred to as the disclosure problem. Several paradigm cases exemplify this problem. Here are two: septic tank .

Andrew owns an income-​producing three-​unit apartment-​house building with a septic tank that he knows is inadequate to deal with the building’s sewage and therefore is illegal. Andrew offers to sell the building to Brown for $400,000, based on the recent sale prices of comparable investment properties. As Andrew knows or has reason to know, Brown assumes that the building is a lawful income-​producing property. If the inadequacy, and therefore the illegality, of the septic tank was known, the building would be worth nothing: the amount of land on which the building sits is legally insufficient to support a septic tank, and the only alternative to deal with the building’s sewage is by hauling it away, which would entail costs greater than the profits the building generates. Andrew does not disclose the insufficiency of the septic tank, and Brown purchases the property for $400,000.2 mineable ore .

Beta Mineral Corporation is in the business of mining, smelting, and selling minerals. Beta’s geologists employ various techniques to identify sectors of public and private land that seem to have mineable ore bodies and are not located in areas that have previously been thought to be mineral-​ bearing. If a parcel of public land seems promising, Beta’s geologists conduct a further investigation by going onto the land. If a parcel of private land, such as farmland, seems promising, Beta overflies the land with a plane that has instruments to detect magnetic anomalies in the earth below. 1.  The term commodity is used in this book to mean anything that can be bought or sold. For purposes of the disclosure problem, the term material fact is used to mean a fact that would be likely to influence a reasonable person in deciding whether to enter into a contract and on what terms, other than a fact concerning a party’s preferences, intentions, and evaluations. The terms fact and information will be used more or less interchangeably. 2.  This Illustration is a variant of Lenawee County Board of Health v.  Messerly, 331 N.W.2d 203 (Mich. 1982). In that case, however, neither party knew the relevant facts.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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A magnetic anomaly is a sign of mineralization, but many anomalies are caused either by minerals that have no commercial value or by ore bodies that are not mineable because they are not rich enough to justify the cost of mining. If the geologists find a promising anomaly on farmland, Beta purchases the farm at a farmland price through its wholly owned subsidiary, Sigma Company, and then begins exploratory drilling. Usually, this drilling finds only noncommercial or non-​mineable minerals, in which case Beta resells the land at the farmland price. Periodically, however, Beta finds a mineable body of commercial ore. In 2017 a Beta overflight discovers an extremely promising magnetic anomaly under Roberta Reaper’s farm, and Sigma purchases the farm at the market price for farmland in the area. Sigma does not disclose to Reaper the existence or significance of the anomaly. If the anomaly was known the farm would be worth significantly more than the price Sigma paid. It turns out that the minerals under the farm are extremely valuable and the ore is mineable.3 Traditionally, the issue raised by the disclosure problem has been cast in terms of whether the knowing party has a duty to disclose the relevant fact to the unknowing party—​or to put it differently, whether nondisclosure is permissible, on the one hand, or there is a duty of disclosure, on the other. Because this terminology is functional and convenient, it will be employed in this chapter, but two points should be kept in mind. First, strictly speaking the issue in these cases is not whether A must disclose. Rather, the issue is whether A may contract with B without making disclosure. If A abstains from contracting with B he has no duty of disclosure even though he knows information that would be very valuable to B. Accordingly, the terms duty to disclose and requirement of disclosure will be used as shorthand for a duty to either disclose or abstain. Second, if we focus on the knowing party in such cases the issue is disclosure. However, if we focus on the unknowing party the issue is mistake. Chapter 43 addressed the issue of shared mistaken tacit assumptions concerning the outside world. This issue is to be resolved in the first instance by (1) determining whether the parties had a shared tacit assumption, because the parties’ shared tacit assumptions are just as much a part of their contract as their shared explicit assumptions; and then (2) by determining the effect of the assumption and whether relief is appropriate. In contrast, the disclosure problem concerns unshared mistaken tacit assumptions. In disclosure cases A knows that fact F is the case whereas B tacitly and mistakenly assumes that fact F is not the case. (How do we know that B holds a mistaken tacit assumption about a material fact? Usually, the answer is very simple: the price that B pays or accepts will show that he tacitly assumed that Not-​F was the case, because if he knew that F was the case the price would have been demonstrably higher.) Because the mistaken tacit assumption in nondisclosure cases is not shared, the disclosure problem cannot be resolved by determining whether the parties shared a tacit assumption. Instead, the problem can be resolved only by determining the circumstances under which disclosure by the knowing party should be required on the basis of policy, morality, and experience. Whether the knowing party is under a duty to disclose in cases such as Septic Tank or Mineable Ore is one of the most intractable issues in contract law. A major reason is this: in most issues in contract law, policy and morality point in the same direction. In disclosure cases, however, they often point in different directions. Begin with morality. At least when actors are dealing face to face, rather than in a relatively anonymous market such as a public auction or a stock-​market trading floor, morality suggests 3.  This Illustration is a variant of the facts underlying SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (en banc), a leading insider-​trading case. Insider trading is itself a paradigm of the disclosure problem, although it is governed largely by federal law, primarily Rule 10b-​5 under the Securities Exchange Act of 1934.

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that if one actor knows a material fact that is relevant to the transaction, and knows or has reason to know that the other actor does not know the fact, nondisclosure is sharp dealing, or a kind of moral fraud. For example, in Smith v. Hughes Chief Justice Cockburn considered a hypothetical like Mineable Ore and said that even though the purchase contract in such a case would be binding, “a man of tender conscience or high honour would be unwilling to take advantage of the ignorance of the seller.”4 Similarly, Trebilcock points out that: Although welfare considerations seem fairly unambiguously to militate in favor of non-​disclosure by [a]‌buyer . . . the deliberate exploitation by the buyer of [a] farmer’s ignorance of a crucially important fact bearing on the real value of his property seems to involve the taking of advantage of a less that fully autonomous choice by the farmer if one views as pre-​conditions for fully autonomous choices, as even Milton Friedman does, lack of coercion and full information. It may be plausible to argue that the buyer’s conduct violates the Kantian categorical imperative of equal concern and respect in that if roles were reversed . . . the buyer would not wish his ignorance to be exploited by the seller in this fashion, even though such a precept may come at a cost in terms of long-​run community welfare. . . . [T]he farmer might reasonably ask why his interests should be sacrificed to this greater social end (without his informed consent); that is, why should he be used as a means to the ends of others?5

There are also strong efficiency reasons for requiring disclosure. For one thing, the principle that bargains should be enforced according to their terms rests most securely on a foundation of complete information. Trebilcock makes this point too: Even the most committed proponents of free markets and freedom of contracts recognize that certain information preconditions must be met for a given exchange to possess Pareto superior qualities. For example, to recall the statement of Milton Friedman: “The possibility of coordination through voluntary cooperation rests on the elementary—​yet frequently denied—​proposition that both parties to an economic transaction benefit from it, provided the transaction is bilaterally voluntary and informed.”6

Furthermore, requiring disclosure may save socially wasteful costs of searching for information that the knowing party already has or of duplicate searches by multiple potential buyers. Trebilcock also writes: One might also reasonably argue that requiring disclosure for this range of defects avoids various forms of socially wasteful transaction costs, such as a succession of prospective buyers hiring mechanics to inspect cars before purchase or, in the event of purchase in the absence of accurate information, further transactions that might be entailed in moving the goods to their socially most valuable uses, given the now fully revealed condition of the goods. . . .

4. (1871) 6 LRQB 597, 604 (Eng.). See also, e.g., Barry Nicholas, The Obligation to Disclose Information: English Report, in Contract Law Today: Anglo-​French Comparisons 166, 173 (Donald Harris & Denis Tallon eds., 1989). 5.  Michael J. Trebilcock, The Limits of Freedom of Contract 117–​18 (1993). 6.  Id. at 102 (quoting Milton Friedman, Capitalism and Freedom 13 (1962)) (emphasis by Trebilcock).

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Mistake, Disclosure, and Unexpected Circumstances . . . [Absent a requirement] of disclosure of material facts known to one party and unknown to the other . . . the second party and other prospective contracting parties may be induced to invest in wasteful precautions to generate information about the asset that is already possessed by the first party and can be transmitted at trivial marginal social cost.7

Finally, as stated by Anthony Kronman, nondisclosure “is a cost to the contracting parties themselves and to society as a whole since the actual occurrence of a mistake always (potentially) increases the resources which must be devoted to the process of allocating goods to their highest-​valuing users,”8 if only by potentially adding transaction costs. On the other hand, in at least some kinds of cases there are efficiency arguments against a duty of disclosure. This is exemplified by Mineable Ore. Suppose Beta (or its subsidiary, Sigma) was required to disclose the magnetic anomaly to Reaper before concluding a contract. Then Reaper might contact other mineral companies, tell them what Beta has found, and begin an auction for the land. In that case, Beta might have incurred significant exploration costs from which it would derive no benefits, and at least in theory the incentives for Beta and like companies to engage in exploration for minerals would be greatly reduced.9 Since exploration for minerals is normally a socially valuable activity, a duty of disclosure would be undesirable if it dampened such exploration. Furthermore, in cases such as Mineable Ore although Beta’s return may look very large if we focus solely on the transaction with Reaper, Beta’s total return may be moderate because much of Beta’s investment in exploration may be nonproductive. The general rule under classical contract law was that disclosure by a knowing to an unknowing party was not required, although there were a number of exceptions to this rule. Among the principal exceptions were the following: in the case of a proposed transaction between A and B where A is the knowing party, then: (1) If B asked A a question about their proposed transaction, A could decline to answer, but if he did answer he had to answer truthfully. For example, if in Mineable Ore Reaper had asked Sigma’s representative, S, whether there was any indication that there were minerals under Reaper’s farm, S could decline to answer but could not falsely reply, “No.” (2) A could not engage in fraudulent concealment, that is, in conduct designed to prevent B from learning the relevant fact. For example, A could not conceal evidence of termite damage in a wooden floor by covering the damage with a large planter. (3) A could not tell a half-​truth, that is, a statement that was literally true but substantively misleading. For example, if A was attempting to purchase an interest in a mining company from B, A could not truthfully state that the company had just closed down its only mine while omitting to state that the company was about to open a new mine. (4) A had to make disclosure if A and B were in a fiduciary relationship, such as trustee-​beneficiary, or a relationship of trust and confidence, such as nurse-​patient. The classical-​contract-​law rule concerning disclosure has a degree of support in modern cases, but is widely criticized, significantly weakened by exceptions, and eroding in important respects. As a normative matter the rule is justified only in a limited range of cases. Taking into account the moral and efficiency reasons for a general duty of disclosure, on the one hand, and 7.  Id. at 108, 112. 8.  Anthony T. Kronman, Mistake, Disclosure, Information, and the Law of Contracts, 7 J. Legal Stud. 1, 2–​ 3 (1978). Despite these arguments, neither Trebilcock nor Kronman advocates a general duty of disclosure. 9.  This is in theory. In reality, it is not clear how much of a dampening effect a disclosure rule would have in cases such as Mineable Ore. See text at notes 90–​95, infra.

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the possible efficiency losses that such a duty might entail, on the other, the following general principle should guide the formulation of specific rules in this area:  Disclosure of material facts should be required in contract law except in those classes of cases in which a requirement of disclosure would entail significant efficiency costs. This principle will be referred to as the Disclosure Principle. The Disclosure Principle puts a thumb on the scale—​in effect, creates a presumption—​in favor of disclosure, because of the moral and efficiency reasons that support disclosure. To overcome this presumption it is not enough that in a given class of cases a requirement of disclosure would entail some efficiency costs. Instead, the presumption is overcome only if disclosure would entail significant efficiency costs.10 The Disclosure Principle is not intended to be applied directly to individual cases. Instead, the Principle is a guide to the formulation of a series of more specific rules concerning when disclosure should or should not be required in given classes of cases. The balance of this chapter will be devoted to developing those rules.

I I.   D I S C L O S U R E O F   I NF OR M AT I ON T HAT WA S A D V E N T I T I O US LY A CQUI R ED The stage-​setting work on the disclosure problem is Anthony Kronman’s article “Mistake, Disclosure, Information, and the Law of Contracts.”11 Kronman began his analysis of the disclosure problem with a discussion of an old but well-​known case, Laidlaw v. Organ,12 which has also figured in subsequent analyses. Laidlaw was decided by the United States Supreme Court in an opinion by Chief Justice Marshall, in the days when the Supreme Court was still extensively engaged with commercial issues. The opinions in both the Supreme Court and the federal District Court below are exceptionally brief, and as a result some of the facts in the case are unclear. The following account of the case is based on the District Court opinion, the bill of exceptions to that opinion, the arguments of counsel, and a few straightforward inferences based on those sources.13 In early 1815 a British fleet was blockading New Orleans as part of the War of 1812. (Indeed, the greatest battle of the War was fought at New Orleans at this time.) On Saturday, February 18, three Americans, Shepard, White, and Livingston, were for some reason with the British fleet. That day the fleet, and therefore the three Americans, got news that the War had been ended

10.  Trebilcock, supra note 5, considers “a general presumption in favour of disclosure of material facts known to one party and unknown to the other,” in light of the efficiency goal of moving assets to their most productive uses with as few transaction costs as possible. Id. at 112. However, he rejects the presumption, as so formulated, on the ground that it fails to emphasize whether requiring disclosure would reduce the incentives to generate and utilize information in the first place. Id. The Disclosure Principle formulated in this chapter does emphasize incentives to generate information. As to incentives to utilize information, see infra text accompanying notes 19–​23. 11. Kronman, supra note 8. 12.  15 U.S. (2 Wheat.) 178 (1817). 13.  See id. (including the sources in the Reporter’s note).

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some time earlier by a peace treaty signed at Ghent. News of the treaty had been published in British newspapers, and it is likely that the news was imparted to the fleet through delivery of these newspapers, although perhaps it was imparted by letters from England. One of the Americans, White, quickly prepared a handbill with news of the peace treaty for distribution in New Orleans. The handbill was published in New Orleans at 8:00 a.m. on Sunday. It was clear that the price of tobacco in New Orleans would immediately rise when news of the peace treaty became generally known, because tobacco stored in the city would no longer be blockaded. Sometime after sunrise on Sunday, but before White’s handbill was published, Shepard conveyed news of the peace treaty to his brother. Shepard’s brother, in turn, conveyed the information to Organ, a New Orleans merchant who was engaged in the purchase and sale of tobacco. Organ then purchased 111 hogsheads of tobacco from Laidlaw, probably at the then-​ market pre-​news price.14 Shepard’s brother may have had an interest in the profits of this transaction. After news of the peace treaty spread, the price of tobacco in New Orleans increased 30–​50 percent. Laidlaw then either refused to deliver or seized back the tobacco he had sold to Organ, and Organ brought suit in federal District Court for specific performance, damages, or both. The District Court instructed the jury to find for Organ. On appeal the United States Supreme Court concluded that Organ was not under a duty to disclose the news of the peace treaty to Laidlaw: The question in this case is, whether the intelligence of extrinsic circumstances, which might influence the price of the commodity, and which was exclusively within the knowledge of the vendee, ought to have been communicated by him to the vendor? The court is of opinion that he was not bound to communicate it. It would be difficult to circumscribe the contrary doctrine within proper limits, where the means of intelligence are equally accessible to both parties. But at the same time, each party must take care not to say or do any thing tending to impose upon the other.15

Kronman comments: From a social point of view, it is desirable that information which reveals a change in circumstances affecting the relative value of commodities reach the market as quickly as possible (or put differently, that the time between the change itself and its comprehension and assessment be minimized). If a farmer who would have planted tobacco had he known of the [peace treaty] plants peanuts instead, he will have to choose between either uprooting one crop and substituting another (which may be prohibitively expensive and will in any case be costly), or devoting his land to a nonoptimal use. In either case, both the individual farmer and society as a whole will be worse off than if he had planted tobacco to begin with. The sooner information of the change reaches the farmer, the less likely it is that social resources will be wasted.  . . .  Allocative efficiency is promoted by getting information of changed circumstances to the market as quickly as possible. Of course, the information doesn’t just “get” there. Like everything else, it

14.  See text at notes 46–​56, infra. 15.  15 U.S. (2 Wheat.) at 194.

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is supplied by individuals (either directly, by being publicized, or indirectly, when it is signaled by an individual’s market behavior).16

This argument is unobjectionable, but Kronman isn’t explicit about how the argument applied to Laidlaw. In the context of his article is seems clear that Kronman believes Laidlaw was correctly decided on allocational grounds. In fact, however, Laidlaw had nothing to do with allocational efficiency, because the problems of time and communication would have made it impossible for disclosure to affect the productive decisions of farmers, carriers, or anyone else. In short, on the facts of Laidlaw whether or not to require disclosure was purely a distributional issue. However, Kronman immediately shifts away from that argument and instead focuses on the development of two other concepts that he argues should govern the disclosure problem. Under Kronman’s first concept, disclosure should be required if the relevant information was acquired by the knowing party “casually.” Hereafter such information will be referred to as adventitiously acquired information. Under Kronman’s analysis information is casually or adventitiously acquired if the costs incurred to engage in the activity that produced the information were not incurred for the purpose of acquiring such information.17 To put this differently, information is adventitiously acquired if it is acquired in the course of an activity engaged in for a purpose other than acquiring the information. In contrast, under Kronman’s second concept disclosure should not be required if the information was acquired as the result of the actor’s deliberate and costly search for the information. Hereafter such information will be referred to as deliberately acquired information.18 Kronman illustrated the two concepts as follows: In some cases, an individual who has information has acquired it by a deliberate search. in other cases, the information has been acquired casually. A  securities analyst, for example, acquires information about a particular corporation in a deliberate fashion—​by carefully studying evidence of its economic performance. In contrast, a businessman who acquires a valuable piece of information when he accidentally overhears a conversation on a bus acquires the information casually.19 Kronman did not argue that his two concepts should be made into legal rules, because he believed it would be too costly to determine on a case-​by-​case basis whether information was casually or deliberately acquired. Instead, he proposed that the concepts be used as a guide to formulate rules that would either require disclosure or permit nondisclosure of various categories of legal information. The contours of these rules would turn on whether information in the relevant category was usually acquired casually or deliberately, not on whether the information in the actual case was acquired casually or deliberately.20 The problem with this analysis is that although any specific rule in this area will likely be somewhat overinclusive, under-​inclusive, or both, rules based on Kronman’s categories would be excessively so. Furthermore, such rules would be extremely costly to formulate and

16. Kronman, supra note 8, at 12–​13. 17.  Id. at 13. 18.  Id. Kronman defines information that falls within the second concept as “[i]‌nformation whose acquisition entails costs which would not have been incurred but for the likelihood, however great, that the information in question would actually be produced.” 19.  Id. 20.  Id. at 17–​18.

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administer because the appropriate categorizations of information would be almost endlessly contested. It is probably no accident that Kronman himself formulated only one rule of this type—​that information about changing market conditions would not need to be disclosed. Kronman properly argued that information that is adventitiously acquired should be disclosed for at least two reasons:  (1) Mistakes are costs, and disclosure will prevent those costs.21 (2) Since an actor who acquires information adventitiously makes no investment in the acquisition, a requirement of disclosure in such cases is unlikely to reduce the production of socially useful information.22 It might be argued against this approach that although adventitiously acquired information is neither earned nor gifted, an actor who learns such information is entitled to reap its benefit. After all, it is often acceptable for an actor to retain an unearned and ungifted benefit. In these cases we say that the actor is lucky. Often, however, an actor is not entitled to retain an unearned and ungifted benefit. In these cases, the actor is not lucky. What constitutes luck in this context—​that is, when an actor is entitled to retain an unearned and ungifted benefit—​is partly a matter of policy and morality, which may change over time, and partly a matter of law, which will normally follow policy and morality. Therefore, whether an actor who adventitiously acquires valuable information is lucky is not the starting point of analysis, but the conclusion. If, on the basis of policy and morality, the actor should be able to use such information without disclosing it he is lucky; if he shouldn’t he is not lucky. Accordingly, the concept of luck has little or no independent weight in determining the application of the Disclosure Principle to a given class of cases. Unless there is a good reason of policy or morality to protect an unearned and ungifted advantage, an attempt to utilize the advantage may be exploitive or worse. Next it might be argued that requiring disclosure of information that is adventitiously acquired would fail to provide efficient incentives for the development of knowledge and skill because even when an actor acquires information adventitiously he may understand the value of the information only because of an investment that he has made in developing his knowledge and skill. For example, suppose that, amplifying Kronman’s bus hypothetical, B is engaged in the real-​estate business. B overhears a conversation on a bus, which he correctly understands to mean that unknown to the general public the State Highway Department is about to approve plans for a new highway running through a certain agricultural area. B realizes that the price of farmland adjacent to the proposed highway will sharply escalate once the highway is publicly announced because the land will have valuable new commercial uses. Before the new highway is announced B purchases farms that will be adjacent to the highway. B did not ride the bus to acquire information, but he did invest in the acquisition of knowledge and skill that enabled him to evaluate the information he overheard. Most people who heard the same conversation would have gotten nothing out of it. This argument against disclosure is unconvincing. Although it is conceivable that the possibility of adventitiously acquiring and utilizing valuable information might figure in the mix of reasons why an actor decides to acquire knowledge and skills, that possibility, if it exists at all, would be vanishingly small. Accordingly, even if a rule that required disclosure of information that is adventitiously acquired would marginally diminish

21.  Id. at 2. 22.  Id. at 15–​16.

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the incentive to acquire knowledge and skill, that cost would be too slight to overcome the presumption in favor of disclosure under the Disclosure Principle.23 A related argument against requiring disclosure of adventitiously acquired information is that although such a requirement would not significantly dampen the incentives to acquire information it would discourage the efficient utilization of information. Take the following paradigm case: Adam Smith. Alan and Barbara are friends. Barbara invites Alan to a party at her house. While at the party Alan notices that Barbara has an autographed first edition of Adam Smith’s The Wealth of Nations. The previous week Alan had learned casually in the course of a dinner conversation with a rare-​book collector that any first edition of The Wealth of Nations, particularly an autographed edition, is exceptionally valuable. Barbara obviously doesn’t realize that her book is valuable, because she is using it as a doorstop. Alan offers to buy the book from Barbara for $15. Barbara accepts. Adam Smith is loosely based on a hypothetical developed by Trebilcock. In such cases, Trebilcock says, enforced disclosure would “diminish [the buyer’s] incentives to use this information in the marketplace, thus retarding the movement of resources from lower-​valued to higher-​valued uses.”24 Trebilcock’s argument can be restated as follows. In cases such as Adam Smith, if Alan is required to disclose the value of the book, Barbara will either keep the book or sell it to Alan or a third party at full market value. Therefore, Alan will not profit from his information. Because Alan will not profit he has no incentive to disclose the information. Because he has no incentive to disclose, he will not utilize the information, and the book will not be moved to a higher-​valued use, but instead will remain as a doorstop. Call this the utilization argument. In many or even most of the cases that might implicate this argument the issue is not squarely raised, because disclosure would be mandated under one or more of the exceptions to the traditional rule, discussed below. Adam Smith might fall into this category if there is a relationship of trust and confidence between Alan and Barbara.25 Assume, however, that the utilization argument is squarely raised. In the context of a case such as Adam Smith, the argument has two flaws. First, the argument assumes that only economic incentives move people to act. In Adam Smith, Alan is likely to inform Barbara about the value of her book even if Alan will not profit by doing so because Barbara is Alan’s friend and he owes her the obligations that friends owe to each other. Second, even if it were true that only economic incentives count, it is also true that Alan could profit from his information even though he is under a duty to disclose. Recall that the term duty to disclose is shorthand for a duty to disclose or abstain. Accordingly, even if Alan was under a duty to disclose if he proposed to purchase the book, he would be free to sell the information to Barbara, without purchasing the book, by making the following offer:  “You own an object whose value is much greater than you realize. I will tell you what the object is if you agree to sell it and share your profit with me fifty-​fifty.” Alan has an economic incentive 23.  This doesn’t mean that an actor who has special knowledge and skills can’t make use of them without disclosing. For example, a bibliophile can troll used bookstores for rare books that the seller has underpriced, and an art expert can troll galleries and antique stores for paintings that the seller has underpriced. In these cases, the buyer has invested not only in acquiring knowledge and skill, but in a deliberate search to make use of the knowledge and skill—​unlike the bus-​rider in Kronman’s hypothetical. 24.  Trebilcock, supra note 5, at 113. 25.  See infra Section VIII.

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to make this offer because otherwise he gets no economic return. Barbara has an incentive to accept this offer for the same reason. Indeed, bargains like this are not uncommon. There a line of business in which companies try to locate funds that belong to actors, such as missing heirs, who don’t realize that the funds exist, and then make contracts with the actors to provide information about the amount and location of the funds in exchange for a percentage of the funds.26 Given Alan’s incentives to disclose, even if a rule that required disclosure of adventitiously acquired information would diminish the utilization of information that diminution would be too small to overcome the presumption in favor of disclosure under the Disclosure Principle. Finally, it might be argued that a rule that required disclosure of adventitiously acquired information would dampen the efficient allocation of resources. This possible cost is also vanishingly small. To summarize, one element of the rule that should govern the disclosure problem is that an actor should be required to disclose information that was adventitiously acquired, that is, acquired in the course of an activity that the actor engaged in for purposes other than acquiring the information.

I II.   D I S C L O S U R E O F  I NF OR M AT I ON TH AT I S O N LY F O REKNOWL EDGE Under Kronman’s analysis, concept an actor who has acquired information deliberately normally should not have a duty of disclosure. The idea that Kronman advances in support of this concept is that if the law required disclosure of information that is deliberately acquired the incentive to invest in the acquisition of information would be significantly diminished. This idea is incorrect, or at least much too sweeping. One way to characterize Kronman’s analysis is as a process approach, because whether the disclosure of information is required under his analysis depends upon the process by which information was acquired: if information is acquired by an adventitious process, disclosure is required; if information is acquired by a deliberative process, disclosure is not required. In contrast to Kronman’s process approach, several leading economists have formulated substantive approaches to the disclosure problem, under which the permissibility of nondisclosure would turn on the character of the relevant information rather than on the process through which the information was obtained.27 The most notable contributions to this line of analysis are Jack Hirshleifer’s article “The Private Value of Information and the Reward to Inventive Activity,”28

26.  See, e.g., Locator of Missing Heirs, Inc. v.  Kmart Corp., 33 F.  Supp.  2d 229, 230 (W.D.N.Y. 1999); Intersource, Inc. v. Kidder Peabody & Co., 1992 WL 369918, at *1 (S.D.N.Y. Nov. 20, 1992). 27.  See Muriel Fabre-​Magnan, Duties of Disclosure and French Contract Law: Contribution to an Economic Analysis, in Good Faith and Fault in Contract Law 99, 111 (Jack Beatson & Daniel Friedmann eds., 1995) (“the efficiency of duties of disclosure mainly depends . . . on the nature or content . . . of the information to be disclosed”). 28.  Jack Hirshleifer, The Private and Social Value of Information and the Reward to Inventive Activity, 61 Am. Econ. Rev. 561 (1971).

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Robert Cooter and Thomas Ulen’s book Law and Economics,29 and Steven Shavell’s article “Acquisition and Disclosure of Information Prior to Sale.”:30 Hirshleifer’s seminal contribution to the disclosure problem was to draw a critical distinction between discovery, on the one hand, and, foreknowledge, on the other. Discovery is the recognition of a fact that possibly already exists but that will be hidden from view unless and until the discovery is made.31 Here, “Nature’s secret will not be autonomously revealed but must be extracted by man.”32 Discovered information makes the pie larger33 and can bring social gains from allocating resources more efficiently. It increases social wealth because it “increases ex ante each person’s potential share” of general wealth.34 In contrast, foreknowledge is knowledge that will in due time be evident to all; it is information that “Nature will . . . autonomously reveal.”35 Foreknowledge involves “only the value of priority in time of superior knowledge.”36 Foreknowledge can bring gains to an actor who privately acquires the information, and actors therefore may deliberately invest in acquiring foreknowledge. But the gains from foreknowledge are often only redistributive, not social. The information “does not increase the pie’s share, only the shares of those who have the relevant information,”37 and the cost of acquiring such foreknowledge may very well exceed its social value. Accordingly, the law need not and indeed should not provide incentives for the deliberate acquisition of foreknowledge.38 Hirshleifer did not specifically address the disclosure problem. His interest was in the general issue whether and when an investment in acquiring information is inefficient and the specific issue of optimum patent-​law policy. In contrast, Cooter and Ulen developed a principle 29.  Robert Cooter & Thomas Ulen, Law and Economics 353–​60 (6th ed. 2012). 30.  Steven Shavell, Acquisition and Disclosure of Information Prior to Sale, 25 Rand J. Econ. 20 (1994). 31. Hirshleifer, supra note 28, at 562. 32.  Id. at 569. 33.  See Jules L. Coleman et al., A Bargaining Theory Approach to Default Provisions and Disclosure Rules in Contract Law, 12 Harv. J.L. & Pub. Pol’y 639, 694 (1989) (describing Hirshleifer’s analysis). 34.  Id. 35. Hirshleifer, supra note 28, at 562. 36.  Id. (emphasis omitted). 37.  Coleman et al., supra note 33, at 694. 38.  Trebilcock sets out the following hypothetical: Suppose a weekend hiker passing through a ravine on the periphery of a farmer’s land stumbles across oil seepage from a crevice. Further investigation suggests a strong possibility of an oil deposit on the farmer’s land. Here a rule of disclosure may have no effect on the likelihood of generation of this information, but such a rule will operate as a major disincentive to its utilization in procuring a transaction with the farmer, thus . . . retarding the movement of resources from lower-​to higher-​valued uses.

Trebilcock, supra note 5, at 113. This hypothetical is somewhat ambiguous, because the seepage is discovered casually but the prospect of oil is determined by deliberate investigation. Accordingly, this hypothetical is not really a pure utilization case. Suppose, however, that there was no further investment. Instead, the hiker buys the land, without disclosing the seepage, because based on the seepage it’s a good bet that there is oil under the land, and if there isn’t the hiker can almost certainly resell the land at the price he paid. Because the seepage will presumably become evident to everyone, including the farmer, within a relatively short time, the hypothetical seems to involve foreknowledge, and for the reasons discussed in Sections IV and V, below, foreknowledge should always be disclosed.

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that distinguishes between different kinds of information for the specific purpose of dealing with the disclosure problem. Their analysis is generally comparable to Hirshleifer’s but differs in certain ways. For example, rather than distinguishing between discovery and foreknowledge Cooter and Ulen draw a comparable but not identical distinction between productive information and redistributive information. “Productive information can be used to produce more wealth. The discovery of a vaccine for polio and the discovery of a water route between Europe and China were productive. . . . In contrast, redistributive information creates a bargaining advantage that can be used to redistribute wealth in favor of the informed party. To illustrate, knowing before anyone else where the state will locate a new highway conveys a powerful advantage in real-​estate markets.”39 Cooter and Ulen conclude that searching for redistributive information is socially wasteful and therefore the law should discourage the expenditure of resources on this type of search. One important means of discouraging such expenditure is to impose a duty of disclosure on an actor who has acquired private information that is only redistributive: . . . [Investment] in discovering redistributive information wastes resources. In addition, investment in redistributive information induces defensive expenditures by people trying not to lose their wealth to better-​informed people. Defensive expenditures prevent redistribution, rather than produce something. Thus, investment in redistributive information wastes resources directly and indirectly. The state should not create incentives to discover redistributive information. Instead, the state should discourage investment in discovering redistributive information. . . . These considerations prompt . . . [the formulation of the following] economic principle  . . . :  Contracts based upon one party’s knowledge of productive information . . . should be enforced, whereas contracts based upon one party’s knowledge of purely redistributive information should not be enforced. This principle rewards investment in discovering productive information and discourages investment in discovering redistributive information.40

Shavell also focuses on the disclosure problem, and draws a distinction, comparable to those drawn by Hirshleifer and by Cooter and Ulen, between information that is mere foreknowledge and information that is socially valuable because it allows action to be taken that will raise the value of a commodity to an actor who possesses the commodity and the information. Shavell concludes that an actor should be required to disclose private information that is mere foreknowledge, to reduce the incentive to wastefully acquire information that does not have social value.41 39.  Cooter & Ulen, supra note 29, at 357. Cooter and Ulen developed this approach in the first edition of their book, published in 1987. See generally Robert Cooter & Thomas Ulen, Law and Economics (1988). However, the quotes from Cooter and Ulen in this chapter are from the (sixth) edition of their book, published in 2012. 40.  Id. at 357–​358. 41.  Shavell states: [I]‌f information is not socially valuable, then effort to acquire it . . . is a social waste. Accordingly, a disclosure obligation is socially desirable because it will reduce . . . the incentive to acquire [such] information. In contrast, in the absence of an obligation to disclose, [all] information will have positive private expected value. . . . Thus, in the absence of a disclosure obligation, parties will be led to invest in acquisition of information even though that is socially undesirable.

Shavell, supra note 30, at 21.

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Although there are terminological and substantive differences between the formulations of Hirshleifer, Cooter and Ulen, and Shavell, the common themes are much stronger than the differences:  certain kinds of information are not socially valuable, the costs of acquiring such information therefore represent a social waste, and accordingly the law should not provide incentives for the acquisition of such information, but on the contrary should provide disincentives—​in particular, should require disclosure of such information. To summarize, another rule that should govern disclosure in contract law is that disclosure of foreknowledge should be required.

I V.   A L L O C AT I VE EF F I CI ENCY A striking aspect of Kronman’s analysis is that he placed his bets on two very different horses. The first horse, Allocation, whose jockey is Laidlaw, rides under the spur of allocating social resources efficiently by getting information to the marketplace. The second horse, Incentives, whose jockey is Deliberate Search, rides under the spur of giving incentives to invest in the acquisition of information where incentives are needed, but not otherwise. Kronman apparently thought that he had made only one bet, because the two horses share the same racing colors. But they don’t. Under Kronman’s analysis a bet on Incentives wins if the acquisition of information is deliberately acquired, but loses if the information is adventitiously acquired. In contrast, a bet on Allocation wins whenever information is brought to the marketplace, even indirectly and perhaps trivially, as by the fact of a purchase or sale, regardless of how the information is acquired and what kind of information is involved. Thus Randy Barnett, who bets only on Allocation, scolds Kronman for not putting all his money on that horse: Resource prices produced both by those who trade and those who decline to trade represent a summation of innumerable amounts of radically-​ dispersed information concerning the competing alternative uses of scarce resources and the relative subjective desirability of these uses. Therefore, a person in possession of [even] “windfall” information concerning a particular scarce resource still contributes importantly to the welfare of others by causing the price of that resource to move in an information-​revealing direction, whether the direction is up, down, or unchanged. The price-​effect of the decision to trade or refrain from trading results notwithstanding that the trader may neither have produced the information nor intentionally disclosed it. I  do not claim that this informational process is perfect, but only that it is both vital and irreplaceable. Imposing a duty to disclose on those in possession of information concerning a future change in market demand for a resource eliminates the possibility of profiting from the information, and thereby greatly reduces any incentive for potential traders to engage in information-​revealing transactions.42

42.  Randy E. Barnett, Rational Bargaining Theory and Contract: Default Rules, Hypothetical Consent, the Duty to Disclose, and Fraud, 15 Harv. J.L. & Pub. Pol’y 783, 797–​98 (1992).

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In short, Barnett argues for a general regime of nondisclosure even where the relevant information was foreknowledge or was adventitiously acquired, on the ground that the mere act of buying or selling generates a signal that moves prices to a more efficient level. The argument against disclosure based on allocative efficiency has two basic flaws. First, the argument implicitly assumes that more information is always good because of its allocational effect. However this assumption disregards the cost of producing this good. As Birmingham points out: “Judicial rules should encourage cows” does not follow from “cows are good.” . . . We may already have too many cows in that the marginal cost of maintaining a cow exceeds a cow’s marginal benefit. The same may be true of information. Where should the encouragement stop? We are talking about social cost here. Maximizing the number of cows or the amount of information seldom optimizes . . . [because information is costly to produce and the] resources used to produce this information might have produced something else.43

Second, it is not the case that there will always be an efficiency gain from getting information into the market through purchase-​and-​sale transactions. For example, recall that in Septic Tank Andrew sells his building to Brown at a price based on the sales of comparable buildings, knowing that the building’s septic tank is inadequate and therefore illegal. Andrew’s sale does not result in an allocative-​efficiency gain. Take now the case of homogenous commodities, as exemplified by Laidlaw.44 It is safe to assume that Organ purchased the tobacco at the then-​market (wartime) price, because if Organ offered more than the market price Laidlaw would have become suspicious that something was afoot. It is therefore hard to believe that Organ’s purchase had any discernible effect on the price of tobacco, since Organ was almost certainly purchasing a relatively small amount of a homogeneous commodity at the market price in a market with many buyers and sellers. Recall here Kronman’s conclusion that “information of the sort involved in Laidlaw v. Organ will have allocative consequences.”45 The phrase “of the sort” is telling. Kronman did not say that the actual information in the actual case had allocative consequences—​and for good reason, because it is inconceivable that the actual information in the actual case had allocative consequences. The information of which Organ had foreknowledge was to become public in an hour or two, and Organ must have known this. There is no way in which the price signal sent by Organ’s purchase—​which was probably a null signal in any event—​could have affected the production of tobacco or the allocation of productive resources. Nor did Organ’s contract with Laidlaw move the tobacco to a higher-​valued use. As Baird, Gertner, and Picker conclude: [I]‌n Laidlaw v. Organ, one of the parties [may have] spent a lot of money to become the first to know that the War of 1812 was over and that the British blockade of New Orleans was soon to be lifted. This information, however, only gave the person who gathered it the ability to profit at

43.  Robert L. Birmingham, The Duty to Disclose and the Prisoner’s Dilemma: Laidlaw v. Organ, 29 Wm. & Mary L. Rev. 249, 259 (1988). 44.  15 U.S. (2 Wheat.) 178 (1817). 45. Kronman, supra note 8, at 11 n.34 (emphasis added).

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someone else’s expense. There is no (or at least very little) social benefit in knowing a few hours earlier than anyone else that a peace treaty had been signed many weeks before. . . . When there is no obligation to disclose information . . . information about whether the war is over has value to the person who knows it even though it has little or no social value. Because of its value to the individual, that individual will spend resources acquiring it. . . . On balance, [if disclosure is required] the informed person does no better than the uninformed one. Indeed, because the information is costly to acquire, the informed person does worse, and hence has no reason to gather the information in the first place. Because the information, by assumption, has no social value, a law requiring disclosure has a desirable effect. When information has no social value, a law requiring disclosure works better than one that imposes no disclosure requirement.46

In any event, isolated face-​to-​face trading on the basis of private information is unlikely to have an allocational effect on the price levels of homogeneous goods, such as tobacco, because the market price of a homogeneous good is unlikely to be shifted more than microscopically, if at all, by such transactions. The allocational-​efficiency argument has even less traction in cases that involve differentiated commodities. Prices for differentiated commodities are negotiated within a range. Accordingly, there is usually too much noise in any single price to provide a clear price signal for other transactions. Indeed, if transactions based on private information send any signal it will often be the wrong signal. For example, assume that B purchases A’s farm because B has foreknowledge of nonpublic information that the Highway Department is about to construct a new highway adjacent to the farm. B’s purchase will not send a signal that farms adjacent to the planned highway are now more valuable: no one else knows that the highway is planned. If B’s purchase sends any signal, it will be that farmland generally is worth more than was previously thought. However, that would be precisely the wrong allocational signal. Farmland generally would not be worth more than was previously thought. Only A’s farm, and other farms that are adjacent to the projected highway, whose location is secret except to B, are worth more than previously thought. Similarly, the price in Septic Tank sends the wrong signal because the property is drastically overpriced in light of the irremediable-​septic-​tank problem.

V.   R E G I ME S O F   P UR E EXCHA NGE There are many ways to slice and dice economic regimes. One is to distinguish between regimes of production and exchange and regimes of pure exchange—​that is, regimes in which production does not take place, so that “[a]‌n individual dissatisfied with his endowment . . . can modify it only by trading.”47 In a regime of pure exchange new commodities are not produced and economic activity consists of exchanging existing commodities. Accordingly, there is no need to

46.  Douglas G. Baird, Robert H. Gertner & Randal C. Picker, Game Theory and the Law 98 (1994); see also Birmingham, supra note 43, at 269; Cooter & Ulen, supra note 29, at 357. 47. Hirshleifer, supra note 28, at 563.

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incentivize the acquisition of productive information in such a regime, so that disclosure should always be required. Kronman conceded that even deliberately acquired information should be disclosed in a regime of pure exchange, but minimized the concession by relegating the point to a footnote and treating regimes of pure exchange as essentially unrealistic.48 However, although a long-​running regime of pure exchange is not easily imaginable in a modern economy, regimes of pure exchange can easily persist over a short-​run period during which there is insufficient time to make significant productive or allocative decisions. In particular, foreknowledge is often acquired and utilized in short-​lived regimes of pure exchange, because whereas foreknowledge typically has a short shelf life, allocative decisions typically are developed over a significant period of time. Therefore, it is unlikely that important allocational decisions will be made between the time at which foreknowledge of information is employed and the time at which the information becomes generally known. As Hirshleifer states, “Foreknowledge . . . [involves] only the value of priority in time of superior knowledge,”49 and normally this priority is very short-​lived. During that short-​lived period decisions on which the foreknowledge bears typically will occur in a regime of pure exchange, will be redistributive rather than productive, and will not have allocational consequences—​and all this is true even if the foreknowledge is deliberately acquired.50 Indeed, that is just what occurred in Kronman’s centerpiece case, Laidlaw v. Organ. No one was likely to make a significant and irrevocable decision about planting tobacco between shortly after sunrise on February 18, 1815, and 8:00 a.m. when news of the peace treaty was distributed in a handbill. As Robert Birmingham puts it: In Laidlaw . . . private gain was the difference between the price Organ paid and the price after the news that the war had ended was made public, or some $3000; the social gain was zero. Laidlaw contains only a transfer payment. Organ gets more money, Laidlaw gets less. The effect of the contract in Laidlaw is redistributive only, hence prima facie inconsequential.51

More generally, Kronman drastically underestimated the significance of regimes of pure exchange. It is true that long-​run regimes of pure exchange will be relatively rare. However, foreknowledge typically has a very short shelf life—​typically, hours, days, or at the most weeks—​ just because it is information that “Nature will . . . autonomously reveal.”52 During that short shelf life a regime of pure exchange will normally prevail, because there will not be enough time to make investments in or reallocations of productive resources. Accordingly, Kronman’s acknowledgement that in a regime of pure exchange a disclosure rule is okay and a nondisclosure rule is unnecessary, even for deliberately acquired information, has a very wide ambit. Therefore, another rule that should govern the disclosure problem is that disclosure should always be required in transactions that occur in regimes of pure exchange. 48. Kronman, supra note 8, at 11 n.34. 49. Hirshleifer, supra note 28, at 562 (emphasis omitted). 50.  Kronman advances two examples where this won’t be so. However, the examples are unrealistic—​the first self-​admittedly; the second close to self-​admittedly. See Kronman, supra note 8, at 12–​13. 51. Birmingham, supra note 43, at 270. 52. Hirshleifer, supra note 28, at 562.

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V I .   D I S C L O S U R E BY   S EL L ER S In terms of the disclosure problem, transactions by sellers have several special characteristics. To begin with, the access of a seller and a buyer to information is systematically asymmetric, because sellers typically have special access to the characteristics of commodities they own. Normally, this informational advantage is effectively unerodable by buyers. Even if the buyer can investigate the commodity, the investigation will involve costs of a magnitude that the seller will not confront.53 A seller’s private information concerning the characteristics of a commodity he owns is almost invariably acquired without an investment in search. Instead, the information is usually an adventitious byproduct of ownership. That would be true, for example, in the Septic Tank hypothetical, in which the seller knows from his ownership that the septic tank on his property is inadequate. In general, therefore, requiring disclosure by sellers is usually a special case of requiring the disclosure of information that is adventitiously acquired. Furthermore, a buyer’s investigation of a highly differentiated commodity, such as a used machine or a home, will seldom produce all the information that the seller has acquired throughout the history of his ownership. Another important difference between nondisclosure by sellers and by buyers is that typically nondisclosure by buyers results only in forgone gains, whereas nondisclosure by sellers results in actual losses. A buyer will always disclose private information showing that a commodity he wants to purchase is worth less than it appears, because the information will drive down the price. Accordingly, a buyer will only withhold private information that the commodity is worth more than appears. Therefore, in the case of nondisclosure by a buyer the seller only forgoes a gain she might have made by not selling. In contrast, a seller will always disclose private information that a commodity is worth more than appears, because the information will drive up the price. Accordingly, a seller will only withhold private information that the commodity is worth less than it appears. Therefore, nondisclosure by a seller usually results in an actual out-​of-​pocket loss to the buyer, who is stuck with a commodity that is worth less than he paid for it. Behavioral economics has shown that actors are loss-​averse; that is, the disutility of giving up what one has is greater than the utility of acquiring what one doesn’t have.54 To put this differently, an actor perceives the loss of existing endowments as a greater harm than a failed opportunity to augment his endowments by an equal amount. Accordingly, perceived losses, such as out-​of-​pocket costs, are more painful than forgone gains. As Daniel Kahneman explains it, “There is an asymmetry between gains and losses, and it really is very dramatic and very easy to see . . . People really discriminate sharply between gaining and losing and they don’t like losing.”55 The difference between gains and losses has a systematic impact in the case of nondisclosure by sellers. Because a loss is felt more sharply than a forgone gain, there is extra reason 53.  See Kronman, supra note 8, at 25. 54.  See, e.g., Richard H. Thaler, The Winner’s Curse: Paradoxes and Anomalies of Economic Life 63–​78 (1992); Daniel Kahneman, Jack L. Knetsch & Richard H. Thaler, Experimental Tests of the Endowment Effect and the Coase Theorem, 98 J. Pol. Econ. 1325, 1344–​46 (1990); Amos Tversky & Daniel Kahneman, Rational Choice and the Framing of Decisions, in The Limits of Rationality 60, 67–​68 (Karen Schweers Cook & Margaret Levi eds., 1990). 55.  See Erica Goode, A Conversation with Daniel Kahneman: On Profit, Loss and the Mysteries of Mind, N.Y. Times, Nov. 5, 2002, at F1.

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to be solicitous about protecting buyers against nondisclosure. As Trebilcock states, “Treating wipe-​outs differently from windfalls may be justifiable on the grounds either that risk aversion . . . is more apposite to prospective losses than prospective gains or, on a related Rawlsian difference principle, that people generally would prefer a legal regime that shields them from catastrophic losses.”56 Finally, a nondisclosure rule is most easily justified where it provides significant incentives for the production of socially useful information. However, an owner normally does not need special incentives to invest in obtaining information about his own property: ownership itself normally provides a sufficiently strong incentive for making such an investment because the information will maximize the owner’s utility while he owns the property and allow him to set the correct price if he sells the property. Accordingly, a requirement of disclosure by sellers normally will not significantly diminish the incentives of owners to invest in information about their property.57 As Shavell points out, “If sellers are deciding whether to acquire information, they will have an excessive incentive to obtain it in the absence of a disclosure requirement. . . . [S]‌ellers will make the socially desirable decision about acquisition of information [even] if there is a disclosure requirement. Sellers will have the correct, positive incentive to acquire information even when required to disclose it because they will be able to capture an increase in value due to information. . . . “58 It is true that a rule requiring disclosure by sellers may slightly diminish the amount of investment that sellers make in acquiring information about their own property. For example, although a homeowner has an incentive to get termite inspections because he wants to preserve the value of his property, if it turns out that later he wants to sell his house and at that point he must disclose a bad termite report, his incentive to get termite inspections may be slightly diminished. However, under the Disclosure Principle it is not enough that disclosure would have some efficiency costs. The costs must be significant. A disclosure requirement will only infrequently diminish an owner’s incentive to invest in information about his own property, and even when such diminution occurs it is likely to be insignificant. The slight possibility that requiring disclosure by sellers would diminish the incentives of owners to invest in information about their own property is not enough to overcome the presumption in favor of disclosure embodied in the Disclosure Principle. Accordingly, another rule of contract law under the Disclosure Principle should be that sellers are required to disclose all material information they have concerning property they own and propose to sell, regardless of how they obtained the information.

A.  MARKET INFORMATION For some or all of these reasons, Kronman agrees that a seller should disclose material information concerning latent defects in the property he proposes to sell.59 However, Kronman would not require a seller to disclose private market information concerning the property—​that is, 56.  Trebilcock, supra note 5, at 146. 57.  See Shavell, supra note 30, at 21. 58.  Id. 59.  See Kronman, supra note 8, at 26.

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information that bears on the value of the commodity but is external to the commodity. Market information is equivalent to what Justice Marshall characterized in Laidlaw v. Organ as “intelligence of extrinsic circumstances, which might influence the price of a commodity,”60 as opposed to intelligence of a commodity’s intrinsic characteristics. Most market information is public, but some may be private for a short time. Laidlaw is an example. Organ did not have any private information about the characteristics of the tobacco he wanted to purchase, but he did have short-​lived private information about the market for tobacco. It is true that two of the reasons for requiring disclosure by sellers do not apply to market information:  sellers do not have asymmetric access to market information, and may acquire market information deliberately rather than adventitiously. However, the other reasons remain. In most cases, market information will consist merely of foreknowledge, as in Laidlaw; an owner has an incentive, by virtue of her ownership, to gather information about her property regardless of the kind of information that is involved; and market information possessed by a seller but not a buyer will normally result in a loss to the buyer rather than simply a forgone gain.

B.  CURRENT LAW AND PRACTICE In theory, under current law there is no general rule requiring disclosure by sellers. In fact, however, a rule that sellers have a duty to disclose would not cause a major change in either law or practice. To begin with, modern economic theory teaches that sellers will frequently disclose even if they have no legal obligation to do so, because nondisclosure will often unravel under competition. Baird, Gertner, and Picker illustrate this effect with an example involving sealed boxes of apples.61 Assume that a box of apples can hold up to 100 apples; sellers know how many apples are in a box but buyers do not, and if a seller lies about the number of apples in a box the buyer can sue the seller and recover damages. Start with the case of a seller who packs 100 apples in his boxes. If a seller does not disclose the number of apples in his boxes, buyers will assume that the boxes have fewer than 100 apples and will refuse to pay a 100-​apple price. As a result, 100-​apple sellers will disclose that there are 100 apples in their boxes. Now consider 99-​apple sellers. These sellers do not want to be lumped together with silent sellers whose boxes have less than 99 apples. Therefore, in order to receive the 99-​apple price the 99-​apple sellers will disclose that their boxes have 99 apples. But now 98-​apple sellers will face the same dilemma previously faced by the 100-​apple and 99-​apple sellers. Because those sellers are disclosing, if 98-​apple sellers remain silent buyers will lump them together with silent sellers whose boxes have less than 98 apples. Therefore, in order to receive the 98-​apple price the seller will disclose that its boxes have 98 apples. This effect cascades all the way down to 1-​apple sellers. Thus, all sellers will disclose the number of apples in their boxes. Unraveling will occur only under certain conditions. For example, if buyers know that some sellers do not possess the relevant information, buyers cannot determine whether a seller is silent because he does not wish to disclose or because he does not have the information. Even where unraveling will not occur, however, a wide variety of statutes and regulations

60.  Laidlaw v. Organ, 15 U.S. (2 Wheat.) 178, 195 (1817); see also Barnett, supra note 42, at 796–​98. 61.  Baird, Gertner & Picker, supra note 46, at 89–​90.

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require disclosure by sellers. For example, the Securities Act imposes extensive disclosure requirements on persons who sell securities.62 The Food and Drug Act requires extensive disclosure by sellers of food and drugs.63 The Uniform Commercial Code indirectly requires disclosure by sellers of goods through the imposition of extensive implied warranties.64 (Warranty is an even more powerful concept than disclosure. A  duty to disclose usually applies only to facts that an actor knows and therefore does not provide the actor with an incentive to investigate. In contrast, a warranty is not dependent on the state of an actor’s knowledge. Accordingly, warranty law provides actors with an incentive to investigate so as not to give an implied warranty that cannot be supported.65 Sellers who want to avoid the impact of those warranties must either disclose the defects in their products or disclaim or limit the warranty, which will send a signal about the quality of their goods.) Various state statutes require sellers of homes to make extensive disclosures. For example, California Civil Code § 1102 requires the seller of a home to disclose, among other things, significant defects or malfunctions in walls, ceilings, and plumbing; environmental problems, flooding problems, and neighborhood-​noise problems.66 The courts have also begun to more aggressively require disclosure by sellers, particularly in the case of real property. For example, in Hill v. Jones67 the seller of a home knew of but did not disclose a past termite infestation. The court held that disclosure was required if the infestation was material: The modern view is that a vendor has an affirmative duty to disclose material facts where: 1. Disclosure is necessary to prevent a previous assertion from being a misrepresentation or from being fraudulent or material; 2. Disclosure would correct a mistake of the other party as to a basic assumption on which that party is making the contract, and if nondisclosure amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing; 3. Disclosure would correct a mistake of the other party as to the contents or effect of a writing, evidencing or embodying an agreement in whole or in part; 4. The other person is entitled to know the fact because of a relationship of trust and confidence between them. . . . Courts have formulated this duty to disclose in slightly different ways. For example, the Florida Supreme Court declared that “where the seller of a home knows of facts materially affecting the value of the property which are not readily observable and are not known to the buyer, the seller is under a duty to disclose them to the buyer.” . . . We find that the Florida formulation of the

62.  See 15 U.S.C. §§ 77a–​77aa (2015).. 63.  See 21 U.S.C. §§ 301–​399 (2015).. 64.  U.C.C. §§ 2-​314 to 2-​316 (Am. Law Inst. & Unif. Law Comm’n 1977). 65.  See S.M. Waddams, Pre-​contractual Duties of Disclosure, in Essays for Patrick Atiyah 237, 245–​46 (Peter Cane & Jane Stapleton eds., 1991) (relation between warranties and disclosure). 66.  Cal. Civ. Code §§ 1102–​1102.18 (West 2007). See also, e.g., Tex. Prop. Code Ann. § 5.008(b) (West 2017); Va. Code Ann. § 55-​519 (2017). 67.  725 P.2d 1115 (Ariz. Ct. App. 1986).

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disclosure rule properly balances the legitimate interests of the parties in a transaction for the sale of a private residence and accordingly adopt it for such cases.68

Similarly, in Weintraub v. Krobatsch69 the New Jersey Court held that the seller of a home had to disclose a cockroach infestation, and in Reed v. King70 a California court held that the seller of a home had to disclose that a woman and her four children had been murdered in the home ten years earlier if that information would have a measurable effect on the home’s market value.71 In short, another element of the rule that should, and to a significant effect does, govern disclosure in contract law is that subject to certain exceptions actors should be required to disclose material facts concerning property that they own and propose to sell.

V I I .   I N F O R MAT I ON A CQUI R ED T H R O U G H   I MPR OPER   M EA NS Disclosure should also be required by actors who acquired the relevant information through improper means such as stealing, breaching a fiduciary duty, or hacking into email. The major rationale for not requiring disclosure is to provide an incentive for the acquisition of productive information. This rationale does not apply, or is trumped, when the means used to acquire the information is socially undesirable, because the use of such means should not be incentivized. This category of cases is exemplified by Illustration 1 to Restatement Second section 161: [A, seeking to induce B to make a contract to sell land to A, learns that the land contains valuable mineral deposits. A knows that B does not know this, but does not disclose this to B. B makes the contract.] A learns of the valuable mineral deposits from trespassing on B’s land. . . . A’s non-​ disclosure is equivalent to an assertion that the land does not contain valuable mineral deposits, and this assertion is a misrepresentation.

This category of cases is also illustrated by the law of insider trading, which generally makes it improper to trade securities on the basis of misappropriated information.72 68.  Id. at 1118–​19. See also, e.g., Johnson v. Davis, 480 So. 2d 625, 629 (Fla. 1985). Modern law also imposes a warranty of habitability on landlords and sellers of new homes. See Javins v. First Nat’l Realty Corp., 428 F.2d 1071, 1080–​81 (D.C. Cir. 1970); Conklin v. Hurley, 428 So. 2d 654, 656–​58 (Fla. 1983); Revised Unif. Residential Landlord & Tenant Act § 302 (2015​); 7B U.L.A. 326–​327 (2006). 69.  317 A.2d 68, 75 (N.J. 1974). 70.  193 Cal. Rptr. 130 (Ct. App. 1983). 71.  Id. at 133–​34. See also Bethlahmy v. Bechtel, 415 P.2d 698, 710–​11 (Idaho 1966) (seller had to disclose that a buried water conduit ran under the attached garage); Thacker v. Tyree, 297 S.E.2d 885, 888 (W. Va. 1982) (duty to disclose that the house had been built on filled ground, causing structural problems). In some states, however, the seller of a home is not required to make disclosure. See, e.g., Stevens v. Bouchard, 532 A.2d 1028, 1030 (Me. 1987) (absent a special relationship between buyer and seller, seller has no duty to disclose defects in the premises). 72.  See United States v.  O’Hagan, 521 U.S. 642, 655–​66 (1997); United States v.  Falcone, 257 F.3d 226, 233–​35 (2d Cir. 2001).

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V I I I .   F I D U C I A RY R EL AT I ONS HI PS AN D R E L AT I O N S HI PS OF   T R US T A N D C O N F IDENCE Still another class of cases in which disclosure should be required is that in which the knowing party stands in a fiduciary relationship or a relationship of trust and confidence to the unknowing party. In United States v. Dial Judge Posner set out an economic justification for requiring disclosure in fiduciary cases: Fraud in the common law sense of deceit is committed by deliberately misleading another by words, by acts, or, in some instances—​notably where there is a fiduciary relationship, which creates a duty to disclose all material facts—​by silence. . . .  The essence of a fiduciary relationship is that the fiduciary agrees to act as his principal’s alter ego rather than to assume the standard arm’s length stance of traders in a market. Hence the principal is not armed with the usual wariness that one has in dealing with strangers; he trusts the fiduciary to deal with him as frankly as he would deal with himself—​he has bought candor.73

In addition to the economic justification requiring a fiduciary to make disclosure, there is a moral justification: if A owes B a fiduciary obligation, social morality will lead B to fairly expect candor by A, as A knows or should know. The requirement of relationship-​based candor is not limited to fiduciary relationships. Rather, it applies to any ongoing relationship in which either social conventions or implicit understandings give one or both parties a justified expectation that the other will exercise candor in transactions between them. In contract law such relationships are referred to as relationships of trust and confidence. As stated in Restatement Second Section 161: A person’s non-​disclosure of a fact known to him is equivalent to an assertion that the fact does not exist . . . (d) where the other person is entitled to know the fact because of a relation of trust and confidence between them.74

Comment f to section 161 states: . . . . Even where a party is not, strictly speaking, a fiduciary, he may stand in such a relation of trust and confidence to the other as to give the other the right to expect disclosure. Such a relationship normally exists between members of the same family and may arise in other situations as, for example, between physician and patient. . . . [Illustration] 13. A, who is experienced in business, has raised B, a young man, in his household, and B has habitually followed his advice, although A is neither his parent nor his guardian. A, seeking to induce B to make a contract to sell land to A, knows that the land has appreciably increased in value because of a planned shopping center but does not disclose this to B. B makes

73.  United States v. Dial, 757 F.2d 163, 168 (7th Cir. 1985). 74.  Restatement (Second) of Contracts § 161 (Am. Law Inst. 1981).

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the contract. A’s non-​disclosure is equivalent to an assertion that the value of the land has not appreciably increased, and this assertion is a misrepresentation.

Many relationships of trust and confidence fall into well-​established and well-​defined social patterns, such as parent-​child or physician-​patient. As Illustration  13 suggests, however, any ongoing relationship should be treated as one of trust and confidence for purposes of requiring disclosure if the relationship is one that gives rise to a justified expectation of candor. So, for example, long-​term close friends would have a justified expectation of candor if one buys a used car from the other. Even some commercial relationships might give rise to a justified expectation of candor, as where one of the parties is an expert, the other is not, and the nonexpert has long put himself in the expert’s hands. An example would be the relationship between a stamp dealer and a regular customer who has relied on the stamp dealer in building his collection. The question is whether the parties were in an ongoing relationship and, as a matter of the social conventions that apply to such a relationship or the understandings that are implicit in such a relationship, the unknowing party had a justified expectation of candor in the kind of transaction the parties entered into.75

I X .   E X CEPT I ONS Some of the rules developed thus far are subject to exceptions, which will be considered in this section.

A.  THE RISK THAT THE UNKNOWING PARTY WAS MISTAKEN WAS ALLOCATED TO THAT PARTY In the case of a shared assumption the risk that the assumption is mistaken may be contractually allocated to the adversely affected party.76 The risk that an unshared assumption is mistaken may also be allocated to the unknowing party by a contractual provision or a trade practice. For example, it might be a usage in the commercial real estate business that when both the buyer and the seller are in the business each party is strictly on its own and disclosure normally will neither be expected nor made unless the information was improperly acquired. If there is such a usage then even information that was adventitiously acquired, was mere foreknowledge, or was held by a seller would not need to be disclosed, because those who participate in the business would impliedly consent to its trade usages.

75.  Cf. Restatement (Second) of Torts § 551(2) (Am. Law Inst. 1977)  (“One party to a business transaction is under a duty to exercise reasonable care to disclose to the other before the transaction is consummated . . . facts basic to the transaction, if he knows that the other is about to enter into it under a mistake as to them, and that the other, because of the relationship between them, the customs of the trade or other objective circumstances, would reasonably expect a disclosure of those facts.”). 76.  See supra Chapter 43 Section II(B).

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B.  THE UNKNOWING PARTY WAS ON NOTICE, FAILED TO CONDUCT A REASONABLE SEARCH, OR BOTH The risk that an unshared assumption is mistaken should also be allocated to the unknowing party where a reasonable person in that party’s position would have been on notice that her assumption was incorrect, would have conducted a search that would have corrected her assumption, or both. In Septic Tank, for example, if prior to making the contract the buyer had seen raw sewage seeping out of the ground the seller should not have been obliged to disclose the septic-​tank problem, because a reasonable person in the buyer’s position would have been put on notice that the sewage system was defective and would have discovered the defect through a reasonable search. Much the same is true of the actual transaction that is the basis of Mineable Ore. This hypothetical is based on the facts of (or facts related to) a famous insider-​trading case, SEC v. Texas Gulf Sulfur Co.,77 but the actual transaction differed in important respects from the hypothetical. In the actual transaction, the buyer—​or more accurately, the optionee—​was Texas Gulf Sulphur Company, and the seller—​or more accurately, the optionor—​was the Royal Trust Bank of Canada, acting as executor of the Hendrie Estate, a sizeable estate that included the relevant parcel of land. This parcel was not a farm, nor was it in a farm area. Instead, it was located in the Timmins region of the Canadian Shield, a vast and relatively barren area that is valuable principally for timber and minerals. Furthermore, Texas Gulf did not purchase the Hendrie parcel. Instead, it purchased, for $500, an option that allowed it to explore the property for two years, and the further option to acquire mining rights on the property for $18,000 during that period. If Texas Gulf exercised the further option and then discovered a commercial body of ore the Estate would get 10 percent of the profits, which was standard in the industry.78 Prior to securing the first option Texas Gulf had written the Bank that “[our] mining exploration department . . . has performed extensive work in the Timmins area on [adjacent public] lands. To complete our assessment of the area we are considering possible groundwork on lands held by private individuals or companies.”79 Various elements of this transaction put the Bank and the Estate on notice that Texas Gulf had private information that there was a significant prospect that a mineable body of ore was located under the Hendrie parcel. Since the Canadian Shield is relatively barren, the parcel was likely to have value only for timber or minerals—​and Texas Gulf was not a timber company. Texas Gulf informed the Bank that it had performed extensive mining-​exploration work in the region. Texas Gulf also specifically informed the Estate that it wanted access to the property to complete its assessment of the Timmins region. Pretty clearly, Texas Gulf did not plan to explore for minerals on every property in the vast Canadian Shield, and the Bank and the Estate must have known that Texas Gulf had singled out the Hendrie parcel for an ore r​ eason; obviously, Texas Gulf ’s “extensive work” had led it to believe there was a significant prospect that the Hendrie parcel contained a mineable body of ore. Of course, Texas Gulf did not disclose its specific findings to the Bank or the Estate. Nor did it need to, because it was a buyer rather than a seller; its information was not acquired either 77.  401 F.2d 833 (2d Cir. 1968). 78.  Morton Shulman, The Billion Dollar Windfall 1–​11, 75–​86 (1969). 79.  Id. at 81.

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adventitiously or improperly (although there was a little doubt here, because Texas Gulf might have unlawfully entered on the Estate’s land prior to acquiring the basic option), and the information was not mere foreknowledge. In any event, Texas Gulf did more than enough to put the Bank and the Estate on notice that it had favorable information about the possibility that the Hendrie parcel was mineral-​bearing. Accordingly, if Texas Gulf was under an obligation to disclose, it satisfied that obligation. At that point it was the Estate’s burden to make a further inquiry about what Texas Gulf knew in more detail. If the Estate made such an inquiry and Texas Gulf declined to provide further information, then the Estate had a choice of either not doing business with Texas Gulf or rolling the dice and making the deal that Texas Gulf proposed, knowing that Texas Gulf must have undisclosed favorable information concerning the Hendrie parcel. The Estate rolled the dice, made a fair bet, and should not complain that it lost.

C.  THE SOCIAL CONTEXT IN WHICH THE TRANSACTION OCCURRED IS A GAME IN WHICH BUYERS TROLL FOR MISTAKES BY SELLERS An actor may also assume the risk that he is mistaken concerning the facts of a transaction by virtue of the social context in which the transaction occurs. For example, suppose that A, an amateur but well-​trained bibliophile, finds a rare, valuable, and significantly underpriced book in a used-​book store owned and managed by B, and it is clear from the book’s price that B does not know the book’s character or value. For reasons already considered A is under no obligation to disclose: he is a buyer, not a seller; his determination that the book is rare and valuable is more than foreknowledge because it is a discovery that might never have been made but for A’s knowledge and skill; and the information is neither adventitiously nor improperly acquired. But there is still another reason why A should not be required to make disclosure. The social context in which A’s discovery occurred is the rare-​book game, in which buyers with knowledge and skill regularly troll used-​book stores hoping to find underpriced books whose value the dealers have failed to recognize. Used-​book dealers know that there is an ongoing rare-​book game. Overall they benefit from this game even if they occasionally lose on a particular transaction, because the game brings more traffic into their stores and buyers who arrive hoping to come away with a bargain will often buy a book even if they do not find a bargain. Accordingly, the responsibility is on a dealer, if he doesn’t want to lose the game, to make himself knowledgeable about rare books and to scrutinize his inventory with care. Of course, a high-​volume used-​book dealer might conclude that it isn’t efficient for him to carefully examine the rarity of every book that he takes into stock, but that is the dealer’s choice and he should stand behind it. The same point holds in certain other social contexts. Take, for example, garage sales. People who hold garage sales know that there is a garage-​sale game in which buyers troll garage sales in the hope of making a strike. This game benefits sellers because it increases the volume of buyers. A seller who stands to benefit from the game cannot fairly complain when he loses. _​_​_​_​_​_​_​_​_​_​_​_​_​_​ The exceptions discussed in this Section are not applicable in every case. They would usually fail to justify nondisclosure by an actor who acquired information by improper means, or failed to make disclosure in the context of a relationship of trust and confidence. Where applicable, however, these exceptions would permit nondisclosure even by actors who acquired

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information adventitiously, actors whose private information is mere foreknowledge, and sellers.

X .   S U MM A RY To summarize, the principle that should govern disclosure in contract law is as follows: An actor who has material information concerning a proposed contractual transaction that he knows is unknown to his counterparty should be required to disclose the information if: • the information was acquired adventitiously; • the information is mere foreknowledge; • the parties are transacting in a realm of pure exchange; • the information was acquired improperly; or • the actor and his counterparty are in a fiduciary relationship or a relationship of trust and confidence;

except that disclosure should not be required if: • the parties are not in a fiduciary relationship or a relationship of trust and confidence, the information was properly acquired, and the risk that the assumption of the unknowing party concerning facts of the transaction was mistaken was allocated to her by the contract or by trade practice; • the unknowing party was on notice that her mistaken assumption was unfounded, failed to conduct a reasonable search, or both; or • the social context in which the transaction occurred is a game in which buyers troll for mistakes by sellers.

_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​

A P P E N D I X :   H O W M UCH DOES A N O N D I S C L O S UR E R EGI M E C O N T R I B U T E T O   EF F I CI ENCY? It is often explicit or implicit, in arguments justifying the classical-​contract-​law rule allowing a wide scope for nondisclosure, that such a rule is a crucial engine for a prosperous economy because much less productive or allocative information would be developed under a regime requiring more disclosure. It is true that somewhat less significant productive and allocative information would be developed under a regime requiring more disclosure, and therefore something would be lost in the way of efficiency if such a regime was adopted. However, it is speculative whether much less productive and allocative information would be developed. Consider, for this purpose, cases such as Mineable Ore. Normally, disclosure should not be

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required in such cases, but probably in most such cases the issue of disclosure is moot. In “Insider Trading, Secret Agents, Evidentiary Privileges, and the Production of Information,” Frank Easterbrook stated that “[T]‌here would have been no discoveries of ore in Timmons, Ontario, by the Texas Gulf Sulfur Corp. unless the discoverer were allowed to use its hard-​won information to appropriate much of the value of the deposits.”80 This statement is hyperbolic at best and probably just wrong. Today many or most new petroleum and mineral deposits lie in areas in which the probability of such deposits is public knowledge. Often these areas are owned by governments that openly sell petroleum and mineral rights at auction. In other cases, petroleum or mineral deposits are discovered by prospecting on public lands in areas where the possibility of petroleum or mineral deposits is public knowledge, and the prospector goes on the land to drill or stake it out for those purposes. In still other cases, potential petroleum or mineral deposits are located under private lands in areas that are known to be petroleum-​ or mineral-​bearing, so that sellers are on notice that a buyer is acquiring the land—​or, much more typically, acquiring petroleum or mineral-​rights options or leases—​to extract those commodities. Even when petroleum or mineral deposits are found under private lands located in areas where such deposits were completely unsuspected, it seems likely that in many or most cases the petroleum or mineral company will do something—​such as taking an option to purchase mineral or petroleum rights or executing a mineral or petroleum lease—​that puts the landowner on notice that the buyer believes there are valuable mineral or petroleum deposits under the land. In these cases too the disclosure issue is moot.81 For example, in response to a brief questionnaire sent to several oil-​and-​gas scholars, Professor Ernest Smith, of the University of Texas at Austin, stated: The vast majority of acquisitions by oil companies are through an instrument labeled an oil and gas lease (although it has more characteristics of a deed than a lease). The effect of the typical “lease” is to transfer rights in the oil and gas beneath the described tract for a specified period of years—​perhaps 5—​and for so long thereafter as oil or gas is produced in paying quantities. . . . The form of the transaction clearly alerts the landowner to the purchaser’s interest in oil and gas beneath the land; but unless there has been prior development on nearby land, the landowner is unlikely to know how good the prospects for production actually are. The oil company, on the other hand, almost certainly has geological and seismic information that it is relying on in negotiating the agreement. 30 or more [years ago], when the typical landowner was a farmer or rancher and likely to be relatively unsophisticated, the oil company’s possession of such information gave it an enormous advantage in negotiating the oil and gas lease. Most landowners today use attorneys in negotiating their side of the agreement and an experienced attorney should be able to obtain access to geological information; for there are specialized consultants who provide such information—​at a considerable fee, of course. There are very few instances in which an oil company buys the land outright. One principal reason for this is that a purchase of the surface estate significantly increases the cost of the 80.  Frank H. Easterbrook, Insider Trading, Secret Agents, Evidentiary Privileges, and the Production of Information, 1981 Sup. Ct. Rev. 309, 328. 81.  See email from John S. Lowe, George S. Hutchison Professor of Energy Law, Southern Methodist University to Melvin A. Eisenberg, January 30, 2003.

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Mistake, Disclosure, and Unexpected Circumstances transaction to the oil company. This was true even 50 years ago and is certainly true today, when surface rights are not uncommonly far more valuable than mineral rights.82

Similarly, Bruce Kramer, of Texas Technical University, stated: In the modern world before an oil and gas lease will be negotiated in an unproven area, the oil and gas development company will negotiate an exploration agreement with the owner of the mineral estate, obviously . . . not hiding the fact that the exploration activities are designed to discover the existence or non-​existence of oil and gas. To my knowledge there is little deception in the leasing transaction and little evidence of widespread attempts to hide the fact that Exxon or Chevron is seeking to develop the premises for oil and gas.83

Other responses were similar.84 The practice for hard minerals is generally comparable. Mineral companies usually deal with land owners through “landmen.” A landman who wants to acquire mineral rights from a private owner normally acquires a mineral lease in exchange for royalties and a nonrefundable advance, rather than the entire owner’s fee interest.85 Accordingly, the nature of the proposed contract puts the fee owner on notice that the prospective lessee has reason to believe that there are minerals under the land. It is true that Texas Gulf might not have made its discovery if it knew it would have to make disclosure in detail. However, detailed disclosure should not be required as long as the

82.  Email from Ernest Smith, Rex G.  Baker Centennial Chair in Natural Resources Law, University of Texas at Austin, to Howard Tony Loo, Research Assistant to Melvin A. Eisenberg, March 30, 2003. The questionnaire said: We are interested in what the industry practice is when a petroleum or mineral mining company buys private land that the company thinks has oil or valuable minerals underneath it. Specifically, we are interested in whether the private owner of the land is usually on notice that the company believes] that the land has oil or minerals on it. Do petroleum and mineral mining companies commonly put sellers on notice by purchasing or taking options or rights in their own names, or sharing profits with the seller? In other words, we are wondering whether industry practices make it the case that the private land owner knows (because the company tells them so) or should know (by virtue of the fact that the company wanting to purchase the land is an oil company) why the company wants the land. Or, do mining companies sometimes use third parties to buy the land so that the private owner is not tipped off to the fact that a mining company is interested in the land? What’s the industry practice?

83.  Email from Bruce Kramer, Maddox Professor of Law, Texas Technical University, to Howard Tony Loo, Research Assistant to Melvin A. Eisenberg, March 30, 2003. 84.  See, e.g., email from John S. Lowe, George W. Hutchison Professor of Energy Law, Southern Methodist University, to Howard Tony Loo, Research Assistant to Melvin A. Eisenberg, February 5, 2003 (on file with author): [G]‌enerally, oil companies do not buy the land outright, they just lease it. And often they lease it through brokers who do not disclose the name of the principal. There is often a lot of competition too; i.e., groups of competing leasing agents and independent entrepreneurs. I do not think that it is much different from the commercial real estate market. If the market works as it is supposed to, one who approaches it prudently should get a deal in a “fair” range.

85. Telephone Interview with David Phillips, Director, Rocky Mountain Mineral Law Foundation, October 21, 2003.

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landowner is put on notice and can either ask for the more detailed information, decline to go forward, or proceed at its peril. Therefore, a more realistic question is: Would Texas Gulf have made its investment if it knew that it would be required to put a landowner on notice that it had discovered promising information about his land? We know the answer to that question—​Texas Gulf was willing to and did put the Bank and the Hendrie Estate on notice, and other petroleum and mineral companies commonly do the same. Why do petroleum and mineral companies think that they could make use of information they discovered even if it put the landowner on notice that they had made discoveries that affected the value of the land? To be specific, why did Texas Gulf not think that the Hendrie Estate would start an auction once it had been put on notice that it might well own a mineable body of ore? There are several possible answers to that question. First, Texas Gulf offered the Estate the standard royalty terms that were being offered in the industry, so an auction might not have materially improved the royalties the Hendrie Estate would get (although the amount of a nonrefundable advance may be negotiable). Second, Texas Gulf did keep important information to itself—​namely, its exact findings—​and without access to those findings other bidders would be bidding blind. Indeed, any winning bidder other than Texas Gulf would almost certainly have bid too high, because Texas Gulf would bid up to, but only up to, the point at which a bid was economically justified given Texan Gulf ’s findings. A right to not disclose any information as might be an instrument of efficiency in certain relatively isolated areas, such as the fine-​arts world. As Muriel Fabre-​Mignon has written, otherwise “there is no incentive”—​or perhaps more accurately, no economic incentive—​“for the buyer to acquire that information as his efforts to in doing so will only benefit the seller. . . . [M]‌asterpieces would stay unknown, and therefore most probably in the wrong hands.”86 Accordingly, a thoroughgoing disclosure regime would not be justified in that world. Nevertheless, in the end the macroeconomic effect of a right to not disclose is unknown and probably unknowable. Maybe a right to not disclose in these cases is a mighty engine of economic development. Probably it is just a two-​cylinder putt-​putter.

86.  Fabre-​Magnan, supra note 27, at 114.

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The Effects of Unexpected Circumstances—​Impossibility, Impracticability, and Frustration I .   I N T R O DUCT I ON Perhaps the most intractable problems in contract law concern when and how judicial relief should be granted on the basis of impossibility, impracticability, or frustration, which will be referred to collectively in this book as unexpected circumstances. As stated by White and Summers,1 “The doctrines of impossibility [and] commercial impracticability . . . comprise unclimbed peaks of contract doctrine. Clearly, all of the famous early and mid-​twentieth century mountaineers, Corbin, Williston, Farnsworth and many lesser persons have made assaults on this topic but none has succeeded in conquering the very summit.”2 In part, the intractability of the problems in this area results from their inherent difficulty. As in the case of mistake, there seems to be a tension between the concept of relief based on unexpected circumstances and such basic ideas in contract law as risk-​shifting, the security of transactions, and rewards for knowledge, skill, and diligence. The inherent difficulty of the problems presented by unexpected­-circumstances cases has been compounded by a tendency to rest analysis in this area on one or more of three premises: (1) The only issue in unexpected-​circumstances cases is whether or not a promisor’s nonperformance is excused by the relevant circumstance. (2)  Whether relief is warranted on the basis of unexpected circumstances should be determined by the application of a single-​stranded test. (3) That test should focus exclusively on the parties’ expectations ex ante, at the moment of contract formation, and should not take into account ex post considerations, that is, gains and losses to both parties that either arose under the contract or that proximately resulted from or were made possible by the occurrence. All three premises are incorrect:  (1) The 1.  James J. White & Robert S. Summers, Uniform Commercial Code § 4-​10 (6th ed. 2010). 2.  Id. at 181. Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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issues in unexpected-​circumstances cases are much more complex than a choice between excuse and no excuse. (2) Resolution of these issues requires the development of a set of principles whose complexity matches that of the problems involved. (3) These principles should take ex post considerations into account. As a practical matter, unexpected-​circumstance cases frequently do not simply involve the occurrence of a new event. Rather, they often involve the failure of existing circumstances to persist in a manner that the parties expected, or the failure of a regularly recurring event, such as the freezing of a lake in the winter, to occur. Accordingly, an unexpected circumstance often can be described either as a new circumstance or as a failure of an existing circumstance to persist or recurring circumstances to occur. For ease of exposition, in this chapter the terms occurrence and unexpected circumstance will be used to include all three categories unless the context indicates otherwise, and the terms circumstance and event will be used more or less interchangeably. Five principles should govern unexpected­-circumstances cases:







1. Judicial relief normally should be granted if the parties shared a tacit incorrect assumption that the nonoccurrence of some circumstance during the life of the contract was certain rather than problematic, and the incorrectness of that assumption would have provided a basis for judicial relief if the assumption had been explicit rather than tacit. This test will be referred to as the shared-​tacit-​assumption test. 2. Judicial relief should also normally be granted if as a result of a dramatic and unexpected general rise in prices, and therefore costs, performance would result in an unfounded loss to a promisor that would be significantly greater than the risk of loss the parties reasonably would have expected the promisor to have undertaken. This test will be referred to as the unbargained-​for risk test. In a sense, this test is only a special case of the tacit-​assumption test—​the tacit assumption being that neither party will bear the risk of such a loss. However, this test requires special treatment, because it rests on special kinds of circumstances and implicates a special kind of remedy. The application of both the shared-​tacit-​assumption and the unbargained-​risk tests rests in significant part on a methodological and a psychological proposition. The methodological proposition is that the tacit assumptions of contracting parties, like other implied contractual terms, are normally best determined by considering what similarly situated parties would likely have assumed. The psychological proposition is that actors are loss-​averse; that is, actors perceive the loss of existing endowments as a greater injury than a failed opportunity to augment their endowments by an equal amount.3 3. Where judicial relief is based on the shared-​assumption test the promisor normally should not be liable for expectation damages. In certain cases falling under this test, however, the promisor should be liable for reliance damages. 4. Where judicial relief is based on the unbargained-​for risk test the promisor normally should not be liable for conventional (full) expectation damages, but should be liable for a modified form of expectation damages.

3.  See, e.g., Richard H. Thaler, The Winner’s Curse:  Paradoxes and Anomalies of Economic Life 63–​78 (1992); Daniel Kahneman, Jack L. Knetsch, & Richard H. Thaler, Experimental Tests of the Endowment Effect and the Coase Theorem, 98 J. Pol Econ. 1325, 1326, 1328 (1990); Amos Traversky & Daniel Kahneman, Rational Choice and the Framing of Decisions, in The Limits of Rationality 60, 67–​ 68 (Karen Schweers Cook & Margaret Levi eds., 1990).

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5. Under either test, in determining whether to grant relief, and what relief to grant, the courts may properly take into account certain kinds of ex post considerations. _​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​

Section I of this chapter develops the shared-​tacit-assumption test and the relief appropriate under that test. Section II develops the unbargained-​for risk test and the relief appropriate when that test applies. Section III considers and rejects a well-​known alternative test, proposed by Richard Posner and Andrew Rosenfield,4 that would make unexpected-​circumstances cases turn on which party was the cheapest insurer of the risk that the unexpected circumstance would occur. Finally, Section IV develops the role of ex post considerations in unexpected-​circumstances cases. Throughout, consideration will be given to the continuities and discontinuities between the issues raised by unexpected-​circumstances cases and the closely related issues raised by cases involving shared mistaken factual assumptions, that is, mutual mistake. In this chapter the term promisor will be used to mean a party who seeks judicial relief from full enforcement of her promise, and the terms promisor and adversely affected party will be used more or less interchangeably. The terms impossibility and impracticability will be used primarily to refer to cases in which a seller is adversely affected by the occurrence of an unexpected circumstance that either makes her performance impossible or—​more usually—​significantly increases the cost of her performance. In contrast, the term frustration will be used primarily to refer to cases in which a buyer is adversely affected by the occurrence of an unexpected circumstance because the occurrence significantly diminishes the value of the seller’s performance to the buyer.

II.   TH E S H A R E D - T ​ A CI T A S S UM PT I ON  T ES T A.  TACIT ASSUMPTIONS All contracts are based on numerous assumptions. Sometimes an assumption that underlies a contract is made explicit. If a contract is explicitly based on an assumption that turns out to have been incorrect, normally the effect of the assumption would be treated under the category of interpretation. Consider Krell v. Henry,5 which is one of the famous coronation cases along with Griffith v. Brymer (discussed in Chapter 43). Edward VII was to be crowned in Westminster Abby on June 26, 1902, and the coronation procession was to be held on June 26 and June 27. Krell, who had a flat in London, had left England in March 1902. Before he left, Krell instructed his solicitor to let the flat on such terms, and for such period not to exceed six months, as the solicitor thought proper. On June 17, Henry noticed an announcement on the exterior of Krell’s flat that windows to overlook the coronation procession were to be let. Henry then entered into an agreement, confirmed in writing on June 20, to take the flat for the days, but not the nights, of June 26 and June 27, for £75, and put down £25 as a deposit. Very shortly thereafter Edward became ill, and on June 24 his physicians decided that he required surgery. As a result, 4.  Richard A. Posner & Andrew M. Rosenfield, Impossibility and Related Doctrines in Contract Law, 6 J. Leg. Stud. 83 (1977). 5.  [1903] 2 KB 740.

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the coronation and procession were postponed. Henry did not pay the £50 remaining under the agreement, and Krell sued for that amount. The court held for Henry. In the leading opinion Lord Justice Vaughan Williams said, “I think it cannot reasonably be supposed to have been in the contemplation of the contracting parties when the contract was made, that the coronation would not be held on the proclaimed days, or . . . along the proclaimed route.”6 Now suppose the parties in Krell v. Henry had explicitly stated, “This agreement is made on the assumption that the coronation procession will take place in six days as scheduled.” In that case an analysis based on unexpected circumstances would have been unnecessary. Instead, Henry would have prevailed as a matter of interpretation. In the actual case the relevant assumption was tacit rather than explicit. In contrast to explicit shared assumptions, whose effect normally falls within the domain of interpretation, tacit shared assumptions are at the heart of unexpected-​circumstances cases. The concept of a tacit assumption has been explicated as follows by Lon Fuller: Words like “intention,” “assumption,” “expectation,” and “understanding” all seem to imply a conscious state involving an awareness of alternatives and a deliberate choice among them. It is plain, however, that there is a psychological state that can be described as a “tacit assumption,” which does not involve a consciousness of alternatives. The absentminded professor stepping from his office into the hall as he reads a book “assumes” that the floor of the hall will be there to receive him. His conduct is conditioned and directed by this assumption, even though the possibility that the floor has been removed does not “occur” to him; that is, it is not present in his conscious mental processes.7

A more colloquial expression to capture the concept of a tacit assumption is “taken for granted.”8 As that expression indicates, tacit assumptions are as real as explicit assumptions. Tacit assumptions are not made explicit, even where they are the basis of a contract, precisely because they are taken for granted. They are so deeply embedded in the minds of the parties that it simply doesn’t occur to the parties to make these assumptions explicit, any more than it occurs to Fuller’s professor to think to himself every time he is about to walk through a door, “Remember to check that the floor is still there.” Of course, if contracting actors had infinite time and no costs they could ransack their minds to identify all the shared tacit assumptions on which a proffered contract was based, and make each assumption explicit. But actors do not have infinite time, and they do have costs. The principle of bounded rationality is applicable here. As stated by Oliver Williamson, this principle “has been defined . . . as follows: ‘The capacity of the human mind for formulating and solving complex problems is very small compared with the size of the problems whose solution is required for objectively rational behavior in the real world. . . .’ [The principle of bounded rationality] refers both to neurophysiological limits on the capacity to receive, store, retrieve, and process information without error and to definitional limits inherent in 6.  Id. at 750. Some of these facts are based on John D. Wladis, Common Law and Uncommon Events: The Development of the Doctrine of Impossibility of Performance in English Contract Law, 75 Geo. L.J. 1575, 1609, 1618 (1987). 7.  Lon L. Fuller & Melvin Aron Eisenberg, Basic Contract Law 732–​3 (8th ed. 2006). 8.  Cf. Lee B. McTurnan, An Approach to Common Mistake in English Law, 41 Can. B. Rev. 1, 51 (1963) (employing the formulation, “an unquestioning faith in the existence of a fact”).

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language.” 9 So, for example, if the cost of searching for information were zero, then an actor contemplating a decision would make a comprehensive search for all relevant information. In reality, however, searching for information does involve costs in the form of time, energy, and often money. Most actors either don’t want to expend the resources required for comprehensive search or recognize that comprehensive search would not be achievable at any realistic cost. Accordingly, human rationality is normally bounded by limits on information, search, and information-​processing ability and capacity. Under one model of information search, developed by economist George Stigler,10 an actor invests in search until the expected cost of further search equals the expected marginal return from further search. Under this model an actor’s decision to terminate search is rational even though it later turns out that a further search would have produced information that would have improved on the actor’s eventual choice. Although the actor would have wanted to know that information before making a decision, he is rationally ignorant of it. Just as a contracting party acts rationally in terminating the exterior process of searching the outside world for every piece of relevant information, so too does he act rationally in terminating the interior process of searching his mind for every relevant tacit assumption. In any event, normally it would be almost impossible to conduct a complete interior search of this kind. As Randy Barnett points out: [When we add] to the infinity of knowledge about the present world the inherent uncertainty of future events . . . we immediately can see that the seductive idea that a contract can . . . articulate every contingency that might arise before, during, or after performance is sheer fantasy. For this reason, contracts must be silent on an untold number of items. And many of these silent assumptions that underlie every agreement are as basic as the assumption that the sun will rise tomorrow. They are simply too basic to merit mention.11

In short, in contracting, as in other areas of life, some things go without saying. And a central characteristic of things that go without saying is—​they are not said. Instead, as Barnett states, these things are simply too basic to merit attention. Modern contract law recognizes that a contract is “the total legal obligation which results from the parties’ agreement,”12 which in turn means “the bargain of the parties in fact as found in their language or by implication from other circumstances.”13 Among these circumstances are

9.  Oliver E. Williamson, Antitrust Economics 75–​76 (1987). Williamson adds, “The implications for contractual purposes of joining bounded rationality with uncertainty are suggested by the following description of the decision process: ‘For even moderately complex problems . . . the entire decision tree cannot be generated. There are several reasons why this is so: one is the size of the tree. The number of alternative paths in complex decision problems is very large. . . . A second reason is that in most decision situations, unlike chess, neither the alternative paths nor a rule for generating them is available. . . . A third reason is the problem of estimating consequences. . . . For many problems, consequences of alternatives are difficult, if not impossible, to estimate. The comprehensive decision model is not feasible for most interesting decision problems.’ ” Id. at 75–​76 n.18. 10.  George J. Stigler, The Economics of Information, 69 J. Pol. Econ. 213–​25 (1961). 11.  Randy E. Barnett & Nathan B. Oman, Contracts: Cases and Doctrine 1065 (6th ed. 2017). 12.  U.C.C. § 1-​201(12) (Am. Law Inst. & Unif. Law Comm’n 2001). 13.  Id. § 1-​201(3).

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shared tacit assumptions that the parties regard as certain rather than problematic and on which their contract is based. Shared tacit assumptions of this type are just as much a part of a contract as explicit terms, so that where the risk of an unexpected circumstance would have been shifted away from the promisor if the assumption had been made explicit the shared tacit assumption should operate in the same way. This approach to shared tacit assumptions is an application of the usual methodology of determining unspecified contracted terms on the basis of what parties probably would have agreed to if they had addressed the relevant issue. So in Krell v. Henry we can be pretty confident that: (1) actors in the positions of the contracting parties would have shared the tacit assumption that the coronation would take place in six days; (2) the contract was made on the basis of that assumption; (3)  Henry was not assuming the risk that the assumption was incorrect—​was not gambling, and was not being paid to gamble, on whether the coronation would take place; and (4)  due to the phenomenon of loss-​aversion, the impact on Henry of a £50 out-​of-​pocket loss would be greater than the impact on Krell of a £50 forgone anticipated gain.

B.  EXCEPTIONS TO THE SHARED-​ TACIT ASSUMPTIONS TEST Not every shared tacit assumption about the future will justify judicial relief. Here are four major exceptions: (1) Cases in which the possibility of the occurrence of the relevant circumstances was more than negligible. (2) Cases in which the risk that the relevant circumstance would or would not occur is explicitly or implicitly allocated to the adversely affected party. (3) Cases in which the assumption is not shared or is evaluative. (4) Cases in which the impact of the unexpected circumstances is not material.

1.  The Possibility of the Occurrence of the Relevant Circumstance Was More than Negligible To begin with, tacit assumptions should not serve as the basis for judicial relief in unexpected-​ circumstances cases if the parties tacitly recognized that although the relevant circumstance was highly unlikely to occur the probability of the occurrence was not negligible. In such a case, the known uncertainty of the assumption, although slight, will normally have figured into the parties’ decision to contract, the amount of the contract price, or both. As stated by Lee McTurnan in the context of mutual mistake, “when parties contract aware of an uncertainty, the natural inference is that they estimated the probabilities and fixed the price accordingly.”14 This does not mean that an assumption must be objectively nonproblematic to justify judicial relief under the shared-​assumption test. Every assumption concerning the future—​including, for example, the assumption that the sun will rise tomorrow—​is objectively problematic. The

14.  Cf. McTurnan, supra note 8, at 16.

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question is whether the contracting parties tacitly assumed that the future was not problematic in the relevant respect. So in Krell v. Henry it is pretty clear that the parties tacitly assumed that whether the coronation procession would occur in six days, as scheduled, was not problematic. This assumption, therefore, should and did provide a basis for judicial relief, even though objectively the assumption was problematic. One index to whether the parties tacitly assumed that the occurrence of a given circumstance in the future was certain rather than problematic is whether the occurrence was reasonably foreseeable—​that is, foreseeable as likely, or at least not unlikely, to occur.15 Foreseeability is a complex concept, and its meanings can vary with the context. In the context of unexpected-​ circumstance cases whether a circumstance was reasonably foreseeable should depend on (1) the degree of difficulty that the contracting parties would have had in foreseeing the circumstance, and (2) the likelihood that the parties did foresee the circumstance, given the information the parties actually knew and the salience of the possibility that the circumstance would occur. The period of the contract is also relevant. Contracts extend over a given duration. Call this the contract time. The longer the contract time the more likely it is that a variety of circumstances that bear on the contract will occur during that time. For example, if a party rents a theater for twenty years, it is reasonably foreseeable that the theater may be destroyed during the contract time by some catastrophic event. In contrast, if the same party rents the same theater for the next evening, destruction of the theater by a catastrophic event during the contract time may not be reasonably foreseeable. That the occurrence of a given circumstance during the contract time was reasonably foreseeable when the contract was made suggests that the parties did not assume that the occurrence was certain. Conversely, that the occurrence of a given circumstance during the contract time was not reasonably foreseeable suggests that the parties tacitly assumed it was certain that the circumstance would or would not occur during that time. But reasonable foreseeability normally is only an index, not the test. The test is what the parties tacitly assumed. As a practical matter, that question will usually be resolved on the basis of the fact-​finder’s common-​sense intuition concerning what tacit assumptions similarly situated parties probably would have held. Reasonable foreseeability should play a very important but usually not decisive role in that determination.16 A party who is highly sophisticated or who is engaged in large­-scale contractual enterprises might regard the occurrence of a given circumstance during the contract time as problematic whereas a party who is unsophisticated or engaged in very small­-scale enterprises might tacitly assume that the occurrence of the circumstance during the contract time was certain. Lon Fuller has illustrated this point as follows: [W]‌here parties have entered into a contract, an unexpected obstacle to performance may operate disruptively in varying degrees depending on the context. To one who has contracted to carry

15.  See Note, The Fetish of Impossibility in the Law of Contracts, 53 Colum. L.  Rev. 94, 98 n.23 (1953) (foreseeability is properly used “as a factor probative of assumption of the risk of impossibility”). For cases holding that judicial relief on the basis of unexpected circumstances is available only if the circumstances are unforeseeable, see, e.g., E. Air Lines, Inc. v. McDonnell Douglas Corp., 532 F.2d 957, 980 (5th Cir. 1976); Barclay’s Bus. Credit, Inc. v. Inter Urban Broad. of Cincinnati, Inc., No. 90 Civ. 2272, 1991 WL 258751, at *8 (S.D.N.Y. Nov. 27, 1991); Iodice v. Bradco Cleaners, 1993 Mass. App. Div. 54, 58 (1993). 16.  See, e.g., Madeirense Do Brasil, S.A. v. Stulman-​Emrick Lumber Co., 147 F.2d 399, 403 (2d Cir. 1945).

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Mistake, Disclosure, and Unexpected Circumstances goods by truck over a road traversing a mountain pass, a landslide filling the pass may be a very disruptive and unexpected event. But one who contracts to build a road through the mountains might view the same event, occurring during the course of construction, as a temporary set-​back and a challenge to her resourcefulness. 17

Although reasonable foreseeability should usually be significant rather than decisive, there is one class of cases in which it should be determinative. These are cases in which if a reasonably foreseeable circumstance should occur it would affect a large class of sellers who deal in a relatively standardized commodity, and the occurrence of the circumstance is so well foreshadowed that a premium for taking the risk of the occurrence is impounded into the market price. In such a case it should be no defense to an individual seller, who has received the risk premium that was impounded into her price, that she did not personally perceive that the event was foreshadowed.18 For example, in Transatlantic Financing Corp. v. United States,19 on October 2, 1956, during the international crisis that resulted from Egypt’s seizure of the Suez Canal several months earlier, Transatlantic and the United States had executed a voyage charter for the shipment of goods. The charter indicated the termini of the voyage—​Galveston, Texas to Bandar Shapur, Iran—​but not the route. The regular route between these termini was via the Canal. On October 27, Transatlantic’s vessel, the Christos, sailed from Galveston on a course that would have taken her through the Canal; on October 29, Israel invaded Egypt; on October 31, Great Britain and France invaded the Canal Zone; and on November 2, Egypt closed the Canal. As a result the Christos was forced to make a longer and more expensive voyage around the Cape of Good Hope, and Transatlantic claimed that it was entitled to additional compensation for the extra costs of the longer voyage. The court denied the claim. In the course of its opinion, the court stated that “[i]‌f anything, the circumstances surrounding this contract indicate that the risk of the Canal’s closure may be deemed to have been allocated to Transatlantic. We know or may safely assume that the parties were aware, as were most commercial men with interests affected by the Suez situation . . . that the Canal might become a dangerous area. No doubt the tension affected freight rates[.]”20 The conclusion that the tension affected freight rates should have been the end of the court’s analysis. The only meaning that can be given to this conclusion is that carriers, including Transatlantic, had increased their rates by including a premium for the risk that the Canal route might be unavailable. Accordingly, the United States had paid Transatlantic a premium to cover just the risk that occurred. Transatlantic could not both gather a premium for the risk and deny coverage of the risk.

17.  Fuller & Eisenberg, supra note 7, at 769. 18.  See U.C.C. § 2-​615 cmt. 8 (Am. Law Inst. & Unif. Law Comm’n 2002): “[T]‌he exemptions of this section [for excuse by reason of impracticability] do not apply when the contingency in question is sufficiently foreshadowed at the time of contracting to be included among the business risks which are fairly to be regarded as part of the dickered terms, either consciously or as a matter of reasonable, commercial interpretation from the circumstances.” 19.  363 F.2d 312 (D.C. Cir. 1966). 20.  Id. at 318.

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2.  Cases in Which the Risk That the Unexpected Circumstance Would Occur Was Explicitly or Implicitly Allocated to the Adversely Affected Party An unexpected circumstance that would otherwise justify judicial relief should not do so if the risk that the circumstance would occur was explicitly or implicitly allocated to the adversely affected party. This is not a limitation of the shared tacit assumption test, but merely a corollary. That test allocates away from the adversely affected party the risk that a certain kind of unexpected circumstance will occur if the parties share a tacit assumption that the circumstance will not occur, but it does not allocate the risk in that manner if the contract explicitly or implicitly provides otherwise. This exception is straightforward, but its application can sometimes be difficult. Just as a shared assumption may be either explicit or tacit so too may be an allocation of a risk. United States v. Wegematic Corp21 is a leading example. In June 1956 the Federal Reserve Board invited electronics manufacturers to submit proposals for a digital-​computing system. Wegematic submitted a proposal for the provision of a new computer, the ALWAC 800. Wegematic characterized the machine as “a truly revolutionary system utilizing all of the latest technical advances,” and featured that “maintenance problems are minimized by the use of highly reliable magnetic cores.”22 In September the Board ordered the ALWAC 800 for delivery on June 30, 1957. The purchase order provided that in the event Wegematic failed to comply with any provision of the contract the Board could procure the services described in the contract from other sources and hold Wegematic responsible for any excess cost. Wegematic accepted the order. After several notifications of delay, in mid-​October 1957 Wegematic announced that due to engineering difficulties it had “become impracticable to deliver the ALWAC 800 Computing System at this time.”23 The Board then procured an IBM 650 computer, which served substantially the same purpose as the ALWAC 800, but at a higher price, and sued Wegematic for damages. Wegematic defended on the ground that “delivery was made impossible by ‘basic engineering difficulties’ whose correction would have taken between one and two years and would have cost a million to a million and a half dollars, with success likely but not certain.”24 The difficulties may have stemmed from the magnetic cores, used instead of transistors, which did not have sufficient uniformity at this stage of their development.25 At the trial the Federal Reserve Board recovered $179,450 for the excess cost of the IBM equipment. The Second Circuit, in an opinion by Judge Friendly, affirmed, largely on the ground that the risk that the promised computer could not be manufactured had been implicitly assumed by Wegematic: We see no basis for thinking that when an electronics system is promoted by its manufacturer as a revolutionary breakthrough, the risk of the revolution’s occurrence falls on the purchaser; the reasonable supposition is that it has already occurred or, at least, that the manufacturer is assuring the purchaser that it will be found to have when the machine is assembled. . . . If a manufacturer

21.  360 F.2d 674 (2d Cir. 1966). 22.  Id. at 675. 23.  Id. 24.  Id. 25.  Id.

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Mistake, Disclosure, and Unexpected Circumstances wishes to be relieved of the risk that what looks good on paper may not prove so good in hardware, the appropriate exculpatory language is well known and often used.26

3.  Custom and Trade Usage; Inference from the Circumstances The risk of an unexpected circumstance may also be implicitly allocated to the adversely affected party by custom or trade usage or by an inference from the circumstances. As stated in Comment 8 to UCC Section 2-​615: “The provisions of this section [on excuse by reason of impracticability] are made subject to assumption of greater liability by agreement and such agreement is to be found not only in the expressed terms of the contract but in the circumstances surrounding the contracting, in trade usage and the like.”27 For example, suppose that A normally uses a contractual provision that allocates away from A the risk that a certain contingency will occur. If A makes a contract that does not include such a provision there is a strong inference that A has accepted this risk. This point is illustrated by Barbarossa & Sons, Inc. v. Iten Chevrolet, Inc.28 Iten contracted to supply Barbarossa with a large truck for use in Barbarossa’s business, and then ordered the truck from GM. Iten usually made GM-​vehicle contracts with customers on an order form that included an escape clause under which Iten’s obligation to supply a vehicle was made contingent on its ability to obtain the vehicle from the manufacturer. In its contract with Barbarossa, however, lten did not use its usual order form, and the contract it did use had no escape clause and did not refer to GM as the source of supply. Subsequently, GM canceled Iten’s order for Barbarossa’s truck and refused to deliver the truck, apparently because GM was experiencing component shortages. When Iten failed to deliver the truck to Barbarossa, Barbarossa purchased another brand of truck from a third party and sued Iten for damages. Iten defended on the ground that GM’s cancellation of the order and refusal to manufacture the truck made performance impracticable. The court held for Barbarossa, partly on the ground that Iten had not included its usual escape clause in the contract. An implicit allocation of risk is also evidenced by a price that impounds the risk, as in the Transatlantic case. The shared-​assumption test applies only if the relevant assumption is shared—​that is, only if both contracting parties held the assumption. For example, suppose that A, a contractor, agrees to construct a home for B on a parcel of land that B has contracted to purchase from a third party. B, who is not engaged in the business of construction, is likely to tacitly assume that it will be feasible to build the home on the parcel. However, A, as a professional contractor, almost certainly will be aware that she may encounter unexpected subsoil conditions that would materially

26.  Id. at 676–​77. 27.  See also Transatlantic Fin. Corp. v. United States, 363 F.2d 312, 316 (D.C. Cir. 1966) (“Proof that the risk of a contingency’s occurrence has been allocated . . . may be found in the surrounding circumstances, including custom and usages of the trade”); 14 James P. Nehf, Corbin on Contracts § 74.7, at 46 (Joseph M. Perillo ed., rev. ed. 2001). 28.  265 N.W.2d 655 (Minn. 1978).

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increase her costs. If A does encounter such conditions she should not be able to obtain judicial relief under the shared-​assumption test.29 A rule that both parties must share a tacit assumption if the assumption is to be the basis for judicial relief on the ground of unexpected circumstances has a salutary information-​forcing effect. In the subsoil hypothetical, for example, A knew or should have known the risk of unexpected subsoil conditions, and B neither knew nor should have known. Accordingly, if A wishes either to be excused if such conditions materialize or to put the risk of such conditions on B, A should bring the risk to B’s attention and explicitly contract around it. The requirement that the tacit assumption be shared gives A an incentive to do just that. This is generally the scenario in the real world of construction-​contract cases. Under the legal rule that governs such cases the contractor bears the risk of unexpected subsoil conditions unless he contracted around the risk.30 Strikingly, the most commonly used form contract for construction projects requires an equitable adjustment of the price in such cases.31 Of course, some assumptions made by contracting parties are unshared—​for example, one party assumes that prices will go up and the other assumes that prices will go down. Such cases do not present any special problems; the parties are simply bargaining on the basis of conscious and different evaluations of states of the world that they understand are problematic, rather than on the basis of assumptions they both believe are certain. Indeed, such evaluative assumptions—​ assumptions that are based on conscious evaluations of future probabilities—​will not be relevant even if shared by both parties. materiality .

Finally, a tacit assumption should not provide the basis for judicial relief if the impact of the unexpected circumstance is not material. The impact may be immaterial for a variety of reasons. For example, the unexpected circumstance may concern only a minor aspect of the contract, such as an inability to use a designated carrier to ship goods when comparable carriers are available at the same price, or may concern only an immaterial amount, as where a comparable carrier would charge only slightly more. Or, the promisor may be able to mitigate his financial loss. For example, suppose that A is planning to marry B. A leases a two-​bedroom apartment from Landlord for the purpose of beginning married life, and she informs Landlord of her plan. B dies prior to the marriage and before the term of the lease is to begin. A should not be awarded judicial relief. Even though the lease was made on the basis of the tacit assumption that A and B would get married, A  can avoid most or all of her financial loss by assigning the lease or subletting the apartment. This position is embodied in Restatement Second § 265 Illustration 5: A contracts to sell and B to buy a machine to be delivered to B in the United States. B, as A knows, intends to export the machine to a particular country for resale. Before delivery to B, a government regulation prohibits export of the machine to that country. B refuses to take or pay for the

29.  If the increase in costs is very substantial, A may be entitled to judicial relief under the u ​ nbargained-​for risk test. See Section II, infra. 30.  See, e.g., Rowe v. Town of Peabody, 93 N.E. 604, 605–​06 (Mass. 1911). 31.  Am. Inst. of Architects, General Conditions of the Contract for Construction, Art. 3.7.4 (AIA Doc. A201, 2017 ed.).

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Mistake, Disclosure, and Unexpected Circumstances machine. If B can reasonably make another disposition of the machine, even though at some loss, his principal purpose of putting the machine to commercial use is not substantially frustrated. B’s duty to take and pay for the machine is not discharged, and B is liable to A for breach of contract.32

C.  THE ROLE OF FAULT AND THE NATURE OF JUDICIAL RELIEF UNDER THE SHARED-​ASSUMPTION TEST Judicial relief in both mutual-​mistake cases (that is, cases in which the parties share a mistaken assumption about the existing world) and most unexpected-​circumstances cases is based on the existence of shared tacit assumptions that turn out to be incorrect.33 But since mutual-​mistake and most unexpected circumstances cases are governed by a common test, why should and why does contract law separate these two doctrinal categories? One answer to this question is that actors commonly take for granted that the present world has certain characteristics, but less commonly take for granted that the future world will have certain characteristics. As a result, contracting parties are more likely to share a tacit assumption that a fact of the present world is certain than to share a tacit assumption concerning the certainty of some aspect of the future world. In a related context, Barak Medina has pointed out that: [Psychological research, shows] that people prefer to bet on a risk which has not been realized yet rather than to bet on a risk whose realization is not yet known to them. For instance, [Heath and Tversky 1991; Rothbart and Snyder 1970] report that people are more willing to bet on the next week’s price of a certain share than they are on the (unknown to them) price of the same share last week. According to these results, people are more willing to bear a risk about future events than they are about the nature of an event that already happened but whose result is unknown to them.34

Accordingly, courts may appropriately be more reluctant to give relief in unexpected-​ circumstances cases, which concern future states of the world, then in mutual-​mistake cases, which concern present states of the world. However, there are also deeper and more complex reasons for the doctrinal separation, based on certain recurring practical differences between mutual-​mistake and unexpected-​ circumstances cases. Although these practical differences do not rise to the level of watertight

32.  See also, e.g., Swift Can. Co. v. Banet, 224 F.2d 36, 38 (3d Cir. 1955) (United States buyer of lamb pelts was to take title to the pelts in Canada, but supervening regulation prohibited importation of the pelts into the United States. The buyer’s defense of frustration was rejected on the ground that “Even if the goods could not be imported into the United States . . . the rest of the world was free to the buyer, so far as we know, as destination for the shipment”); Coker Int’l v. Burlington Indus., 747 F. Supp. 1168, 1171 (D.S.C. 1990), aff ’d, No. 90-​2494, 1991 WL 97487 (4th Cir. June 11, 1991); Nicholas R. Weiskopf, Frustration of Contractual Purpose—​Doctrine or Myth?, 70 St. John’s L. Rev. 239, 256–​57 (1996). 33.  See Restatement (Second) of Contracts §§ 152, 261 (Am. Law Inst. 1981)  [hereinafter Restatement Second). 34.  Message from Barak Medina to Melvin Eisenberg, December 11, 2006.

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distinctions they nevertheless have significant theoretical and doctrinal implications.35 One of these practical differences concerns the role of fault. In mutual-​mistake cases the adversely affected party will rarely be at fault for having caused the actual facts of the world to differ from the facts that the parties tacitly assumed.36 In contrast, in unexpected-​circumstances cases the adversely affected party may well be at fault for the occurrence of the relevant circumstance. For example, a recurring kind of unexpected­-circumstances case concerns the destruction of the contract’s subject-­matter—​say by fire. In such cases, the destruction may well have resulted from the fault of the party who was in possession of the subject-​matter when the destruction occurred. Accordingly, although in theory fault on the part of the adversely affected party might figure in either mutual-​mistake or unexpected-​circumstance cases, in practice fault is unlikely to figure in the former type of case but not unlikely to figure in the latter. Restatement Second Section 157 highlights this difference between mutual-​mistake cases and unexpected-​circumstances cases. Under this Section a mistaken party’s fault normally will not bar him from coming within the shelter of mutual-​mistake doctrine: A mistaken party’s fault in failing to know or discover the facts before making the contract does not bar him from avoidance or reformation under the rules stated in this Chapter, unless his fault amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing.

In contrast, the provisions of Restatement Second that afford judicial relief based on the occurrence of an unexpected circumstance explicitly apply only where the adversely affected party is not at fault for having caused the relevant event. For example, Section 261 provides that: Where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-​occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate the contrary.37

Suppose an unexpected circumstance that would otherwise provide an excuse to the promisor was caused by her fault.38 For example, suppose that the owner of a theater was unable to perform his contract to lease the theatre because of a fire in the theater that resulted from his

35.  The differences between mutual-​mistake and unexpected­circumstances cases that are discussed in this chapter are based on recurring characteristics of cases in each category rather than on characteristics that necessarily inhere in cases in each category. In the occasional situation in which a mutual-​mistake case has a characteristic more typically associated with an unexpected-​circumstances case, the principles developed in this chapter to deal with the latter type of case should normally be extended by analogy and applied accordingly. 36.  Of course, one party may be at fault for misrepresenting or failing to disclose a fact, but such cases are not mutual-​mistake cases because they do not involve shared tacit assumptions. 37.  (Emphasis added.) See also Restatement Second § 266(1) (existing impracticability) and§ 265 (discharge by supervening frustration). 38.  For a nuanced discussion of the role of fault in unexpected­circumstances cases, with special emphasis on comparative and historical contexts, see James Gordley, Impossibility and Changed and Unforeseen Circumstances, 52 Am. J. Comp. L. 513 (2004).

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having carelessly discarded an unextinguished cigar. Certainly the promisor’s fault should be given some effect. Under Restatement Second the promisor’s fault operates in a binary fashion, like an on/​off switch, to bar the promisor from employing an unexpected-​circumstances excuse that she would otherwise be entitled to invoke. However, there is another way to view this problem—​that fault should operate on a continuum, like a dimmer switch. A promisor’s fault in causing the unexpected circumstance may be slight or severe. At one extreme, the fault may consist of intentional or reckless conduct. At the other extreme, the fault may consist only of minor negligence. The location of the promisor’s conduct on the fault continuum should affect the promisee’s measure of damages. Where a promisor would be excused by reason of unexpected circumstances but for her fault, if her fault is minor a reasonable accommodation is to require the promisor to pay reliance damages—​the costs that the promisee incurred in reliance on the promise—​but not expectation damages. The promisor should be required to pay reliance damages because she is at fault and her fault has caused the promisee to be worse off than he was before the promise was made. However, the promisor should be excused from paying expectation damages because but for her fault she would be excused from liability, the fault is minor, and the promisee will have no loss in the usual sense of that term—​that is, no diminution in his pre-​contract wealth—​after he is compensated for his costs by reliance damages. This remedial approach is exemplified by a series of four important decisions by the Massachusetts Supreme Court. The decisions in all the cases arose out of a contract between John Bowen Co., a general contractor, and the Massachusetts Department of Health, acting with the approval of the State Public Building Commission, for the construction of the Lemuel Shattuck Hospital in Boston.39 The series began with Gifford v. Commissioner of Public Health,40 which concerned the validity of the contract. This case did not involve unexpected circumstances but it set the stage for the other three decisions. Under a Massachusetts statute, contracts such as the one at issue had to be put out to bid and awarded to the lowest qualified bidder. The contract was awarded to Bowen, but another bidder, Slotnik, challenged the award. The Massachusetts Supreme Court held that Bowen had failed to fully comply with the relevant statute in setting out the components of its bid, and that if Bowen had fully complied, Slotnik would have been the lowest qualified bidder.41 Accordingly, the court canceled the award of the contract to Bowen. Under the statute, each general contractor’s bid had to be divided into two items. Item 1 covered the work that the general contractor would perform. Item 2 covered the work that subcontractors would perform, and had to include the names of the subcontractors and the amounts of their bids. On Item 1, Slotnik’s bid was lower than Bowen’s by $21,784. On Item 2, Bowen’s bid was lower than Slotnik’s by $21,942.75—​even though Slotnik and Bowen named the same twenty-​six subcontractors and received the same bids from those subcontractors. There were two reasons for the discrepancy. First, Bowen had reduced the painting subcontractor’s bid by $20,000, the projected cost of certain fabric wall covering. Bowen claimed that it had merely shifted the $20,000 to Item 1. Second, Albre Marble & Tile Co. had submitted two bids, one for the installation of marble and one for the installation of tile, and each bid stated that “If a performance bond will be required, add ¾ of 1% of the above proposal to the contract sum.”

39.  The hospital is alternatively named in the four decisions as “a chronic diseases hospital in Boston” and the “Chronic Diseases Hospital and Nurse’s Home.” 40.  105 N.E.2d 476 (Mass. 1952). 41.  Id. at 481.

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Since the Public Building Commission’s form for bids by general contractors provided that the awarding authority could require subcontractors to furnish a performance bond, Slotnik added three-​quarters of 1  percent to Albre’s bids. Bowen did not, on the grounds that Bowen itself would be providing a performance bond so that a performance bond from Albre would be unnecessary, and that as a matter of custom the Public Building Commission had never required performance bonds from subcontractors. The court held that Bowen should not have reduced $20,000 from Item 2 and should have added three-​quarters of 1 percent to Albre’s two sub-​bids, and if that had been done, in which case Bowen’s bid would have been higher than Slotnik’s. The next three decisions in the series involved suits against Bowen by subcontractors who had entered into contracts with Bowen before Bowen’s contract with the Department of Health was canceled by Gifford. The first of these decisions, M. Ahern Co. v. John Bowen Co.,42 was an action by a plumbing subcontractor, Ahern, for unpaid labor and materials furnished by Ahern on the hospital job before Bowen’s contract was canceled. The court began by pointing out that although Bowen was not liable for Ahern’s expectation damages by reason of the unexpected circumstance that Bowen’s contract with the Department of Health had been canceled, that was not the end of the case. The courts have not been deterred “from giving recovery in cases of excusable impossibility for such performance as has been received.”43 This was nothing new; it is hornbook law that even where unexpected circumstances excuse expectation damages they do not excuse restitution for the value of a benefit conferred. But the court then made two important moves. First, the court moved away from grounding recovery in such cases on the basis of “the principle of unjust enrichment which underlies restitution.”44 Instead, the court said, “Our decisions have spoken of ‘an implication [from the contract] that what was furnished was to be paid for’ ”45 even though the defendant had not been benefited in the normal sense of that term. Presumably the court made this first move because Ahern’s unpaid-​for work had conferred a benefit on Massachusetts rather than on Bowen. The court then made its second important move. It not only rejected unjust-​enrichment theory as the basis of recovery for what was furnished in suits such as that brought by Ahem, but also held that “[i]‌t is no longer necessary to find implications of a contract to support recovery.”46 Instead, the court said, recovery was to be based on “what the court holds to be fair and just in the unanticipated circumstances.”47 In Ahern itself, the court concluded, what was fair and just turned at least in part on the role that Bowen had played in causing performance of the contract to be impossible: This is not a case where the defendant stands fully apart, as the plaintiff does, from the circumstances which caused the unexpected destruction of the subject matter of the contract. The defendant did those things with respect to the subbids discussed in Gifford v. Commissioner of Public Health . . . which caused its bid to appear the lowest, although in fact it was not. The Gifford decision has held that what the defendant did was not properly done. Even though we assume, as the defendant 42.  133 N.E.2d 484 (Mass. 1956). 43.  Id. at 485. 44.  Id. 45.  Id. 46.  Id. at 486. 47.  Id. (emphasis added).

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urges here, that it acted in good faith, and in respects as to which the prescribed course was not clear, the fact is that its actions, in a field where it had a choice, had a significant part in bringing about the subsequent critical events—​the awarding to it of an apparent contract which turned out to be void and the ensuing decision of this court. In the circumstances it is plain that this is not a case of fully excusable impossibility.48

The next decision in the Lemuel Shattuck series was Boston Plate & Window Glass Co. v. John Bowen Co.49 In this case Boston Plate, a subcontractor, had entered into contracts with Bowen to furnish glass, glazing, and miscellaneous nonferrous metal work for construction of the hospital. After Bowen failed to perform the contract, Boston Plate sued Bowen for expectation damages. Bowen argued that it was not liable because the decision in Gifford rendered performance of the contracts with Boston Plate impossible. The court agreed. “It is apparent that the validity of the general contract was tacitly assumed by both parties. Therefore, since the validity of the general contract was essential to the performance of the subcontracts, its validity was a condition to the continued existence of obligations under the subcontracts.”50 To summarize the story so far: the occurrence of an unexpected circumstance may excuse the promisor from liability for expectation damages even where the promisor bears some fault for the occurrence. However, the promisor will not be excused from liability for what the promisee furnished under the contract before the occurrence of the unexpected circumstance. The concept of “furnished,” for this purpose, is elastic and depends in whole or in part on what is fair and just under the circumstances. This story leaves open the treatment of costs that a promisee has incurred in cases where the promisee had not furnished anything before the occurrence of the unexpected circumstance. That issue was the subject of the fourth decision in the Lemuel Shattuck series, Albre Marble & Tile v. John Bowen Co.51 Albre, another subcontractor, had contracts with Bowen for the installation of marble and tile for the hospital. Albre sued Bowen on four counts. The first and second counts sought expectation damages for Bowen’s breach of those contracts. Bowen pleaded impossibility, and these two counts were dismissed on summary judgment. Albre’s third and fourth counts sought to recover the value of its work and labor under its contracts, which consisted of the “preparation of samples, shop drawings, tests and affidavits,”52 rather than labor or materials furnished in the construction of the hospital. To put this differently, in its third and fourth counts, Albre sought reliance damages. Accordingly, a major issue in the case was whether a promisee could recover reliance damages against a promisor who was excused from paying expectation damages by reason of unexpected circumstances. The court concluded that even though Bowen was not sufficiently at fault to be liable for expectation damages it was sufficiently at fault to be liable for reliance damages: Although the matter of denial of reliance expenditures in impossibility situations seems to have been discussed but little in judicial opinions, it has however, been the subject of critical comment by

48.  Id. 49.  141 N.E.2d 715 (Mass. 1957). 50.  Id. at 717. 51.  155 N.E.2d 437 (Mass. 1959). 52.  Id. at 439.

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scholars.53 In England the recent frustrated contracts legislation provides that the court may grant recovery for expenditures in reliance on the contract or in preparation to perform it where it appears ‘just to do so having regard to all the circumstances of the case’. . . [T]‌his is not a case of mere impossibility by reason of a supervening act. . . . Although the defendant’s conduct was not so culpable as to render it liable for breach of contract . . . nevertheless, it was a contributing factor to a loss sustained by the plaintiff which as between the plaintiff and the defendant the latter ought to bear to the extent herein permitted.54

In short, the governing principle, exemplified by the Lemuel Shattuck series, should be that where the occurrence of an unexpected circumstance would warrant judicial relief except that the promisor is proven to have been at fault, but the fault was minor, the promisor normally should be relieved from liability for expectation damages but not for reliance damages. Suppose, however, that the promisor is not proven to be at fault. Even then, reliance damages for the promisee may be justified where the promisor had control over the conditions that led to the occurrence of the unexpected circumstance. Liability for reliance damages in such cases may be justified on one of two grounds. To begin with, if the promisor had such control there will often be a significant likelihood that the promisor was at fault for the occurrence even though the promisee cannot prove that fault. Alternatively, liability in such cases can be based on the ground that responsibility follows from control, because control implies some ability to take steps to prevent the loss from occurring. There are ample precedents for this approach. For example, worker’s compensation law, which makes an employer liable for accidents to employees even without a showing of fault, is at least partly justified on the ground that the employer is responsible for workplace accidents because it is in control of the workplace. Products-​liability law, which makes a manufacturer liable for injuries caused by product defects even without a showing of fault, is at least partly justified on the ground that the manufacturer is responsible for injuries caused by defective products because it is in control of the production process. The law of agency, which makes an employer vicariously liable for tortious injuries caused by an employee acting within the scope of his employment if the employer had the right to control the manner and means of the employee’s performance is at least partly justified on the ground that the employer is responsible for such injuries because of its control. The facts (although not the decision) in the famous case of Taylor v. Caldwell55 illustrate how the control principle should be applied. On May 27, 1861, the owners of a music hall had agreed to allow a lessee to use the hall for four days, the first of which was June 17, to give a series of concerts and fetes in exchange for £100 per day. Prior to June 17 the hall was destroyed by fire. The lessee claimed damages for expenses it had incurred in advertising and in preparing for the concerts. The court said, “we must take it on the evidence [that the destruction of the hall] was without the fault of either party,”56 and held that the owners were excused. That result was correct as far as expectation damages but seems doubtful as far as reliance damages. The owners

53.  See LonL. Fuller & William R. Perdue, Jr., The Reliance Interest in Contract Damages: 2, 46 Yale L. J. 373, 379–​83 (1937). 54.  Albre, 155 N.E.2d at 440–​41. 55.  (1863) 122 Eng. Rep. 309; 3 B&S 826. 56.  Id. at 312; 3 B&S at 832.

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were in control of the hall and therefore had at least some ability to prevent a fire; the lessee did not. Although the owners were not proven to be at fault, given their control over the premises they bore some responsibility to ensure its safety, and it would have been appropriate to make the owners responsible for the lessee’s costs on that basis. What should be the remedial consequences under the shared tacit assumption test if the promisor was neither at fault for the occurrence of the unexpected circumstance nor in control of the conditions that led to the occurrence? Clearly, the promisor should not be liable for expectation damages; that is the minimum significance of the conclusion that judicial relief is appropriate under the test. Clearly, too, the promisor should be liable for restitutionary damages, because it would be unjust to allow the promisor both to be excused from performance and to retain any benefits that she received under the contract. The more difficult issue is whether reliance damages should be granted against the promisor even in the absence of fault or control. One possible approach is that the promisee should be able to recover reliance damages in all such cases. That approach would be inappropriate. Very often, perhaps typically, if the parties had addressed the relevant circumstance ex ante they would have treated the occurrence of the circumstance as a condition to the promisor’s obligation to perform. A good example is Krell v. Henry, the coronation case.57 If the parties had addressed the issue directly, Krell, the lessor, almost certainly would not have promised that the coronation procession would take place in six days, as scheduled. Instead, the contract almost certainly would have provided that the occurrence of the procession as scheduled was a condition to Henry’s obligation to pay for the rooms. When a contract is subject to a condition that is not fulfilled, normally neither party has a right to either expectation or reliance damages, because both parties take the risk of nonfulfillment. For example, if Corporation A and Corporation B enter into a contract to merge subject to the condition that the Internal Revenue Service rules that the merger will be tax­free, and the IRS rules that the merger is taxable, A and B will each absorb its own merger-​related costs. By the same token, reliance damages should normally not be awarded in cases, such as Krell v. Henry, in which judicial relief is based on a shared tacit assumption that if made explicit would best be interpreted as a condition, because the same remedial treatment should be given to the tacit assumption as would be given if the assumption had been explicit. Although it would be inappropriate to make the promisor liable for reliance damages in all cases in which relief from expectation damages should be granted on the basis of the shared­ assumption test, reliance damages are appropriate in some cases. One example, considered above, consists of cases in which the promisor is at fault for the creation of the unexpected circumstance, but the fault is minor; another example, also considered above, consists of cases in which the promisor is in control of the conditions that led to the occurrence of the unexpected circumstance. Reliance damages would also normally be appropriate in frustration cases in which the promisee has incurred costs in reliance on the contract prior to the occurrence of the frustrating event, and an objective of the contract was to induce the promisee to incur those costs because the promisor wanted to reserve the promisee’s time or labor. For example, in Krell v. Henry Lord Justice Williams set out a hypothetical in which a cabman was engaged to take a person, A, to Epsom on Derby Day “at a suitable enhanced price for such a journey,”58 and the Derby was

57.  See supra text at notes 5–​6. 58.  [1903] 2 KB 740 at 750.

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called off. Williams concluded that A would not be entitled to judicial relief. That conclusion was wrong in general and inconsistent with Krell v. Henry in particular. It seems clear that the contract in the hypothetical was made on the tacit assumption that the Derby would take place. Therefore, the cabman should not be entitled to expectation damages. However, suppose that as a result of the contract the cabman had turned down another booking, unrelated to the Derby, for the same day, and after the Derby was called off the cabman was unable to get a substitute booking. Here A’s purpose was to reserve the cab, and he should compensate the cabman for the latter’s cost for maintaining the reservation, that is, the cost of forgoing an opportunity to contract for a fare at the regular price.59 The same reasoning would apply to a hypothetical variation of Krell v. Henry in which a party reserved a hotel room at an advanced rate to view the coronation procession and, after the coronation was cancelled, the hotel was unable to fill the room even at its regular rate. In such a case the hotel should be entitled to receive its regular rate as damages. The same reasoning also applies to a hypothetical, formulated by Perillo, in which a dressmaker sews up a specially designed wedding dress for a prospective bride and the wedding is then called off by the prospective groom.60 The dressmaker should be entitled to recover for her time and materials. There may be other cases in which the adversely affected party should be liable for reliance damages. Indeed, there may be occasional cases in which, if the parties had addressed the issue, they would have provided that if the occurrence of a given unexpected circumstance justified judicial relief, the relief should take the form of equalizing the out-​of-​pocket costs they incurred in reliance on the contract. Inevitably, the courts must have a certain amount of discretion at the remedial stage; this may be seen as a consequence of the hypothetical-​contract methodology.

III.   T H E U N B A R G A I NED-​F OR R I S K  T ES T A. THE TEST Many unexpected-​circumstances cases turn on the occurrence of a discrete event and can be resolved by applying the shared a­ ssumption test. Other cases, however, do not turn on such an occurrence. Often, a dramatic increase in the promisor’s cost of performance should support judicial relief even if not tied to a discrete event, because in many and perhaps most contracts the parties do not expect that the promisor has undertaken an enormous financial risk. A special test is needed to address these cases. Under this test a promisor should be entitled to judicial relief if, as a result of a dramatic and unexpected rise in costs, performance would

59.  In contrast to frustration cases, in which normally the promisor is a buyer, in impossibility and impracticability cases normally the promisor is a seller. Unlike buyers, who will often have a specific interest in inducing a seller to incur certain costs in reliance on the contract, as in the cabman and wedding-​dress hypotheticals, a seller will typically be indifferent to whether and how the buyer relies, at least if the reliance does not affect the seller’s damages for breach. However, if a seller in an impossibility or impracticability case does have a specific interest in inducing a buyer to incur certain costs in reliance on the contract, the seller may appropriately be made liable for the buyer’s reliance damages. 60.  Joseph M. Perillo, Hardship and Its Impact on Contractual Obligations: A Comparative Analysis 7 (1996).

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result in a financial loss significantly greater than the risk of loss that the parties would reasonably have expected the promisor to have undertaken. This test will be referred to as the unbargained-​for risk test. It may be viewed as either a free-​standing test or a special application of the shared-​assumption test where the shared assumption concerned the amount of risk assumed by the promisor. More generally, for purposes of unexpected-​circumstances cases a circumstance can be defined not only by its characteristics but also by its magnitude—​that is, by its dollar cost. An annual inflation of 5 percent is one thing; an annual inflation of 200 percent is another. As Paul Joskow has pointed out: It may facilitate the contracting process . . . if it is understood or implied in the contract that when events such as [wars, embargoes, changes in government rules and regulations, destruction of key supply facilities, or hyperinflation] occur and lead to dramatic increases in the cost of performance or the impossibility of performance that the contract will simply be discharged or renegotiated. . . . For example, if we had two similar occurrences, let’s say embargoes, the seller would have to perform if the price rise were small, but would not be required to perform if the resulting cost increase were very large. Such asymmetric treatment of differing consequences from similar events only appears to make sense if we expand our notion of possible contingencies to include elements identified by both event and consequence, and assume that, given a particular type of occurrence, the size of the consequence and the probability of the consequence occurring are negatively correlated. That is to say, given the set of possible embargoes, those with small consequences are much more probable than those with large consequences. Then we could appeal to the notions of bounded rationality . . . and argue that the low­probability events are outside of the boundary and not legally part of the contract.61 Whichever way it is viewed, the unbargained-​for risk test requires independent development, partly because the test does not focus on a discrete event and partly because the test carries special remedial considerations in its wake.

B.  COMPARISON WITH MUTUAL MISTAKE Unbargained-​for risk cases reflect still another way in which mutual­mistake and unexpected-​ circumstances cases tend to differ in practice in a manner that gives rise to important differences in theory and doctrine. Under the shared-​tacit-​assumption test the major difference between mutual-​mistake and unexpected-​circumstances cases concerns the role of fault. Under the unbargained-​for risk test, the major difference between the two kinds of cases concerns the 61.  Paul L. Joskow, Commercial Impossibility, The Uranium Market and the Westinghouse Case, 6 J. Leg. Stud. 119, 154, 160–​61 (1977). The effect of the magnitude of the impact of an event, as opposed to the nature of the event, is also recognized in Restatement Second § 261 cmt. d: Performance may be impracticable because extreme and unreasonable difficulty, expense, injury, or loss to one of the parties will be involved. A severe shortage of raw materials or of supplies due to war, embargo, local crop failure, unforeseen shutdown of major sources of supply, or the like, which either causes a marked increase in cost or prevents performance altogether may bring the case within the rule stated in this section. . . . A mere change in the degree of difficulty or expense due to such causes as increased wages, prices of raw materials, or costs of construction, unless well beyond the normal range, does not amount to impracticability since it is this sort of risk that a fixed-​price contract is intended to cover. (Emphasis added.)

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structure of the parties’ positions. In mutual-​mistake cases the buyer is characteristically the adversely affected party, while in unexpected-​circumstances cases the seller is characteristically the adversely affected party. The implications of this structural difference are highly significant. In the typical mutual mistake case, in which the buyer is the adversely affected party, the contract price sets an upper boundary on the buyer’s loss. Even in atypical mutual mistake cases, in which the seller is the adversely affected party, normally the seller will have no loss at all in the normal sense of that term, but will merely forgo a windfall. In contrast, in the typical unexpected circumstance case, in which the seller is the adversely affected party, if the contract is enforced there may be no practical bounds on the seller’s potential risk and loss. Here is why this is so. In the typical mutual mistake case a buyer claims that she will take a loss if she does not obtain relief, because as a result of a mistaken shared tacit assumption the commodity that she has agreed to purchase lacks some or all of its expected value. For example, recall that in Lenawee County Board of Health v. Messerly62 the Messerlys sold Carl and Nancy Pickles a supposed income-producing investment property consisting of a three-​unit apartment building located on a 600-​square-​foot parcel. The parties shared the tacit assumption that the existing use of the building was legal. That assumption was mistaken because, unknown to either party, the Messerlys’ predecessor in interest had installed a septic tank on the property without a permit and in violation of the health code. Subsequently, the County Board of Health condemned the property and obtained a permanent injunction proscribing habitation until the property was brought into conformity with the health code. However, it was impossible to remedy the illegal septic system within the confines of the remaining 600-​square-​ foot parcel because the health code required 750 square feet of property for a septic tank for a one-family-​dwelling and 2,500 square feet for a three-​family dwelling. As a result, the only way the apartment building could be put to residential use was to pump and haul the sewage, which would cost double the income generated by the building. Accordingly, the value of the supposed income-​producing property was negative, because the property could not possibly produce income that exceeded or even equaled the cost of processing the sewage. In cases such as Messerly63 the buyer will have a significant or even total loss unless judicial relief is granted on the basis of mutual mistake. However, the potential loss is normally bounded by the purchase price. Where the seller is the adversely affected party in a mutual-­mistake case, typically he will have no loss at all in the normal sense of that term. Rather, the issue in such cases is how to allocate a windfall—​an unexpected and unbargained-​for element of value. For example, in In re Seizure of $82,000 More or Less (discussed in Chapter 43), agents of the Drug Enforcement Administration (DEA) had found $24,000 in drug proceeds wrapped in plastic bags in the battery case of a Volkswagen.64 The car and the money were forfeited to the U.S. government pursuant to statute, and the car was then sold by the government to the Chappells. The Chappells noticed a fuel 62.  331 N.W.2d 203 (Mich. 1982). 63.  For comparable cases, see, e.g., Dover Pool & Racquet Club v. Brooking, 322 N.E.2d 168, 169–​71, 174 (Mass. 1975); Bar-​Del, Inc. v. Oz, Inc., 850 S.W.2d 855, 856–​57 (Ky. Ct. App. 1993); In re Macrose Indus., 186 B.R. 789, 793 (E.D.N.Y. 1995); Reilley v. Richards, 632 N.E.2d 507, 508–​09 (Ohio 1994); these cases are discussed in Chapter 43, text at notes 17–​20.  In Messerly itself, the court held that the buyer would have been excused except for the inclusion of an as-​is provision in the contract. Id. at 210–​21. 64.  119 F. Supp. 2d 1013 (W.D. Mo. 2000).

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problem and took the car to a mechanic, who found $82,000 wrapped in plastic bags in the fuel tank. The DEA seized the $82,000 and the Chappells disputed the seizure. This was a windfall case. The Volkswagen had an unexpected element of value—​the hidden money in the gas tank. Whether the court allocated the $82,000 to the government or to the Chappells, the other party would not be worse off than it expected to be at the time the contract was made. If the cash was allocated to the government, the Chappells would still have the car that they expected to get at the price that they agreed to pay. If—​as occurred—​the cash was allocated to the Chappells, the government would still have the amount that it expected to get in exchange for the car that it agreed to sell. In summary, in mutual-​mistake cases the buyer is typically the adversely affected party and, as in Lenawee, her maximum loss is bounded by the wasted purchase price. If the seller is the adversely affected party, typically neither party will have a loss although one party will forgo a windfall, as the government did in the drug-​money case. Some unexpected-​circumstances cases, like most mutual­mistake cases, involve adversely affected buyers. Such cases are usually treated under the doctrine of frustration. Typically, the buyer claims that the commodity that she agreed to purchase has lost most or all of its value because of the occurrence of an unexpected circumstance. Like the buyer in a mutual-​mistake case, the buyer in a frustration case faces a loss—​sometimes a total loss—​if judicial relief is not awarded. Again, however, normally the loss is at least bounded by the contract price. For example, in Krell v. Henry the rooms that the lessee had rented to watch the coronation procession had no value to him when the coronation was canceled. However, if judicial relief had not been granted, the lessee’s loss, although total, would have been limited to the amount of the rent. In contrast, most unexpected-​circumstances cases involve a seller who is adversely affected by an unexpected and significant increase in the cost of performance.65 Cases in which the seller’s cost of performance unexpectedly rises above the contract price often, perhaps usually, stem from a cost increase that is market-​wide. In such cases, the increase normally will raise not only the seller’s costs but also the buyer’s value for, and the market value of, the contracted-​for commodity. Therefore, in the absence of judicial relief to the seller the buyer’s expectation damages, based on the difference between the contract price and the market price, can rise to a very high level66 potentially far above the contract price, and often would give the buyer a windfall.

65.  This difference between mutual-​mistake and unexpected­-circumstances cases, like the other differences discussed in this chapter, is based on typical cases in each of the two categories rather than on characteristics that necessarily inhere in such cases. The rare case in which a mutual mistake increases the seller’s cost of performance should be treated like the counterpart unexpected­circumstances case. 66.  Pietro Trimarchi, Commercial Impracticability in Contract Law: An Economic Analysis, 11 Int’l Rev. of Law & Econ. 63, 65–​66 (1991) has analyzed this issue in formal terms, as follows: Consider a contract in which a promisor (hereafter “the seller”) agrees to supply the promisee (hereafter “the buyer”) with certain goods or services for a price p. The seller’s cost of performance, estimated at the time of the contract, is c (production cost, if the seller is a manufacturer, or purchasing cost, if the seller is a middleman). The value of the goods or services to the buyer, expressed in monetary terms, is V. It may be assumed that V>p>c. Assume that over time the cost of performance rises to c*. . . . Assume that V remains fixed while performance costs increase. If . . . c*> V. and the remedy of specific performance is not given, the seller may breach the contract and pay expectation damages V-​ p. In this case the seller sustains a loss with respect to his initial forecast equal to V-​c. This amount, which normally is not exorbitant, represents the limit of the seller’s risk. This limit no longer exists if V increases as a result of the same factors that increased

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C. EXAMPLE For example, suppose that Packer agrees to sell 10,000 pounds of N nuts, a delicacy, to Distributor at $1.00/​pound. Packer expects to purchase the nuts from farmers at 50¢/​pound but has not yet done so. Because of a blight, the amount of N nuts available from farmers falls dramatically. The price of farmed N nuts to packers rockets to $6.00/​pound, and the price of packed N nuts to distributors happens to rise to $7.00. If Packer does not perform and is not entitled to judicial relief, she will incur damages of $60,000 (based on the difference between the $1.00/​pound contract price and the new $7.00/​pound market price for distributors). If Distributor has not yet made contracts with retailers at a fixed price, Distributor will receive this $60,000 payment of damages as a windfall. More generally, losses and windfalls here depend on the potentially arbitrary timing of contracts among parties who were probably not intending to speculate to so great a degree in the first place.  The profits that the distributors in the hypothetical would reap if judicial relief were withheld would not be windfalls if the parties reasonably believed that the sellers were taking the risk of enormous losses—​because, for example, the buyers were bargaining for the chance of enormous profits. However, in these and most comparable cases that conclusion seems highly unlikely. The buyers are probably not in the business of speculating in the prices of nuts, and the sellers are highly unlikely to believe that they are taking unbounded financial risks. As Pietro Trimarchi has observed: [I]‌t is unreasonable to assume that the parties would normally be willing to gamble on uncertainties about disastrous events. . . . It seems likely that the parties would normally be more inclined to avoid [such a] gamble and to change their overall plans in the event of exceptional unforeseen changes in market conditions; accordingly, a legal rule allowing discharge or amendment of the contract would presumably more often correspond to their preferences.67

The unbargained-​for risk test is congruent with the moral obligation that a promise entails. As stated by Thomas Scanlon, “Saying ‘I promise to  .  .  .’ normally binds one to do the thing promised, but it does not bind unconditionally or absolutely. It does not bind absolutely because, while a promise binds one against reconsidering one’s intention simply on grounds of one’s own convenience, it does not bind one to do the thing promised whatever the cost to oneself and others.”68 The unbargained-​for risk test is also efficient, because it reflects the agreement that the parties would probably have reached if they had specifically addressed the issue. The underlying methodology in unbargained-​for risk cases is the same as in the typical shared-​mistaken-​assumption cases. In both types of case the objective is to construct the term the parties probably would the cost of performance. If V increases to more than c*, the seller will incur a loss equal to the increase in costs, irrespective of its amount.

67. Trimarchi, supra note 66, at 71. Cf. Daniel A. Farber, Contract Law and Modern Economic Theory, 78 Nw. U. L. Rev. 303, 335–​36 (1983) (impracticability doctrine protects promisors against catastrophic losses); Subha Narasimhan, Of Expectations, Incomplete Contracting, and the Bargain Principle, 74 Cal. L. Rev. 1123, 1147 n.60 (1986) (neither party to a contract accepts unlimited risks). 68.  Thomas Scanlon, Promises and Practices, 12 Phil. & Public Affairs 199, 214 (1990).

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have agreed upon if they had addressed the issue. However, the application of that methodology differs significantly in the two types of case. Typical shared mistaken assumption cases are event-­oriented in the sense that the issue is whether the occurrence of a discrete event entitles the adversely affected party to judicial relief. If it does, then usually the relief should consist of an excuse of that party’s obligation to perform, although in some cases the relief may consist only of excusing liability for expectation damages. In contrast, the typical unbargained-​for-​risk case is magnitude-​oriented in the sense that the issue is whether the adversely affected party’s increased cost of performance entitles him to judicial relief. In such cases, determining what the parties would have agreed to if they had addressed the issue and, where judicial relief is appropriate, what form it should take, is a more complex enterprise than in event-​oriented cases. Normally, each party to a contract will expressly or impliedly take some risk. The issue is, how much risk? Assuming that the seller and the buyer had approximately the same wealth, utility for money, and attitude to risk, the seller can reasonably be expected to have accepted a risk of a moderate or reasonably predictable increase in costs, because a purpose of many contracts for sale is to shift the risk of such increases to the seller, and gains and losses within normal bounds are unlikely to significantly affect the wealth of either party. In the normal case, however, a seller would not be willing to accept an extremely large risk or perhaps, more accurately, would charge the buyer a steep premium to accept such a risk, because if the loss materialized it would significantly decrease the seller’s wealth. The buyer, on his part, would be unlikely to want to pay the premium that the seller would demand for exposure to such a loss, especially where the buyer’s damages would essentially amount to a windfall rather than compensation for a loss in the normal sense of that term. In contrast, in some cases it can be inferred from the circumstances that the seller was taking the risk of a very large loss due to market-​wide cost increases. The most obvious case is that in which one or both parties are speculators. Within limits, the acceptance of such a risk may also be inferred from the fact that a contract is for a period of many years, because the longer the term of a contract the more it becomes reasonably foreseeable that a very large increase in costs may occur during that term.69 Price-escalation provisions in a long-​term contract may also suggest that the seller made an evaluative choice among various types of such provisions and took the risk that her choice would turn out badly. But the mere presence of a price-​escalation clause is not necessarily decisive. In the 1970s and 1980s, a number of cases arose in which sellers sought relief under UCC Section 2–​615 based on significantly increased costs resulting from dramatic changes in the energy markets. Generally speaking, the sellers in these cases were unsuccessful.70 A notable

69.  As Trimarchi, supra note 66, at 71 observes: [T]‌he taking of a risk in return for a fixed fee may in some cases be assumed from the nature of the contract, particularly its term, even though there may not be any specific wording to such effect. For instance, it is quite normal to enter into a short-​term commitment to supply goods or services without worrying about the possibility that wholly unforeseeable events may intervene to render performance impracticable. However, where a commitment is entered into for many years it is reasonable to assume that the supplier will have considered the possibility of drastic changes in his costs. Accordingly, in the latter case, a fixed-​ price clause can be reasonably interpreted as an indication that the supplier is willing to take a larger risk.

70.  See, e.g., Iowa Elec. Light & Power Co. v. Atlas Corp., 467 F. Supp. 129, 136 (N.D. Iowa 1978), rev’d on other grounds, 603 F.2d 1301 (8th Cir.1979); E. Air Lines, Inc. v. Gulf Oil Corp., 415 F. Supp. 429, 440–​41 (S.D. Fla. 1975).

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exception was Aluminum Co. of America (ALCOA) v.  Essex Group.71 In December 1967, ALCOA and Essex entered into a contract under which ALCOA would convert alumina supplied by Essex into aluminum. The contract was to run until the end of 1983, but Essex had the option to extend the contract until the end of 1988. The price for each pound of aluminum was calculated by a complex indexing formula: (1) Labor costs were to be escalated in proportion to changes in ALCOA’s average hourly labor cost. (2) Non-​labor costs were to be escalated in accordance with the Wholesale Price Index for Industrial Commodities (WPI-​ IC), published by the U.S. Bureau of Labor Statistics. (3)  The price as escalated by (1)  and (2) was subject to an overall cap of 65 percent of the price of a specified type of aluminum as published in a designated trade journal. This indexing formula was developed by ALCOA with the aid of Alan Greenspan, then a well-​known economist, later chairman of the Federal Reserve Bank. Electrical power is the principal non-​labor cost factor in converting alumina into aluminum. Beginning in 1973, OPEC actions to increase oil prices, and unanticipated pollution-​control costs, greatly increased ALCOA’s cost for electricity, and electric power rates rose much more rapidly than did the WPI-​IC. As a result, ALCOA claimed it was excused from performing, on the ground that the WPI-​IC was incapable of reasonably reflecting ALCOA’s changes in non-​ labor costs. The District Court held that ALCOA was entitled to relief on the grounds of impossibility and frustration, among other things: When ALCOA proposed the price formula which appears in the contract, Essex’s management examined the past behavior of the indices for stability to assure they would not cause their final aluminum cost to deviate unacceptably from the going market rate. ALCOA’s management was equally attentive to risk limitation. They went so far as to retain the noted economist Dr. Alan Greenspan as a consultant to advise them on the drafting of an objective pricing formula. They selected the WPI-​IC as a pricing element for this longterm contract only after they assured themselves that it had closely tracked ALCOA’s non-​labor production costs for many years in the past and was highly likely to continue to do so in the future. In the context of the formation of the contract, it is untenable to argue that ALCOA implicitly or expressly assumed a limitless, if highly improbable, risk. On this record, the absence of an express floor limitation can only be understood to imply that the parties deemed the risk too remote and their meaning too clear to trifle with additional negotiation and drafting. . . . In the present case ALCOA has satisfied the requirements of both [impossibility and frustration]. The impracticability of its performance is clear. The increase in its cost of performance is severe enough to warrant relief, and the other elements necessary for the granting of relief have been proven. . . .72

Based on these conclusions, the court reformed the contract so that the price to Essex would be the lesser of (A) the cap price stated in the contract (65 percent of a price of a specified type of aluminum published in a trade journal), or (B) the greater of (1) the price specified in the contract, computed according to its terms, or (2) a price that yielded ALCOA a profit of 1¢ per pound of aluminum converted from alumina.

71.  499 F. Supp. 53 (W.D. Pa. 1980). 72.  Id. at 69, 73.

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Although ALCOA was seen by some commentators as either the brilliant dawn of a golden age or an awful descent into the fiery pit (depending on the commentator’s perspective), it seems to have turned out to be an isolated judicial event. According to John D. Wladis, in “Impracticability as Risk Allocation: The Effect of Changed Circumstances upon Contract Obligations for the Sale of Goods,”73 the procedural developments in the case after the District Court opinion were as follows: The case was appealed to the United States Court of Appeals for the Third Circuit, but the parties settled before the appeal was decided. The parties then made a joint motion requesting voluntary dismissal of the appeal, vacation of the District Court’s judgment, and the remand of the case to the District Court with directions to dismiss. The Third Circuit granted this relief, and the District Court judge dismissed the action. Wladis reports that on the basis of this procedural history, the ALCOA opinion was characterized to him by judges of the Third Circuit as having only the precedential value of a law review article. Although the unbargained-​for risk test is not explicitly articulated in contract law, it has significant doctrinal support, particularly the doctrine of impracticability. That doctrine is reserved for cases where the seller’s performance is possible, because where performance is not possible the doctrine of impossibility will suffice. Indeed, it is difficult to see how that doctrine could sensibly be interpreted if it did not center on a very large increase in a seller’s costs, the risk of which was not explicitly or implicitly assumed by the seller. So, for example, in City of Vernon v. Los Angeles,74 the California Supreme Court stated that “a thing is impracticable when it can only be done at an excessive and unreasonable cost.”75 That statement was endorsed in Transatlantic.76 In Misahara Construction. Co. v.  Transit-​Mixed Concrete Corp.,77 the Massachusetts Supreme Court stated that “certain risks are so unusual and have such severe consequences that they must have been beyond the scope of the assignment of risks inherent in the contract, that is, beyond the agreement made by the parties. To require performance in that case would be to grant the promisee an advantage for which he could not be said to have bargained in making the contract.”78 Similarly, the Comment to Restatement Second Section 261 (“Discharge by Supervening Impracticability”) states that “Performance may be impracticable because extreme and unreasonable difficulty [or] expense . . . to one of the parties will be involved. . . . A mere change in the degree of difficulty or expense due to such causes as increased wages, prices of raw materials, or costs of construction unless well beyond the normal range, does not amount to impracticability since it is this sort of risk that a fixed-​price contract is intended to cover.”79 73. 22 Ga. L. Rev. 503, 586 n.333 (1988). 74.  290 P.2d 841 (Cal. 1955). 75.  Id. at 847 (quoting Mineral Park Land v. Howard, 156 P. 458, 460 Cal. 1916). 76.  Transatlantic Fin. Corp. v. United States, 363 F.2d 312, 315 (D.C. Cir. 1966). 77.  310 N.E.2d 363 (Mass. 1974). 78.  Id. at 367. See also, e.g., L.N. Jackson & Co. v.  Royal Norwegian Gov’t, 177 F.2d 694, 702 (2d Cir. 1949)  (‘ “it cannot be believed that the contractee would have demanded or the contractor would have assumed’ the risks which it entails”) (L. Hand, J., dissenting, quoting N. German Lloyd v. Guar. Trust Co., 244 U.S. 12, 22 (1917)); Arthur L. Corbin, Recent Developments in the Law of Contracts, 50 Harv. L. Rev. 449, 465 (1937) (“In dealing with the concept of impossibility . . . the courts have given increasing consideration to the extent of the risk that a promisor should be regarded as having undertaken.”). 79. (Emphasis added). See also, e.g., Kan. City, Mo. v.  Kan. City, Kan., 393 F.  Supp.  1, 6 (W.D. Mo. 1975) (rejecting the proposition that “no increase in expense, regardless of its cause or magnitude, will operate to excuse performance”).

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Restatement Second Section 351 (“Unforeseeability and Related Limitations on Damages”) also endorses a version of the unbargained-​for risk test, although in a somewhat different context. Sections 351(1) and (2) set out the principle of Hadley v. Baxendale. Section 351(3) then adopts a much different principle: “A court may limit damages [even] for foreseeable loss by excluding recovery for loss of profits, by allowing recovery only for loss incurred in reliance, or otherwise if it concludes that in the circumstances justice so requires in order to avoid disproportionate compensation.”80 Comment f explains: It is not always in the interest of justice to require the party in breach to pay damages for all of the foreseeable loss that he has caused. There are unusual instances in which it appears from the circumstances either that the parties assumed that one of them would not bear the risk of a particular loss or that, although there was not such assumption, it would be unjust to put the risk on that party.

The unbargained-​for risk test is exemplified by Moyer v. Little Falls.81 Earl Moyer had entered into a contract with the city of Little Falls to dispose of the city’s refuse for five years, beginning April 1, 1984, in exchange for annual payments by the city of $97,700. Moyer planned on dumping the refuse in the Rose Valley Landfill, which was located near the city. At the time the contract was made the estimated amount of the city’s annual refuse was 8,000 cubic feet, and the rate for dumping refuse at the Rose Valley Landfill was $1.50 per cubic yard. In December 1985 the landfill was closed by order of New York State. The only other landfill facility approved by the state and available to Moyer was the Mohawk Valley Sanitary Landfill. Over the eleven-​month period after the Rose Valley Landfill was closed, the Mohawk Valley Landfill increased its rate for dumped refuse from $2.50 per cubic yard to $10.00 per cubic yard, and Moyer’s projected dumping costs increased 666 percent. Moyer stopped performing the contract, and Little Falls brought suit. The court concluded that Mohawk’s rate increases consisted of gouging that had been made possible by the state’s action in giving Mohawk a monopoly position, and held that “the 666  percent increase was not and could not have been within the contemplation of the parties. Such a massive cost escalation is ‘excessive’ as a matter of law and future performance by plaintiff must be excused.”82 In short, as these authorities illustrate, the unbargained-​for risk test normally applies to excuse a seller from full expectation damages where, absent judicial relief, the seller’s loss would greatly exceed the risk that the parties would reasonably have expected the seller to have taken on.

D.  NATURE OF RELIEF Assuming that judicial relief is appropriate under the unbargained-​for risk test, the next issue is what form the relief should take. In typical cases that fall within the shared-assumption test, normally the promisor should be excused either entirely or from expectation damages.

80. Restatement Second § 351 cmt. f. (emphasis added). 81.  510 N.Y.S.2d 813 (Sup. Ct. 1986). 82.  Id. at 815.

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That is not true in cases that fall within the unbargained-​for risk test. The remedy under this test should follow from the underlying theory of relief. This theory is that if the parties had addressed the issue the seller would have accepted the risk of cost increases up to a certain point but not beyond. Accordingly, the buyer should be entitled to expectation damages measured by the difference between the contract price and a constructed price based on the risk of a cost increase that the seller could reasonably have been expected to have bargained for. In other words, when judicial relief is based on the unbargained-​for risk test a seller should not be made better off due to a very large increase in her costs than she would have been if her costs had risen only moderately. If the seller’s costs had risen only moderately the buyer would have been entitled to expectation damages for nonperformance. There is no good reason why the buyer should be required to forgo all damages because the seller’s costs rose excessively. Therefore, in cases where the unbargained-​for risk test is applicable the buyer should be entitled to the damages that would have been awarded based on the maximum percentage increase in the cost of the relevant inputs over a comparable stretch of time during a reasonable past period—​say, the prior ten years.83 The easiest kind of situation in which to apply the unbargained-​for risk test consists of cases, such as the ground nut hypothetical, in which the buyer is purchasing for resale. In such cases the buyer’s only expectation is to make a profit, and if the buyer is awarded the maximum profit that he would have reasonably expected, this expectation will be fulfilled. A more difficult case is presented where the buyer is an end-​user purchasing for consumption or use. Even in end-​user cases the remedy should be the difference between the contract price and a hypothetical market price based on the maximum historical cost increases for the relevant inputs. The buyer’s reasonable expectation would not be frustrated if he could not reasonably have expected the seller to take an excessive unbargained-​for risk. It might be objected that if the buyer had made a contract with another supplier he would have been able to acquire the contracted-​for commodity at the contract price. However, where a cost increase is market-​wide the costs of all sellers of the relevant commodity would have increased in the same way, and all sellers would have the same defense, so that the buyer would have done no better if he had contacted with another seller. Generally speaking, the unbargained-​for-​excessive risk test and the associated remedial consequence comport with business practice. Russell Weintraub conducted a survey of general counsels in which he asked the following question:

83.  In a comment on an earlier draft of this chapter, Shawn Bayern pointed out that: [There is] another advantage of the remedial approach . . . for [unbargained-​for] risk cases. In particular, [the] proposed scheme is advantageous because it avoids a harsh discontinuity (between large damages for the promisee and no damages for the promisee) and, as a result, can reduce the cost of settlement between the parties: the precise relationship between the cost changes that have actually occurred and “reasonable” cost increases is taken off the table in many cases, such that this precise relationship need not be litigated. As a result, the parties disagree about less and should more readily be able to settle their dispute. (There is a similar, related point: what I call “harsh discontinuities” tend to increase the cost of errors in adjudications, because they can—​at least in theory—​amplify small differences in courts’ assessment of what is reasonable into large differences in damages. By contrast, without such discontinuities, parties can better predict the potential damages they face, and this probably encourages settlement.)

Message from Shawn Bayern to Melvin Eisenberg, November 16, 2006.

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Company A  has contracted to sell B a fixed quantity of fuel oil per month at a fixed price for 10 years. An unprecedented OPEC oil embargo causes the cost of the oil to A to far exceed the price that B has agreed to pay. A’s loss over the 10 years of the contract would be so large as to require liquidation of A. B can pass on the added cost of oil to its customers without suffering a competitive disadvantage. A refuses to deliver the oil at the contract price and B sues A for the difference between the contract price of the oil and the much higher price that B must pay to obtain oil from other sources. What result should the court reach?84

In response, 35  percent of the general counsels stated that B should receive a judgment for the difference between the contract price and the market price, but 14 percent stated that A should be excused from performance, and 46 percent stated that the contract price should be adjusted to avoid ruinous loss to A, but give B a significant savings over current market price.85

I V.   A   C O N T R A RY   VI EW George Triantis, in “Contractual Allocation of Unknown Risks: A Critique of the Doctrine of Commercial Impracticability,”86argued that contract law should not allow defenses based on unexpected circumstances. Triantis’s argument is based on the claim that when formulating contracts parties allocate all possible risks. The claim proceeds as follows:  Admittedly many specific risks—​ in particular, unforeseen risks—​ are not explicitly allocated by contracting parties. However, even those risks are implicitly allocated within broader risks that are explicitly allocated. Therefore, if a promisor agrees to render a certain performance, all risks affecting the promisor’s ability to render that performance that are not specified in the contract are contractually allocated to her. Accordingly, “judicial reallocation of risk through contract doctrine such as commercial impracticability is an interference with freedom of contract that cannot be justified on grounds of economic efficiency.”87 Triantis’s claim that contracting parties allocate all risks flies in the face of both ordinary experience88 and experimental evidence, and Triantis offers neither experiential nor experimental evidence to support his claim. Instead, Triantis rests his claim entirely on a long and highly complex model of decision theory as applied to the allocation of unknown risks under conditions of uncertainty. However, Triantis here mistakes a normative theory for a descriptive theory. Triantis assumes that decision theory, on which his claim rests, is a descriptive theory about how real actors actually make decisions. It isn’t. Rather, decision theory is a normative or prescriptive theory about how rational actors should make decisions. Within the last thirty or forty years, psychologists (and increasingly, economists) have experimentally and theoretically

84.  Russell J. Weintraub, A Survey of Contract Practice and Policy, 1992 Wis. L. Rev. 1, 41 (1992). 85.  Id. nn.141–​142. 86.  George G. Triantis, Contractual Allocation of Unknown Risks: A Critique of the Doctrine of Commercial Impracticability, 42 U. Toronto L.J. 450 (1992). 87.  Id. at 480. See also Michael j. Trebilcock, The Limits of Freedom of Contract 127–​30 (1993); but see id. at 144–​45. 88.  See, e.g., Narasimhan, supra note 67, at 1147.

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established that real actors routinely and systematically deviate from the prescriptive dictates of decision theory.89 Triantis’s claim that contracting actors allocate all risks therefore is contradicted not only by ordinary experience but by a mass of experimental evidence. This evidence shows the existence of systematic cognitive problems affecting decision-​making, such as bounded rationality, which limits the future scenarios that actors can be realistically expected to envision; overoptimism; and defects in capability, including systematic underweighting of future benefits and costs as compared to present benefits and costs, and systematic underestimation of low-​probability risks.90 Triantis acknowledges the existence of these cognitive problems, but he argues that they apply to contracting across the board, so that the “selective focus” of unexpected-​ circumstances doctrine is “anomalous.”91 In fact, however, cognitive problems—​particularly, the capacity to imagine future risks and to accurately assess their probability—​are a disproportionately large factor in unexpected-​circumstances cases. There is a huge cognitive difference between deciding how many apples to buy at what price, on the one hand, and imagining and accurately assessing a future that could unfold in hundreds of different ways, on the other. A second basic flaw in Triantis’s argument is that it rests on the unarticulated premise that a contract consists only of the parties’ explicit expressions. This is incorrect. As stated in the comments to the UCC, a contract consists of the bargain of the parties in fact, which includes not only explicit expressions but also—​among other things—​the parties’ tacit assumptions.92 The point of the shared-​assumption test is that even when a writing does not afford relief based upon the occurrence of an unexpected circumstance, the parties tacit assumptions will often make relief contractually appropriate. To put it differently, Triantis mistakes a writing for the contract. Triantis’s claim also ignores the issue of economic magnitude. It cannot reasonably be assumed that parties allocate to a promisor the risk of every unexpected circumstance without regard to the economic magnitude of the risk, because normally a promisee would not pay the price a promisor would demand to bear such a risk. This is the essence of the unbargained-​for risk test. Under both the shared-​assumption and unbargained-​for risk tests judicial relief is not, as Triantis characterizes it, a reallocation of risk but rather a recognition of the allocation of risk based on the parties’ tacit assumptions and what the parties probably would have agreed to if they had addressed the relevant issue.

89.  See, e.g., Judgment under Uncertainty: Heuristics and Biases (Daniel Kahneman, Paul Slovic & Amos Tversky eds., 1982); Choices, Values, and Frames (Daniel Kahneman & Amos Tversky eds., 2000); Daniel Kahneman, A Perspective on Judgment and Choice: Mapping Bounded Rationality, 58 Am. Psychologist 697–​720, (2003); Herbert A. Simon. A Behavior Model of Rational Choice, in Models of Man, Social and Rational: Mathematical Essays on Rational Human Behavior in a Social Setting 241 (1957). 90.  See Melvin Aron Eisenberg, The Limits of Cognition and the Limits of Contract, 47 Stan. L. Rev. 211, 213–​25 (1995). 91. Triantis, supra note 86, at 474. 92.  See text at notes 7–​8, supra.

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V.   T H E R O L E O F   I NS UR A NCE C O N S I D E R AT I ONS If market insurance or hedge instruments that cover a given risk are readily available, and there is a customary practice in a business sector to purchase such insurance or instruments, a promisor who decides not to do so may fairly be deemed to have assumed the risk that would have been insured or hedged under the customary practice. In an influential article, Posner and Rosenfield went one step further and argued that the risk of an unexpected circumstance should always fall on the party who is the cheaper insurer against the risk.93 To put this differently, Posner and Rosenfield argued that the determinative test for judicial relief in unexpected-​circumstances cases should be which party was the cheaper insurer. The argument, in a slightly paraphrased form, proceeds as follows: Discharge of a contractual obligation should be allowed on the ground of unexpected circumstances where the promisor is the superior (more efficient or cheaper) risk bearer. One party is a superior risk bearer if he is in a better position to prevent the relevant risk from materializing. In such a case efficiency requires that party to bear a loss resulting from the materialization of the risk. But prevention is only one way of dealing with risk; the other is insurance. If the promisor is the cheaper insurer her inability to prevent the risk from materializing should not discharge her from a contractual obligation. The factors relevant to determining which party to a contract is the cheaper insurer are risk­appraisal costs and transaction costs. Risk-​appraisal costs are the costs of determining the probability of a loss and the magnitude of the loss if it occurs. Transaction costs are the costs involved in eliminating or minimizing the risk by pooling it with other risks, that is, by diversifying the risk away. This can be done either through the purchase of market insurance or through self-​insurance. Before examining this argument directly it is necessary to clarify two issues. First, Posner and Rosenfield state that in every unexpected-​circumstances case “the basic problem is the same:  to decide who should bear the loss resulting from an event that has rendered performance by one party impracticable.”94 The use of the term loss in this context is somewhat misleading. The traditional objective of remedies in areas of private law other than contracts is to compensate a wrongfully injured party by restoring him to the position that he was in before the injury. Effectuating that objective makes an injured party whole for costs that are losses in the normal sense of that term. Although the remedial regime in contract law is also commonly characterized as compensatory,95 the classic contract-​law remedy of expectation damages is not designed to restore the injured party to the position that he was in before the injury. Instead, that remedy is designed to put the promisee forward to the position he would have been in if the promisor had performed. As stated by Fuller and Perdue, in contract law “we ‘compensate the plaintiff by giving him something he never had. This seems on the face of things a queer

93.  Posner & Rosenfield, supra note 4, at 88–​92. 94.  Id. at 86. 95.  See, e.g., Hawkins v. McGee, 146 A. 641, 643 (N.H. 1929) (“By ‘damages,’ as that term is used in the law of contract, is intended compensation for a breach.”); Restatement Second, ch. 16, intro. note (“The traditional goal of the law of contract remedies has . . . [been] compensation of the promisee for the loss resulting from breach.”).

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kind of ‘compensation.’ ”96 It is therefore somewhat misleading to put the issue in unexpected-​ circumstances cases in terms of “who should bear the loss,” because often there is no loss in the normal sense of a diminution in the promisee’s pre-​contract wealth, but only a failure to achieve an expected gain. Second, although Posner and Rosenfield’s argument mentions market insurance, that is not the kind of insurance that underlies their argument. Market insurance is often or even usually unavailable to cover the expectations and liabilities that unexpected-​circumstances cases involve. Furthermore, many or most unexpected-​circumstances cases involve either events that are too special to be covered by normal market insurance, such as the illness of a king on a given day or the drying up of a stream, or events that are too widespread to be covered by normal market insurance. As to the latter case, Trimarchi points out that: The principle of insurance (in its widest sense) lies basically in aggregating a number of homogeneous and uncorrelated risks, that are sufficient for the statistical regularity of events to make the overall losses in a given timespan predictable with a reasonable degree of accuracy. This reduces risk (defined as the probable variation of actual experience from expected experience). . . . An important requisite for any given risk to be efficiently insurable is, therefore, that it can be assessed in terms of statistical findings. This however is not feasible in the case of such exceptional events as wars, international crises, national political crises, and the like, [which affect society as a whole, or large portions of it, and] the occurrence of which is so spasmodic as to defy statistical calculation over a reasonable timespan.97

Presumably because of the unavailability of market insurance in most unexpected-​circumstances cases, Posner and Rosenfield attempt to treat self-​insurance as more or less interchangeable with market insurance. It isn’t. The term self-​insurance is a misnomer. In its paradigmatic form, it is not insurance at all. Insurance involves the transfer of a risk from one independent entity to another, usually through a market transaction. In contrast, in paradigmatic self-​insurance transactions an entity simply sets aside a reserve to cover future risks (or sets up a captive insurer, which in economic terms is virtually the same thing). But Posner and Rosenfield do not even touch upon paradigmatic self-​insurance—​understandably, since identifying the “cheapest reserve-​creator” would be a nonsensical task. Instead, they argue explicitly or implicitly that what they call “self-​insurance” can be effected in one of four ways other than creating a reserve: charging a premium for bearing the relevant risk, hedging the risk by entering into a forward contract, diversifying, or increasing the scale of the firm (which allows more diversification and facilitates the bearing of risk). Once Posner and Rosenfield’s argument is clarified it cannot be sustained, because the argument is premised on an unspoken and critical incorrect factual predicate; the test that Posner and Rosenfield urge would not be administrable and making liability turn on the elements that Posner and Rosenfield refer to as “self­insurance” would provide incentives for inefficient behavior and would require courts to decide cases on unacceptable grounds.98

96.  L.L. Fuller & William R. Perdue, Jr., The Reliance Interest in Contract Damages: 1, 46 Yale L.J 52, 52–​53 (1936). 97. Trimarchi, supra note 66, at 66–​67. 98.  Posner & Rosenfield, supra note 4, at 91–​92. In addition, although Posner and Rosenfield’s argument pivots on the proposition that risk is a cost they fail to carry out the logic of that proposition by recognizing

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Posner and Rosenfield’s argument depends on the proposition that one party to a contract will be better than the other to appraise the probability that a risk will materialize, determine the magnitude of the loss if the risk does materialize, or both. The unspoken but critical predicate of this proposition is that contracting parties will have appraised the probability and magnitude of the relevant risks in unexpected-​circumstances cases. This predicate is incorrect. Most unexpected-​circumstances cases arise because the parties tacitly assume that a given kind of circumstance will not occur during the contract time. In such cases the parties do not consider, or even foresee, let alone appraise, the risk that the unexpected circumstance will occur. Indeed, if the parties do foresee the relevant risk judicial relief normally should not be granted. Accordingly, it is pretty much irrelevant for present purposes which party can better appraise the probability or magnitude of an unexpected circumstance, because most unexpected-​circumstances cases arise precisely because neither party has thought about engaging in such an appraisal. Next, Posner and Rosenfield’s test would be virtually impossible to apply in practice. Indeed, Posner and Rosenfield themselves are unsure how to apply their test. Concerning one of their hypotheticals, they conclude that “We are inclined to view A as the superior risk bearer in these circumstances and thus to discharge B.”99 Concerning two of the actual cases that they analyze, they conclude that “both cases may have been correctly decided from an economic standpoint.”100 Another group of cases “seem correctly decided when evaluated from the standpoint of economics,”101 and still another result “seems correct.”102 Another case is “difficult to analyze because the two key parameters seem to point in opposite directions” but “is probably correct.”103 Of another case they say, “Unfortunately, it is unclear a priori which would be the more efficient rule.”104 More generally, Posner and Rosenfield admit that “[i]‌n many individual, and perhaps some classes of, cases, economic analysis—​at least of the casual sort employed by the judges and lawyers in contract cases—​will fail to yield a definite answer, or even a guess, as to which party is the superior risk bearer.”105 Michael Trebilcock has excoriated Posner and Rosenfield’s argument in general, and their attempt to rationalize various cases on the basis of their model in particular.106 Take, for example, Transatlantic,107 discussed above, in which a carrier claimed that it had a right to increased compensation because as a result of the Suez Canal closing, it unexpectedly had to transport cargo via the longer Cape route. The court denied the claim. Posner and Rosenfield attempt

that although firms are ordinarily willing to accept the costs of moderate risks, most firms do not want to accept the cost of extreme risks. Because efficiency is based in part on effectuating party preferences, firms that cannot rely on the law of large numbers and are not pure speculators will have a strong preference against either taking extreme risks of loss. 99.  Id. at 93 (emphasis added). 100.  Id. at 102 (emphasis added). 101.  Id at 105 (emphasis added). 102.  Id at 106 (emphasis added). 103.  Id at 108 (emphasis added). 104.  Id at 103. 105.  Id. at 110 (emphasis added). 106.  Michael J. Trebilcock, The Role of Insurance Considerations in the Choice of Efficient Civil Liability Rules, 4 J. L. Econ. & Org. 243 (1988). 107.  Transatlantic Fin. Corp. v. United States, 363 F.2d 312 (D.C. Cir. 1966).

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to explain the case on the ground that “[t]‌he shipowner is the superior risk bearer because he is better able to estimate the magnitude of the . . . loss and the probability of the unexpected event,” 108 and shipowners who own several ships and ply different routes can spread the risks of delay on any particular route even without purchasing market insurance. Trebilcock properly characterizes this rationalization as spurious. “On the particular facts, surely the U.S. government [the shipper] was much better placed than the carrier to appraise the risks of the outbreak of war in the Middle East. Surely it was also better equipped than the carrier to evaluate the consequences of delayed arrival of the goods. And surely it was better placed than the carrier to self-​insure or otherwise diversify the risk of canal closure.”109 Posner and Rosenfield try to defend against critiques of this sort by arguing that the decision in Transatlantic should and did “turn on the characteristics of shippers as a class.”110 But as Trebilcock observes, “what empirical intuitions or generalizations can confidently be offered—​ or at least are likely to be accessible to a court—​as to whether shippers as a class or carriers as a class can better determine the probability of given contingencies and evaluate the consequences of interrupted or aborted performance [or, for that matter as to] which class of actors can more cheaply self-​insure, market-​insure, or otherwise diversify the risks in question?”111 Posner and Rosenfield’s class-​based defense of their argument also raises the difficult and perhaps impossible issue of how to define the relevant class. In a case such as Transatlantic, is the relevant class large-​scale ocean carriers, ocean carriers, carriers, shipowners, transportation companies, or some other class entirely? Self-​insurance. Recall that Posner and Rosenfield identify four types of “self-​insurance”—​ charging a premium for taking the relevant risk, hedging, diversifying, or attaining a large scale. What Posner and Rosenfield mean by charging a premium and by hedging in this context is not completely clear: they could be referring either to actually charging a premium or hedging, or to a superior ability to charge a premium or to hedge. If Posner and Rosenfield are referring to cases in which one of the parties actually charged a premium for bearing the relevant risk, or actually hedged, then the cases do not involve unexpected circumstances. If Posner and Rosenfield are referring to a superior ability to charge a premium or to hedge, their argument fares no better. The capacity to charge a premium cannot differentiate the parties to a contract, because either party can demand a premium for carrying a risk—​the seller, by demanding an increase in the price, or the buyer, by demanding a reduction. Much the same is true of hedging. Normally, if one party could hedge—​most typically, by entering the futures market—​so could the other. Furthermore, hedging is a relatively restricted technique, which generally is available only for standardized commodities, and even then often for only relatively short periods of time. The argument for “self-​insurance” based on diversification and scale also fails. Diversification and scale have business benefits and costs that are independent of the possibility that an unexpected­circumstances case will arise. These business benefits and costs swamp the expected benefits and costs of using these techniques to deal with unexpected­circumstances cases, which are few and far between and usually involve much smaller stakes than business decisions on diversification and scale. Therefore, a firm’s decisions on how much to diversify and what scale 108.  Posner & Rosenfield, supra note 4, at 104. 109. Trebilcock, supra note 106, at 251. 110.  Posner & Rosenfield, supra note 4, at 104. 111. Trebilcock, supra note 106, at 252.

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to attain normally will be made on the basis of benefits and costs other than the prospect that an unexpected-​circumstances case may arise. Presumably those decisions are rational, so that every firm attempts to adopt its efficient degree of diversification and scale, given the nature of its business, its resources, the competitive climate, and so forth. Accordingly, a rule under which liability in unexpected­circumstances cases was imposed on the party who is more diversified, has a larger scale, or both, would inefficiently penalize a firm for having efficiently achieved diversification and large scale. To put this differently, under Posner and Rosenfield’s argument efficiency and success would breed liability. Finally as Trebilcock has tellingly pointed out, imposing liability on a party to a contract on the basis of the party’s attainment of significant diversification and scale would violate basic concepts of justice. “By treating the nature and quality of particular interactions between two parties as irrelevant to determinations of liability, the insurance rationale risks degenerating into a relatively arbitrary selection of an insurer or ‘deep pocket,’ and thus a largely random form of judicially administered wealth redistribution.”112 In short, the cheapest-​insurer rationale is deeply flawed and does not comport with efficiency, corrective justice, or distributive justice.

V I .   T H E R O LE OF   EX POS T C O N S I D E R AT I ONS An important issue in many unexpected-​circumstances cases is whether the courts should base their decisions solely on the basis of the ex ante expectations and assumptions held by the parties at the time the contract is made or, in appropriate cases, should also take into account ex post considerations—​that is, gains and losses to both parties that either arose under the contract prior to the occurrence of the unexpected circumstance or proximately resulted from or were made possible by the occurrence. Here again, there is a practical difference between mutual­ mistake and unexpected-​ circumstances cases that has important theoretical and doctrinal implications. Mutual-​mistake cases concern the present world at the time of the contract. As a result, usually the mistake is discovered very soon after the contract is made and is remediable by rescission. In contrast, unexpected circumstances often occur well after the contract is made. By then the eggs have been scrambled and it is often too late to solve the problem simply by rescission. Instead, more complex adjustments may be required, and in making those adjustments the courts should have the power to take ex post considerations into account in appropriate cases. This power is not a license to reallocate gains and losses on the basis of distributional considerations. Rather, this power is a recognition of the reality presented by many unexpected­circumstances cases, and must be exercised within the general framework of the parties’ joint enterprise. Indeed, an ex post approach to unexpected-​circumstances cases is not necessarily inconsistent with an ex ante approach. If contracting parties had addressed the problem of unexpected circumstances ex ante they might very well have agreed that if unexpected circumstances arose 112.  Id. at 258. See also Shawn J. Bayern, False Efficiency and Missed Opportunities in Law and Economics, 86 Tul. L. Rev. 135, 175–​76 (2011).

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that justified judicial relief the court should resolve the issue in the fairest possible way, taking all relevant considerations into account, rather than specifying the outcome under every possible contingency. A comparable approach was adopted by the parties in Ocean Tramp Tankers Corp. v. V/​0 Sovfracht [The Eugenia],113 another Suez Canal case. The charter in this case was negotiated at a time when “[t]‌he agents of both sides realized that there was a risk that the Suez Canal might be closed, and each agent suggested terms to meet the possibility. But they came to no agreement, and in the end they concluded the bargain . . . without any express clause to deal with the matter. That meant that, if the canal were to be closed, they would ‘leave it to the lawyers to sort out.’ ”114 One type of case in which ex post considerations should be taken into account arises where the unexpected circumstance makes a seller’s performance valueless to the buyer, but simultaneously creates an opportunity for the seller to make an equivalent profit on another contract that could be made only because the unexpected circumstance had occurred. For example, in Krell v. Henry,115 the coronation case, the cancellation of the coronation made the contract valueless to Henry, the lessee. However, after the original coronation was canceled a new coronation procession was scheduled, which took place along the same route. As a result, the lessor had the opportunity to make an equivalent profit, which he could only make because the original procession had been canceled. An appropriate disposition of Krell v. Henry would take that ex post consideration into account. Another type of case in which ex post considerations should be taken into account arises where an unexpected circumstance makes it more expensive for a seller to perform the contract at issue but simultaneously increases the profits that the seller will make on other contracts. Missouri Public Service Co. v. Peabody Coal Co.116is a good example. Missouri Public Service, a public-​utility company, entered into a ten-​year contract with Peabody Coal under which Peabody agreed to supply the coal that Missouri Public Service would require at a new coal-​ burning power plant, at a base price of $5.40 per net ton. The base price was subject to both specific price-​adjustment provisions for changes in designated costs and a general inflation-​ escalator provision based on the Industrial Commodities Index. Performance under the contract was profitable for Peabody during the first two years. Thereafter, however, Peabody’s production costs began to outpace the price-​adjustment and inflation­escalator provisions, and in 1974 Peabody requested modification of that provision. Public Service rejected Peabody’s request for the most part. Peabody thereupon threatened to stop shipping coal, and Public Service sued for specific performance. Peabody defended on the ground that it was suffering excessive economic loss under the contract, because although the Industrial Commodities Index had been an accurate measure of inflation in the years prior to the contract it had ceased to be an effective measure due to the 1973 oil embargo, runaway inflation, and the enactment of costly new mine-​safety regulations. In response, Public Service showed that since performance of the contract had begun Peabody had experienced an approximate threefold increase in the value of its coal reserves, presumably brought about by the 113.  [1964] 2 QB 226 (Eng.). 114.  Id. at 234 (opinion of Lord Denning). 115.  [1903] 2 KB 740. 116.  583 S.W.2d 721 (Mo. Ct. App. 1979).

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same causes that resulted in losses to Peabody under its contract with Public Service. The court awarded specific performance, relying in part on that ex post consideration: [A]‌claim made by Peabody alleged to bring it within the doctrine of “commercial impracticability”, is the Arab oil embargo. . . . Peabody failed to demonstrate that this embargo affected its ability to secure oil or petroleum products necessary to its mining production albeit at inflated cost. In fact . . . this embargo can reasonably be said to have, at least indirectly, contributed to the marked appreciation to the value of Peabody’s coal reserves by forcing the market value of that alternative source of energy upward in this country.117

In the two categories of cases just discussed ex post considerations either support complete judicial relief, as in Krell v. Henry, or militate against any judicial relief, as in Peabody. In some cases, however, ex post considerations suggest an adjustment of the contract. For example, in City of Vernon v. City of Los Angeles,118 the cities of Los Angeles and Vernon had contracts under which Los Angeles agreed to dispose of Vernon’s sewage. As a result of a lawsuit brought by the State of California, Los Angeles had to build expensive new processing facilities for the sewage that flowed through its system. Los Angeles asked Vernon to shoulder its proportionate share of the cost of the new facilities. Vernon refused, and Los Angeles claimed that it was excused from further performance of the contracts because of the greatly increased costs of processing sewage due to the need for the new facilities. The court held that Los Angeles was excused for the most part but that “certain described ‘facilities and rights’ created under the contracts (such as the gauging stations and relief sewer provided for by [one of the contracts] can and should be salvaged.”119 The power of the courts to take ex post considerations into account is supported by other authorities as well. For example, in M. Ahern Co. v. John Bowen Co.,120 the court rejected the concept that recovery for work furnished was based solely on ex ante implications from the contract, and held instead that whether such a recovery should be granted depends “in each case in accordance with what the court holds to be fair and just in the unanticipated circumstances.”121 Similarly, Restatement Second Section 272(2) provides that if the rules concerning impracticability and frustration, together with the rules on remedies, “will not avoid injustice, the court may grant relief on such terms as justice requires.” To the same effect is UCC Section 2-​615 (the principle UCC section dealing with the problem of unexpected circumstances), Official Comment 6, which provides that “In [unexpected-​circumstances cases] in which neither sense nor justice is served by either answer when the issue is posed in flat terms of ‘excuse’ or ‘no excuse’ adjustment under the various provisions of this Article is necessary, especially the sections on good faith, on insecurity and assurance and on the reading of all provisions in light of their purposes, and the general policy of the Act to use equitable principles in furtherance of commercial standards and good faith.” 117.  Id. at 728. 118.  City of Vernon v. Los Angeles, 290 P.2d 841(Cal. 1955). 119.  Id. at 847. 120.  133 N.E.2d 484 (Mass. 1956). 121.  Id. at 486. See also Turner Entm’t Co. v. Degeto Film GmbH, 25 F.3d 1512, 1520–​21 (11th Cir. 1994).

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V I I .   C O N C L US I ON Three fundamental concepts underlie the set of principles that should govern unexpected-​ circumstances cases: (1) A contract consists not only of the writing in which it is partly embodied, but also includes, among other things, certain kinds of tacit assumptions. (2) These assumptions may be either event-​centered or magnitude­centered. (3) The problems presented by unexpected-​ circumstances cases should be viewed in significant part through a remedial lens. The principles that rest on these concepts involve two tests for judicial relief, a repertoire of remedies, and judicial power to take ex post considerations into account. Putting aside certain qualifications, these principles can be summarized as follows. Under the shared-​tacit-​assumption test, a shared non-​evaluative tacit assumption that a given circumstance will either persist, occur, or not occur during the contract period should provide a basis for judicial relief where the assumption would have provided a basis for relief if it had been explicit. Normally, the remedial treatment that should be given where a tacit assumption fails should be the same as the remedial treatment that should be given if the assumption was explicit. Very often, perhaps typically, in such cases, if the parties had addressed the relevant circumstance ex ante they would have treated the occurrence or nonoccurrence of the relevant circumstance as a condition to the promisor’s obligation to perform. If a shared tacit assumption takes the form of an express condition, normally neither party would have a right to damages for nonfulfillment of the assumption, because normally both parties take the risk of nonfulfillment of an express condition. Accordingly, if the shared tacit assumption test is applicable, and the promisor was neither at fault for the occurrence of the unexpected circumstance nor in control of the conditions that led to the occurrence, she should not be liable for expectation damages. However, the promisor should be liable for restitutionary damages, because it would be unjust to allow the promisor both to be excused from performance under the contract and to retain any benefits that she received under the contract. Even in the absence of a conventional benefit conferred by the promisee, the promisor should be liable for reliance damages where the promisor should be excused from paying expectation damages because although she was at fault the fault was minor, but nevertheless she was at fault, or in frustration cases in which an objective of the contract was to induce the promisee to incur out-​of­pocket or opportunity costs because the promisor wanted to reserve the promisee’s time, labor, or productive capacity. Under the alternative unbargained-​for risk test, a seller should be entitled to judicial relief if as a result of a dramatic and unexpected rise in costs, performance would result in a financial loss that was not bargained for and is significantly greater than the risk of loss that the parties would reasonably have expected the seller had undertaken. In addition, if the buyer’s value for, and the market value of, the contracted-​for commodity have risen in tandem with the seller’s costs, the buyer should be entitled to modified expectation damages, limited to the profit the buyer would have made if a historically foreseeable increase in the seller’s cost of performance, and a corresponding increase in the market value of the commodity, had occurred. Finally, in appropriate unexpected circumstances cases courts should take into account ex post considerations—​that is, gains and losses to both parties that either arose under the contract prior to the occurrence of the unexpected circumstance, or proximately resulted from, or were made possible by, the occurrence. One type of case in which ex post considerations should be taken into account arises where the unexpected circumstance makes a seller’s performance valueless to the buyer, but simultaneously creates an opportunity for the seller to

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make an equivalent profit on another contract that could be made only because the unexpected circumstances occurred. Another such case arises where the unexpected circumstance makes it more expensive for a seller to perform the contract at issue, but simultaneously increases the profits that the seller will make on other transactions. In some cases, perhaps rare, ex post considerations may suggest judicial adjustment of the contract.

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PROBLEMS OF PERFORMANCE

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Introduction to Problems of Performance Assume that A  and B have made a c on tr act. N o m i sta k e i s su es

arise concerning the interpretation of the contract or the effect of unexpected circumstances, but issues do arise concerning other post-contract formation matters, such as a promisee’s rights where the promiser has rendered a performance that is substantial but imperfect. These and other post-formation issues are referred to in this book as problems of performance. Generally speaking, problems of performance are remedial in nature—​that is, they concern sanctions for breach other than damages or specific performance, such as suspension of performance or termination of the contract by the aggrieved party. These sanctions are often much more severe than damages. For example, if a promisee has the right to terminate a contract, the promisor may lose the profits she would have earned if the contract had continued as well as the value, or at least the contract price, of the performance she rendered before the contract was terminated. These sanctions differ from damages in other important ways. For example, the recovery of damages can be initiated only by filing a complaint. In contrast, some of the most important sanctions that are associated with problems of performance, such as termination of the contract, are normally initiated by self-​help, although subject to later judicial review. The problems of performance considered in this Part include: • The order in which the contracting parties’ performances are to be rendered (constructive conditions). • The consequences of a party’s repudiation of a contract before his performance is due (anticipatory repudiation). • Whether and when a promisee can demand that the promisor provide adequate assurance that her performance will be forthcoming. • The consequences of failing to provide such assurance when it is rightfully demanded. • When a promisee has the right to suspend or terminate performance of a contract based on a breach by the promisor.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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• Whether a promisor has the right to cure an imperfect performance. • Whether and when the victim of a breach is entitled to damages for breach of the entire contract as opposed to damages only for the breached portion of the contract. • The consequences of substantial but imperfect performance of a promise. • The consequences of substantial but imperfect fulfillment of an express condition.

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what order are the performances or tender of performances by each party to take place. The significance of this issue is that if A must render or tender performance before or simultaneously with B, then unless A has performed or tendered B is not obliged to perform and will not be in breach for not performing. For example, if A agrees to sell her car to B for $20,000, B is not obliged to pay unless and until A tenders the car, and A is not obliged to convey the car unless and until B tenders the $20,000. Often the parties’ contract specifies the order of performance. For example, construction contracts often provide that the owner will pay for the contractor’s performance in stages as designated milestones are achieved—​say 25 percent when the foundation is laid, 25 percent when the first floor is completed, and so forth. Often too, the circumstances provide a clear answer to the order-​of-​performance issue. For example, in the case of unilateral contracts, in which A promises to pay B for an act, the circumstances make clear that B must perform before A must pay. In many cases, however, neither the contract nor the circumstances provide a clear answer to the order-​of-​performance issue, and in these cases the answer is supplied by implication of law. Generally speaking, the law favors the implication of simultaneous performance, if that can be achieved. Restatement Second Section 234(1) provides that “Where all or part of the performances to be exchanged under an exchange of promises can be rendered simultaneously, they are to that extent due simultaneously, unless the language or the circumstances indicates the contrary.”1 The Comment to Section 234 lists four categories of cases in which simultaneous performance is required: where the same time is fixed for the performance of each party, where a time is fixed for the performance of one of the parties and no time is fixed for the other, where no time is fixed for the performance of either party, and where the same period is fixed within which each party is to perform. Several of these categories are exemplified in the Illustrations to Section 234:

1. A promises to sell land to B, delivery of the deed to be on July 1. B promises to pay a $50,000, payment to be made on July 1. Delivery of the deed and the payment of the price are due simultaneously.

1.  See also, e.g., U.C.C. §§ 2-​507, 2-​511. Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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2. A promises to sell land to B, delivery of the deed to be on July 1. B promises to pay A $50,000, no provision being made for the time of payment. Delivery of the deed and the payment of the price are due simultaneously. . . . 3. A promises to sell land to B, delivery of the deed to be on July 1. B promises to pay A $50,000, payment to be on or before July 1. Delivery of the deed and the payment of the price are due simultaneously.

Suppose that in a case where simultaneous performance is required one party brings a suit for damages. If both parties stayed home neither should be allowed to recover damages from the other: the rule should be and is that where performances are to be simultaneous neither party can recover damages unless he has done something to put the other party in default. This would usually mean making a tender or a definite offer to perform and having the capacity to carry out the offer. This explains why the law prefers the implication of simultaneous performance: If the order of performance is consecutive, then the party who must perform first is at risk that he will lose the value of his performance if the other party does not perform. In contrast, if the order of performance is simultaneous, neither party takes that risk.2 Suppose it cannot reasonably be implied that the parties’ performances are to be simultaneous. In that case, the usual implication is that if one performance takes time and the other does not, the performance that takes time must be rendered first, and only then is the other party obliged to render performance. This rule is embodied in Restatement Second Section 234(2): “[W]‌here the performance of only one party. . . . requires a period of time, his performance is due at an earlier time than that of the other party. . . .” The rule is exemplified in i­llustration  9 to Section 234. “A contracts to do the concrete work on [a] building being constructed by B for $10 a cubic yard. In the absence of language or circumstances indicating the contrary, payment by B is not due until A  has finished the concrete work. . . .” So far, so good. Unfortunately, the order-​of-​performance issue has been confused by describing the issue in terms of constructive conditions. So, for example, if A is obliged to perform before B, then it is said that A’s performance is a constructive condition to B’s duty to perform. If A and B are obliged to tender or perform simultaneously, then it is said that tender or performance by each party is a concurrent condition to tender or performance by the other. This nomenclature is both unnecessary and muddled. It is unnecessary, because the order of performance can be fully and clearly described without using the term condition, by simply stating that the parties’ performances must be rendered or tendered simultaneously or sequentially, as the case may be. It is muddled, because a constructive condition is a completely different animal than an express condition. An express condition is not a promise; in contrast, a constructive condition is a promise. An express condition must be perfectly fulfilled, at least under traditional contract law; in contrast, because a constructive condition is a promise it need only be substantially performed although the promisor will be liable for damages based on the shortfall in performance. The reason a promise is called a constructive condition in the order-​of-​performance context is that where A and B have a contract involving mutual promises, then performance or tender 2. See Restatement (Second) of Contracts § 234, cmt. a (Am. Law Inst. 1981).

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by one party is normally a prerequisite to the other party’s obligation to perform or tender. This prerequisite can be described as a condition but should not be, because the order of performance can be described without using that term, and using that term to describe promises promotes confusion. Accordingly, the term constructive condition should be dropped from the analysis of order-​of-​performance cases.

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The Principle of Anticipatory Repudiation I .   T H E G E N E RA L PR I NCI PL E Suppose that on January 15 Promisor contracts to render a designated performance to Promisee on March 15 in return for a fixed sum payable on that date. On February 15 Promisor repudiates the contract. A repudiation of this sort—​that is, a repudiation of a contract by a promisor before she is required to perform—​is conventionally referred to as an anticipatory repudiation or an anticipatory breach. Both terms are inaccurate. A repudiation of a contract is a present repudiation, whenever it occurs. It is also a present breach, as explained in the landmark English case, Hochster v. De La Tour.1 In this case, in April 1853 de la Tour engaged Hochster to accompany him as a courier—​ apparently a traveling companion and expediter—​on a tour to begin on June 1. On May 11, de la Tour told Hochster that he had changed his mind, and declined to use Hochster’s services. On May 22, Hochster filed suit for damages. [De] la Tour argued that there could be no breach of the contract before June 1, the date performance was to begin. The court held for Hochster: . . . [W]‌here there is a contract to do an act on a future day, there is a relation constituted between the parties in the meantime by the contract, and . . . they impliedly promise that in the meantime neither will do anything to the prejudice of the other inconsistent with that relation. As an example, a man and woman engaged to marry are affianced to one another during the period between the time of the engagement and the celebration of the marriage. In this very case of traveler and courier, from the day of the hiring till the day when the employment was to begin, they were engaged to each other; and it seems to be a breach of an implied contract if either of them renounces the engagement.2

1.  (1853) 118 Eng. Rep. 922; El. & Bl. 678. 2.  Id. at 926; El. & Bl. at 689. Although Hochster v. De La Tour is generally taken to be the fountainhead of the principle of anticipatory repudiation, Keith Rowley has shown that the principle had some earlier support. Keith A. Rowley, A Brief History of Anticipatory Repudiation in American Contract Law, 69 U. Cin. L. Rev. 565, 575 (2001).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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Learned Hand elaborated on this reasoning in Equitable Trust Co. v. Western Pacific Railway: [A]‌promise to perform in the future by implication includes an engagement not deliberately to compromise the probability of performance. A promise is a verbal act designed as reliance to the promisee, and so as a means to the forecast of his own conduct. Abstention from any deliberate act before the time of performance which makes impossible that reliance and that forecast ought surely to be included by implication. Such intermediate uncertainties as arise from the vicissitudes of the promisor’s affairs are, of course, a part of the risk, but it is hard to see how, except by mere verbalism, it can be supposed that the promisor may within the terms of his undertaking gratuitously add to those uncertainties by announcing his purpose to default.3

Although the terms anticipatory breach and anticipatory repudiation are inaccurate they are so well established that it would be quixotic to try to replace them. Accordingly, in this book a repudiation of a contract by a promisor before her performance is due will be referred to as an anticipatory repudiation. The principle that should govern such cases is as follows: An anticipatory repudiation is a material breach and therefore is governed by the rules applicable to all material breaches as well as all the other general principles of contract law. Call this the principle of anticipatory repudiation. This principle was not generally accepted under classical contract law, largely on the axiomatic ground that a contract could not be breached until the duty to perform had arisen. For example, in Daniels v. Newton, decided in 1876, the Massachusetts court said: [W]‌e are unable to see how [a renunciation of an agreement before the time of performance] can, of itself, constitute a present violation of any legal rights of the other party, or confer upon him a present right of action. An executory contract ordinarily confers no title or interest in the subject matter of the agreement. Until the time arrives when, by the terms of the agreement, he is or might be entitled to its performance, he can suffer no injury or deprivation which can form a ground of damages. There is neither violation of right, nor loss upon which to found an action. . . .4

Similarly, in 1901 Williston stated: From a technical point of view, it seems obvious that in an action on a contract the plaintiff must state that the defendant broke some promise which he had made. If he promised to employ the plaintiff upon June 1, the breach must be that he did not do that. A statement in May by the defendant that he was not going to employ the plaintiff upon June 1 can be a breach only of a contract not to make such statements.5 3.  244 Fed. 485, 502 (S.D.N.Y. 1917), remanded for correction and affirmed, 250 Fed. 327 (2d Cir. 1918)). See also U.C.C. § 2-​609, cmt. 1: [T]‌he essential purpose of a contract between commercial [actors] is actual performance and they do not bargain merely for a promise, or for a promise plus the right to win a lawsuit . . . [A] continuing sense of reliance and security that the promised performance will be forthcoming when due, is an important feature of the bargain. If . . . the willingness of the ability of a party to perform declines materially between the time of contracting and the time for performance, the other party is threatened with the loss of a substantial part of what he has bargained for.

4.  114 Mass. 530, 533 (1876). See also, e.g., Phillpotts v. Evans, (1839) 151 Eng. Rep. 200; 5 M. & W. 475. 5.  Samuel Williston, Repudiation of Contracts, Pt. 2, 14 Harv. L. Rev. 421, 428 (1901).

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Eventually, however, the principle of anticipatory repudiation was all but universally adopted by the courts. Indeed, Williston himself included the principle in Restatement First, for which he was the Reporter. The principle was also adopted in UCC Section 2-​610 (“When either party repudiates the contract with respect to a performance not yet due the loss of which will substantially impair the value of the contract to the other, the aggrieved party may. . . . resort to any remedy for breach. . . .”) and reiterated in Restatement Second, Section 253(1) (“Where an obligor repudiates a duty before he has committed a breach by non‐performance and before he has received all of the agreed exchange for it, his repudiation alone gives rise to a claim for damages for total breach. . . .”).

I I .   W H AT CONS T I T UT ES A N   A N T I C I PAT ORY R EPUDI AT I ON An anticipatory repudiation may consist of either an expression by the promisor that she intends not to perform a significant part of her duties under the contract or conduct by the promisor that renders her unable or apparently unable to perform a significant part of her contractual duties. Interpretation is sometimes required to determine whether conduct or an expression constitutes an anticipatory repudiation. When that is the case the issue should be determined under the general principles of interpretation in contract law—​specifically, whether a reasonable person in the promisee’s position would interpret the expression or conduct as a repudiation and whether the promisee did interpret the expression or conduct in that way. Such a formulation is included in the comment to Restatement Second Section 253: “Repudiation includes language that a reasonable person would interpret to mean that the other party will not or cannot make a performance due under the contract or voluntary affirmative conduct that would appear to a reasonable person to make a future performance by the other party impossible.” Unfortunately, many courts have imposed a stricter test, under which an expression will constitute a repudiation only if, in the words of the Supreme Court, the promisor’s expression is “a positive, unconditional, and unequivocal declaration of fixed purpose not to perform the contract in any event or at any time”6 This strict test is an unjustified departure from the general principles of interpretation, should not be followed, and is not followed by all courts.

III.   T H E E F F E C T O F   A N A NT I CI PAT ORY REP U D I AT I O N W H ER E T HE  PR OM I S EE H A D F U L LY P E RF OR M ED AT   T HE T I M E O F   T H E R EPUDI AT I ON Having lost the war over the principle of anticipatory repudiation, the adherents of the school of classical contract law proceeded to win a battle by establishing an unjustified exception to

6.  Dingley v. Oler, 117 U.S. 490, 502 (1886).

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the principle. Under this exception (the full-​performance exception), the principle is inapplicable if the promisee had fully performed at the time of the promisor’s repudiation. The major application of this exception is to cases where the promisor is obliged to pay for the promisee’s performance in installments. Under the exception if the promisee has fully performed he cannot sue the repudiating promisor for future installments until they become due.7 This exception is inconsistent with the principle of anticipatory repudiation, since a repudiation is no less a breach, and no less material, because the promisee has fully performed. Accordingly, if rigorously applied the exception leads to incongruous results, as exemplified by Restatement Second Section 253, Illustration 6: On January 15, A and B make a contract under which A promises to convey to B a parcel of land on February 1, and B promises to pay A $10,000 at that time and the balance of $40,000 in four annual installments. A conveys the parcel to B and B pays A $10,000. On March 1, B repudiates by telling A that he will not make any further payments. A commences an action against B. Since B has received the land, the agreed exchange for his duty to make the remaining payments, A has no claim against B for damages for breach of contract, until performance is due on the following February 1.

To take an even more extreme example, if A sells and delivers a commodity to B, to be paid for by B in sixty monthly installments, and B repudiates her obligation after paying only one installment, under the full-​performance exception A must, absurdly, bring separate suits to collect each of the remaining fifty-​nine installments. Fortunately, the exception has more bark than bite. To begin with, in most cases a repudiating promisor will probably conform her conduct to a judgment that she is in breach and pay the remaining installments voluntarily. If the promisor continues to withhold installments even after an initial judgment in the promisee’s favor, notwithstanding the exception the courts are unlikely to require the promisee to bring one suit after another for each remaining installment. For example, in Greguhn v. Mutual of Omaha Insurance Co.,8 a disability-​insurance case in which the insurer had defaulted on several installments, the court limited the plaintiff ’s judgment to the installments already due but added: The verdict and the decision of the trial court amounts to a determination that the plaintiff is entitled to the monthly payments as specified in the insurance policies so long as he is totally and permanently disabled. Defendants are not relieved of the obligation of making the payments unless the plaintiff should recover or die. Should the defendant fail in the future to make payment in accordance with the terms of the policies without just cause or excuse and the plaintiff is compelled to file another action for delinquent installments, the court at that time should be able to fashion such relief as will compel performance.9

There are several techniques, in addition to a judicial warning as in Greguhn, by which the courts can nullify the full-​performance exception. For example, a court could order the promisor

7.  See, e.g., Minor v. Minor, 7 Cal. Rptr. 455, 459–​60 (Dist. Ct. App. 1960); Restatement (Second) of Contracts § 253 cmt. c (Am. Law Inst. 1981) [hereinafter Restatement Second]. 8.  461 P.2d 285 (Utah 1969). 9.  Id. at 287.

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to specifically perform her remaining duties as they become due. If such a decree is issued, a non-​complying promisor would be in contempt and therefore subject to a fine or even a jail term. A court could also issue a declaratory judgment that the promisor is obliged to make all her remaining payments promptly. Although such a judgment would not of itself ensure that the remaining payments will be promptly made, if the promisor misses the next payment the court would almost certainly lose patience and order the promisor to make the remaining payments forthwith. Finally, as Allan Farnsworth pointed out, courts have often avoided the exception by spuriously concluding that at the time of repudiation some part of the promisee’s performance had not been rendered.10 In short, as stated in Restatement Second, the full-​performance exception has “been subjected to considerable criticism, and instances of its actual application are infrequent. . . .”11

I V.   W I T H D RAWA L OF   A N A N T I C I PAT O RY R EPUDI AT I ON A repudiation of a contract is a material breach, because it is a statement that the promisor will not perform her contractual obligations. The same is true of an anticipatory repudiation. Accordingly, as a matter of principle a promisor should not be allowed to withdraw an anticipatory repudiation. That is not the law, but the right to withdraw an anticipatory repudiation is cut off if the promisee either relies on the repudiation12 or notifies the promisor that he considers the repudiation final. Restatement Second justifies the latter rule on the ground that “it is undesirable to make the injured party’s rights turn exclusively on such a vague criterion” as reliance.13 This justification is disingenuous considering the numerous sections of Restatement Second that make important rights turn on reliance. A better justification is that since the best rule would be that a repudiation cannot be withdrawn, the second-​best rule is that the law should make it hard to withdraw a repudiation by giving the promisor the right to lock in the repudiation by a notice.

V.   D I S R E GA R D OF   A N A N T I C I PAT O RY R EPUDI AT I ON It has been held that in response to an anticipatory repudiation the aggrieved party may elect “to treat the repudiation as an empty threat and wait until the time for performance.”14 However, this election should give way to the duty to mitigate, and there is much authority to that affect. 10.  E. Allan Farnsworth, Contracts 584–​85 (4th ed. 2004). 11.  Restatement Second § 253, cmt. d. 12.  Id.. See also U.C.C. § 2-​611; Restatement Second § 256. 13.  Restatement Second § 256, cmt. c. 14.  Taylor v. Johnston, 539 P.2d 425, 430 (Cal. 1975).

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For example, Rockingham County v. Luten Bridge (discussed in Chapter 10) held that the aggrieved party may not elect to continue to perform in response to a repudiation when the choice is unreasonable. Similarly, UCC Section 2-​610, Comment 1 provides that if the aggrieved party “awaits performance beyond a reasonable time he cannot recover resulting damages which he should have avoided,” and Calamari and Perillo state that “The modern cases, representing the overwhelming weight of authority, hold the duty to mitigate damages overrides the concept of election.”15

V I .   A B I L I T Y O F  A GGR I EVED PA RT Y T O   P ER F OR M When performances are due simultaneously a party normally must tender performance to put the other party in breach. A repudiation excuses the promisee from the need to tender performance to bring a claim for breach, but to prevail the promisee should and must prove that “he had the willingness and ability to perform before the repudiation and that he. . . . would have rendered the agreed performance if the defendant had not repudiated. . . .”16 In Kanavos v. Hancock Bank & Trust Co.17 Hancock Bank held stock representing ownership of an apartment and Kavanos had an option to buy the stock. The bank persuaded Kanavos to relinquish the option in return for $40,000 and a right of first refusal to purchase the stock if the bank attempted to sell the stock within a sixty-​day period. The bank sold the stock for $760,000 within this period without informing Kanavos and giving him an opportunity to exercise the option and purchase the stock at that price. Kanavos sued for breach and presented evidence the stock was worth $1,500,000 at the time of the bank’s default. The court held that Kanavos’s financial ability was material because he should not recover damages unless he proved he had the ability to pay for the stock. However, the court laid down a very flexible test for ability to pay: The burden was on Kanavos to prove his ability to finance the purchase of the stock. The fact of his ability to do so was an essential part of establishing the defendant’s liability. Circumstances concerning his ability to raise $760,000 for the stock were far better known to him than to the bank. . . . Although Kanavos admitted that he was in financial difficulty during the relevant times, he had connections with people who might have assisted him. He testified that he could have purchased the stock if the bank had given him timely notice of his rights. Moreover, the jury found that the apartment complex was worth $1,500,000 more than the principal balance of the first mortgage, and thus $780,000 more than Kanavos would have had to have paid the bank for the stock (the same price of $760,000 less the $40,000 the bank owed him). This differential suggests that financing was not an impossibility for Kanavos. Considering Kanavos’s admitted financial difficulties at that time, the question of his ability to purchase the stock (or to sell his rights to another) may depend on whether the earnings of the apartment complex were sufficient to support 15.  John D. Calamari & Joseph M. Perillo, Calamari and Perillo on Contracts 439 (6th ed. 2009). 16.  Record Club of Am., Inc. v. United Artists Records Inc., 890 F.2d 1264, 1275 (2d Cir. 1989). 17.  479 N.E.2d 168 (Mass. 1985).

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some arrangement to finance the acquisition within the various limitations applicable under the federally guaranteed first mortgage (assuming it were not to be discharged in the process).18

V II.  T H E ME A S U R E M ENT OF   DA M A GES FO R   A N A N T I C I PAT ORY R EPUDI AT I ON The measurement of damages for an anticipatory repudiation raises the problem: As of what time should the measurement be made? Traditionally, the courts have chosen between two formulas. Under one formula the promisee’s damages are measured by the difference between the contract price and the replacement price (that is, the cover or market price) at the time of the repudiation. Under the other formula the promisee’s damages are measured by the difference between the contract price and the replacement price at the time when performance was to be rendered.19 Neither formula properly measures the promisee’s expectation damages. The objective of expectation damages is to put a promisee in the position he would have been in if the promise had been performed. If the promise had been performed the promisee would have received the contracted-​for performance at the time specified in the contract. If the repudiating promisor is a seller, the buyer’s damages therefore should be measured by the difference between the contract price and the price of a contract with a third party at the time of the breach for rendering the contracted-​for performance at the time specified in the contract. This point is most easily illustrated by contracts for the sale of commodities that are traded on organized futures markets. For example, suppose that on January 2, A  agrees to sell 200 bushels of corn to B at $10/​bushel, delivery on June 18. On May 1, A repudiates the contract. B should recover the difference between the $10 contract price and the price on May 1, the date of repudiation, for corn to be delivered on June 18. If on May 1 corn for immediate delivery is selling for $11/​bushel, and corn futures for delivery on June 18 are selling for $11.50/​bushel, the buyer’s damages should be the difference between the $10 contract price and the $11.50 price for September 18 delivery. Of course, most contracts do not involve commodities that are traded on an organized future market. Normally, that should make no difference, because cover for future delivery is routinely achieved outside organized futures markets. For example, suppose that on January 2, A  agrees to construct a building for B for $5  million, to be completed by December 20. On September 1, B repudiates. A should recover the difference between the $5 million contract price and the market price on September 1 for an identical building to be completed on December 20.

18.  Id. at 172. 19.  These formulas are often modified to include a reasonable period after the relevant time. This modification does not address the basic differences between the two formulas, and for ease of exposition the formulas will be stated without the modification.

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Under current law the problem of determining the date for measuring damages in anticipatory-​repudiation cases is complicated by two elements. First, the courts traditionally do not follow the futures-​based approach—​perhaps because they do not understand it—​but instead incorrectly view the timing issue as a choice between measuring damages based on the replacement price at the time of the repudiation or at the time performance was due. Second, many anticipatory-​damages cases involve the sale of goods and therefore are governed by Article 2 of the UCC, which lacks clarity on this issue. Three sections of the UCC are relevant: 2-​610, 2-​708(1), and 2-​713(1). Section 2-​610 provides that: When either party repudiates the contract with respect to a performance not yet due the loss of which will substantially impair the value of the contract to the other, the aggrieved party may (a) for a commercially reasonable time await performance by the repudiating party; or (b) resort to any remedy for breach even though he has notified the repudiating party that he would await the latter’s performance and has urged retraction; and (c) in either case suspend his own performance or proceed in accordance with the provisions of this Article on the seller’s right to identify goods to the contract notwithstanding breach or to salvage unfinished goods (Section 2-​704).

Section 2-​708(1) provides “the measure of damages for . . . repudiation by [a]‌buyer is the difference between the market price at the time and place for tender and the unpaid contract price. . . .” Section 2-​713(1) provides that “the measure of damages for . . . repudiation by the seller is the difference between the market price at the time when the buyer learned of the breach and the contract price.”20 (Section 2-​713(2) provides that “Market price is to be determined as of the place for tender. . . .”) The most obvious interpretation of Section 2-​713(1) is that “learned of the breach” means learned of the repudiation, because a repudiation is a breach. White and Summers agree this is the most obvious interpretation, but nevertheless oppose it: [One] argument against “obvious” interpretations of 2-​713 in anticipatory repudiation cases is that, if the “learned of the breach” language is construed to mean “learned of repudiation,” 2-​713 will be inconsistent with the analogous section on seller’s damages, 2-​708. Section 2-​708(1) measures an aggravated sellers’ damages for repudiation as the “difference between the market price at the time and place for tender and the unpaid contract price. . . .” Thus, under our interpretation of 2-​713, a court would always measure repudiation damages from the date of performance under the contract except in those few cases under 7-​723(1). 21

This view has some force, but undesirably trades off one problem of statutory interpretation for another, by rejecting the obvious interpretation of Section 2-​713 and by failing to deal with the purpose of expectation damages. Accordingly, White and Summers’s view is not accepted by the majority of courts. For example, in Oloffson v. Coomer22 on April 16, 1970, Coomer, a farmer, 20.  (Emphasis added in both sections.) Both Sections go on to provide that damages include “any incidental and consequential damages provided in this Article . . . but less expenses saved in consequence of the seller’s breach.” 21.  James J. White & Robert S. Summers, Uniform Commercial Code 328 (6th ed. 2010). 22.  296 N.E.2d 871 (Ill. App. Ct. 1973).

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agreed to sell 40,000 bushels of corn to Oloffson, a merchant—​20,000 at a price of $1.12 and ¾, to be delivered by October 30, and 20,000 at a price of $1.12 and ¼, to be delivered by December 15. Oloffson, in turn, contracted to sell the corn to a third party. On June 3, Coomer repudiated the contract. The price of corn on June 3 for future delivery was $1.16 a bushel. The scheduled delivery dates passed with no deliveries. Oloffson covered his obligation to his vendee by purchasing 20,000 bushels at $1.35 a bushel, and 20,000 at $1.49 a bushel, and brought suit. The court held that Coomer was entitled to recover the difference between the contract prices and $1.16 rather than the difference between the contract prices and the market prices on October 30 and December 15. In Trinidad Bean and Elevator Co. v. Frosh23 the court said: The word “breach” as used in § 2-​713(1) is ambiguous and must be interpreted within its statutory setting. There are essentially two views as to how the ambiguity is to be interpreted:  (1) “learned of the breach” refers to time of repudiation or (2) “learned of the breach” refers to time of performance under the terms of the parties’ contract. . . . Plausible arguments support both interpretations. . . . The shortcoming of the performance date interpretation is that it fails to explain § 2-​610(a), which appears to allow an aggrieved party to await performance only “for a commercially reasonable time.” As one court has said: “If buyer is entitled to market-​contract damages measured at the time of performance, it is difficult to explain why the anticipatory repudiation section limits him to a commercially reasonable time to await performance.” Moreover, the policy behind the commercial reasonableness of § 2-​610(a) is to compensate a buyer based on the prevailing market. The goal in sales contract cases should be to compensate an aggrieved buyer in whole and this is accomplished by the Code’s policy on cover. “[M]‌easuring buyer’s damages at the time of performance will tend to dissuade the buyer from covering, in hopes that market price will continue upward until performance time.” Cosden Oil v. Karl O. Helm Aktiengesellschaft, 736 F.2d 1064, 1072 (5th Cir.1984). . . . When a performance [time] measure is applied, an aggrieved buyer in a rising market will speculate that prices will continue to rise. If the market falls after repudiation, the buyer will obtain the same goods at a price lower than under the contract. The effect is to over-​compensate the buyer and penalize the seller. We conclude that best effect is given to the statutes if “learned of the breach,” in § 2-​713(1), refers to the time the buyer learned of the seller’s repudiation.24

Although admittedly cases such as Trinidad seem to take a time-​of-​repudiation approach, they can be read to take a futures approach. The phrase “price of the goods on the date of repudiation” is ambiguous, because it can be interpreted to mean either the price of goods for immediate delivery on the date of repudiation or the price on that date for goods to be delivered at time of delivery specified in the contract. Since the latter interpretation is consonant with the principle of expectation damages and the former is not, the latter interpretation should prevail.

23.  494 N.W.2d 347 (Neb. Ct. App. 1992). 24.  Id. at 352–​53.

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the promisee becomes justifiably insecure about whether the promisor will perform. The governing principle in such a case should be that the promisee can require the promisor to provide adequate assurance that her performance will be forthcoming, and the promisor’s failure to provide such assurance is a breach of contract. The reason for this principle, which is commonly referred to as the principle of adequate assurance, is set out in UCC Section 2-​609: (1) A contract for sale imposes an obligation on each party that the other’s expectation of receiving due performance will not be impaired. When reasonable grounds for insecurity arise with respect to the performance of either party the other may in writing demand adequate assurance of due performance and until he receives such assurance may if commercially reasonable suspend any performance for which he has not already received the agreed return . . . (4) After receipt of a justified demand failure to provide within a reasonable time not exceeding thirty days such assurance of due performance as is adequate under the circumstances of the particular case is a repudiation of the contract.

More elaborately, Official Comment 1 to that section states that: The section rests on the recognition of the fact that the essential purpose of a contract between commercial men is actual performance and they do not bargain merely for a promise or for a promise plus the right to win a lawsuit and that continuing sense of reliance and security that the promised performance will be forthcoming when due, is an important feature of [a]‌bargain. If either the willingness or the ability of a party to perform declines materially between the time of contracting and the time for performance, the other party is threatened with the loss of a substantial part of what he has bargained for. A seller needs protection not merely against having to deliver on credit to a shaky buyer, but also against having to procure and manufacture the goods, perhaps turning down other customers. Once he has been given reason to believe that the buyer’s performance has become uncertain, it is an undue hardship to force him to continue his own performance. Similarly, a buyer who believes that the seller’s deliveries have become uncertain cannot

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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safely wait for the due date of performance when he has been buying to assure himself of materials for his current manufacturing or to replenish his stock of merchandise.

Larry Garvin points out: Entering commercial law with hardly any adverse comment, this section proved very successful—​ so much so, in fact, that with very few changes the American Law Institute added it to the Restatement (Second) of Contracts. Though not every jurisdiction has yet embraced the common-​ law version of adequate assurance, a good many have, and [as of  1998] only one . . . so far has rejected it. Even Louisiana’s Civil Code contains adequate assurance, and international contract law treats adequate assurance very much in the manner of the UCC.1

There are several kinds of cases in which a promisee becomes justifiably insecure about whether the promisor will perform even in the absence of an explicit repudiation, and in which the promisor should be obligated to provide adequate assurance that she will perform. Here are three important types: Case 1. Apparent repudiation. A promisor may engage in conduct or use an expression that appears to constitute a repudiation of the contract, but is ambiguous. In that case the promisee should have the right to require clarification, because if he treats the promisor’s conduct or expression as a repudiation and a court later determines it was not, he himself will likely be in breach, while if he ignores the promisor’s conduct or expression he may make an investment in preparation to perform his duties under the contract that will be wasted if the promisor does not perform hers. The promisee should not be put in this dilemma where the promisor has created the problem by engaging in ambiguous conduct or using an ambiguous expression and, as is typically the case, the cost of clarifying the promisor’s intention would be close to zero. In such a case it is reasonable for the promisee to request adequate assurance that the promisor will perform. If the promisee makes such a request the promisor should be required to provide the assurance, and if she does not, she should be deemed to be in breach. Case 2. Apparent material breach. A promisor may appear to have engaged in conduct that constitutes a material breach but it may be unclear whether the promisor actually did engage in the conduct. The promisee should be entitled to assurance that the promisor did not engage in such conduct, because unless such assurance is given the promissee would be put in the same type of dilemma as in Case 1. As in Case 1, the promisor should be required to give adequate assurance that she will perform, especially because here too the cost to the promisor of clarifying whether she engaged in conduct constituting a material breach normally would be close to zero. Case 3. Breach by the promisor of other contracts with the promisee or comparable contracts with third parties. Suppose the promisor breaks other contracts with the promissee, or breaks contracts with third parties that are comparable to her contract with the promisee. In such cases too it is reasonable for the promisee to require adequate assurance that the promisor will perform his contract. As stated in the Official Comment Sec. 2-​508: 1.  Larry T. Garvin, Adequate Assurance of Performance: Of Risk, Duress, and Cognition, 69 U. Colo. L. Rev. 69, 72 (1998).

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Under commercial standards and in accord with commercial practice, a ground for insecurity need not arise from or be directly related to the contract in question. . . . [A]‌buyer who contracts for precision parts that he intends to use immediately upon delivery, may have reasonable grounds for insecurity if he discovers that the seller is making defective deliveries of such parts to other buyers with similar needs.

The principle of adequate assurance was not widely recognized under classical contract law, probably because classical contract law focused on the literal provisions of contracts at the time they were made and as White and Summers point out: All demands for adequate assurance call for more than was originally promised under the contract, and that is precisely what 2-​609 authorizes. If, for example, it was appropriate to sell on open credit at the outset of a contract but subsequent events cause insecurity, 2-​609 calls for modification of the contract to provide greater security to the seller than the seller could have demanded, absent such insecurity. Thus it is the very purpose of 2-​609 to authorize one party to insist upon more than the contract gives.2

The principle of adequate assurance is actually more faithful to contracts than was classical contract law, because, as stated in the Official Comment to UCC Section 2-​609(1): “A contract for sale imposes an obligation on each party that the other’s expectation of receiving due performance will not be impaired” and “[a]‌a continuing sense of reliance and security that the promised performance will be forthcoming when due, is an important feature of [a] bargain.” Accordingly, a requirement of adequate assurance, where appropriate, far from departing from a contract, actually brings the contract into compliance with the parties’ intent. Although there were some early harbingers of the principle of adequate assurance, for all intents and purposes the principle entered contract law with the adoption of UCC Section 2-​ 609. Eventually, the principle was extended beyond contracts for the sale of goods. For example, Restatement Second Section 251 provides: Where reasonable grounds arise to believe that the obligor will commit a breach by non-​ performance that would of itself give the obligee a claim for damages for total breach under §243, the obligee may demand adequate assurance of . . . due performance and may, if reasonable, suspend any performance for which he has not already received the agreed exchange until he receives such assurance. The obligee may treat as a repudiation the obligor’s failure to provide within a reasonable time such assurance of due performance as is adequate in the circumstances of the particular case.

Today, the principle of adequate assurance has ample although not universal support in the case law. The leading example is Norcon Power Partners v. Niagra Mohawk Power Co.3 Norcon, an independent power producer, and Niagara Mohawk, a public utility, entered into a contract under which Niagara Mohawk agreed to purchase electricity generated at Norcon’s facility for twenty-​five years, with the aim of reselling the electricity to Niagara Mohawk customers. Under the contract there were three pricing periods. In the first period Niagara Mohawk was to 2.  James J. White & Robert S. Summers, Uniform Commercial Code § 7-​2, at 278 (6th ed. 2010). 3.  705 N.E.2d 656 (N.Y. 1988).

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pay Norcon 6¢ cents per kilowatt-​hour for electricity. In the second and third periods Niagara Mohawk was to make payments based on its “avoided cost,” that is, the cost that Niagara Mohawk would have incurred to either generate electricity itself or purchase the electricity from other sources. If in the second period the avoided cost fell below a designated floor Niagara Mohawk was obliged to pay the floor price. If the avoided cost rose above a designated ceiling, Niagara Mohawk’s payments were capped by a ceiling price. An adjustment account tracked the difference between payments actually made by Niagara Mohawk in the second period and what those payments would have been if they were based solely on Niagara Mohawk’s avoided cost. (The third period was not in issue in Norcon.) In February 1994 Niagara Mohawk presented Norcon with a letter stating its belief that the cumulative adjustment account would reach over $610 million by the end of the second period, and asked for assurance that Norcon would pay whatever was owing. Norcon did not give such an assurance and instead brought suit in federal court for a declaratory judgment that there was no right to adequate assurance under New York law. The federal district court held for Norcon. On appeal the Second Circuit preliminarily agreed with the District Court that no right to demand adequate assurance existed under New  York law. However, because of the uncertainty concerning the issue the Second Circuit certified the following question to the New York Court of Appeals: Does a party have the right to demand adequate assurance of future performance when reasonable grounds arise to believe that the other party will commit a breach by non-​performance of a contract governed by New York law, where the other party is solvent and the contract is not governed by the UCC?4

The New York Court of Appeals answered the question in the affirmative: New  York, up to now, has refrained from expanding the right to demand adequate assurance of performance beyond the Uniform Commercial Code. This Court is now persuaded that the policies underlying the UCC 2-​609 counterpart should apply with similar cogency for the resolution of this kind of controversy. A useful analogy can be drawn between the contract at issue and a contract for the sale of goods. If the contract here was in all respects the same, except that it was for the sale of oil or some other tangible commodity instead of the sale of electricity, the parties would unquestionably be governed by the demand for adequate assurance of performance factors in UCC 2-​609. We are convinced to take this prudent step because it puts commercial parties in these kinds of disputes at relatively arm’s length equilibrium in terms of reliability and uniformity of governing legal rubrics. . . . to resolve their own differences, perhaps without the necessity of judicial intervention. Open, serious renegotiation of dramatic developments and changes in unusual contractual expectations and qualifying circumstances would occur because of and with an eye to the doctrine’s application.5

4.  Id. at 658. 5.  Id. at 661–​62.

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Augmented Sanctions: Material Breach, Total Breach, and Opportunistic Breach; Cure; Suspension and Termination Ev ery b reach of c ontract, even i f i m m ateria l , g i ves the pro m-

isee the right to recover expectation damages. For example, if A and B make a contract under which B will construct a twenty-​story office building for A, and the lighting in one office does not meet contract specifications, A can sue B for the cost of repairing or replacing the defective lighting, however low that cost may be. Under certain circumstances a promisee may have the right to invoke more draconian remedies, including damages measured on the basis that the promisor totally failed to perform the contract (as opposed to damages measured only by the harm from breach of a particular term) or suspension and termination of the contract. For ease of exposition, in this book these remedies will be referred to collectively as augmented sanctions. The remedy of termination may be especially severe, because if a promisee properly terminates a contract on the ground of the promisor’s breach, the promisor will lose both the future value of the contract and the contract price of her work prior to the breach (although she may be entitled to restitution for the value of any benefit that she conferred). The issue considered in this chapter is what principles should and do determine the kinds of breach that will give rise to one or more augmented sanctions.

I.   T E R MI N O L O G Y A ND DEF I NI T I ONS The law governing augmented sanctions, and particularly termination, which is the most draconian and important of these sanctions, is in disarray, for two reasons.

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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The first reason concerns terminology and definitions. The traditional term used to describe the kind of breach that gives rise to termination is material breach. For example, Perillo states that “Where a party fails to perform a promise, it is important to determine if the breach is material. If the breach is material, and no cure is forthcoming, the aggrieved party may cancel the contract and may sue for total breach.”1 Restatement Second takes a much different approach. The Restatement’s provisions are not a model of clarity, partly because they turn on the language of conditions, which is both inappropriate and confusing in this context. However, Allan Farnsworth, who was the Chief Reporter for most of Restatement Second, including the provisions dealing with augmented sanctions, set out a clear exposition of the way in which Restatement Second addresses those issues (although not the way in which these issues should be addressed). Farnsworth stated that under Restatement Second the remedy of termination involves a two-​step process. In the first step the promisee can suspend his performance if “the breach is material, that is, sufficiently serious to warrant this response.”2 In the second step the promisee can terminate the contract after an appropriate time has passed and the breach still has not been cured, that is, remediated.3 In that event, the breach is referred to not as a material breach, but as a total breach. In other words, under Restatement Second a material breach is one that justifies the promisee in suspending his performance, but does not without more justify the promisee in terminating the contract. This approach departs from the conventional and better usage, under which a material breach, without more, justifies the promisee in terminating the contract. Once the term material breach is properly defined, the term total breach becomes unnecessary and should not be employed. In addition to employing conflicting terminologies, the authorities often substitute laundry lists for definitions. For example, Restatement Second Section 241 provides that in determining whether a defective performance by the promisor is material, and therefore justifies the promisee in suspending his performance, the following circumstances are significant:

(a) the extent to which the injured party will be deprived of the benefit which he reasonably expected; (b) the extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived; (c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture; (d) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances; (e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.

Section 242 adds more items to the laundry list: In determining the time after which a party’s uncured material failure to render or to offer performance discharges the other party’s remaining duties, the following circumstances are significant: (a) those stated in § 241; 1.  John D. Calamari & Joseph M. Perillo, Calamari and Perillo on Contracts 374 (6th ed. 2009). 2. E. Allan Farnsworth, Contracts 562 (4th ed. 2004) (emphasis in original). See Restatement (Second) of Contracts § 247 (Am. Law Inst. 1981) [hereinafter Restatement Second]; id. at cmt. a. 3.  Farnsworth, supra note 2, at 562.

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(b) the extent to which it reasonably appears to the injured party that delay may prevent or hinder him in making reasonable substitute arrangements; (c) the extent to which the agreement provides for performance without delay, but a material failure to perform or to offer to perform on a stated day does not of itself discharge the other party’s remaining duties unless the circumstances, including the language of the agreement, indicate that performance or an offer to perform by that day is important.4

No area of law can be properly developed on the basis of conflicting definitions or the use of laundry lists in lieu of definitions. In this book the term material breach will be used to mean a breach that justifies a promisee in terminating the contract. The definition of material breach and related terms will be further developed in the balance of this chapter. The second reason why the law governing augmented sanctions is in disarray is that courts and commenters tend to determine the applicability of these sanctions on only one dimension, such as the likelihood of future performance by the promisor, when in fact four dimensions should be taken into account:  the likelihood of future performance by the promisor, the economic significance of the breach, whether the breach was opportunistic, and the possibility of cure.

I I .   T H E L I K E L I HOOD OF   F UT UR E P E R F O R MA N C E BY  T HE PR OM I S OR In “A New Look at Material Breach in the Law of Contract”5 Eric Andersen forcefully argued that a promisee has two expectation interests:  an interest in the promisor’s performance of obligations that have become due, and an interest in the probability that the promisor will perform obligations that will become due. Andersen points out that serious invasion of the second interest should constitute a material breach.6

4.  See also Principles of the Law of Software Contracts § 3.11 (Am. Law Inst. 2010): (a) A  breach occurs if a party without legal excuse fails to perform an obligation as required by the agreement. (b) An uncured breach, whether or not material, entitles the aggrieved party to remedies. (c) In determining whether a breach is material, significant factors include: i.  The terms of the agreement ii.  Usage of trade, course of dealing, and course of performance; iii.  The extent to which the aggrieved party will be deprived of the benefit reasonably expected iv. The extent to which the aggrieved party can be adequately compensated for the part of the benefit deprived v.  The degree of harm or likely harm to the aggrieved party; and vi. The extent to which the behavior of the party failing to perform or to offer to perform departs from standards of good faith and fair dealing. . . . (e) The cumulative effect of nonmaterial breaches may be material.

5. 21 U.C. Davis L. Rev. 1073, 1095–​101 (1988). 6.  Id. at 1101–​05.

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III.   T H E E C O N O MI C S I GNI F I CA NCE O F   T H E   B R EA CH Whether a breach is material should also depend on its economic significance. In considering the economic significance of a breach. For the purpose of applying an augmented sanction, breaches can be ranged along a spectrum that runs from economically immaterial to economically material. The location of a breach on this spectrum depends on two variables: (1) the ratio between the loss to the promisee that results from the breach and the total value of the contract to the promisee (the loss-​to-​total value ratio), and (2) whether the breach is remediable by the promisee at low cost.

A.  ECONOMICALLY IMMATERIAL BREACHES At one end of the spectrum are cases in which either the loss-​to-​total value ratio of a breach is low, or the breach is easily remediable by the promisee. In such cases the breach is economically immaterial. An example is the failure to provide the required lighting in one office in the office-​building hypothetical. If a breach is economically immaterial it should not and will not give rise to an augmented sanction, because if a breach either inflicts a loss that is only a small fraction of the total value of the contract to the promisee or is easily remediable by the promissee, it is reasonable and fair that the promisee should remediate the breach and sue for conventional expectation damages rather than have the right to invoke an augmented sanction.

B.  ECONOMICALLY MATERIAL BREACHES At the other end of the economic-​significance spectrum are cases where the loss-​to-​total value ratio is very high and the breach is not easily remediable by the promisee. Such breaches are economically material and should give the promisee the right to invoke any augmented sanction, including termination. This is so for two reasons. First, the commission of an economically material breach is a strong indication that further performance by the promisor will not be forthcoming. Second, a contract reflects a deal, a deal is a relationship, and an economically material breach fractures the relationship unless the breach is inadvertent and promptly cured.

C.  ECONOMICALLY SIGNIFICANT BREACHES In the middle of the economic-​significance spectrum are breaches that are remediable by the promise, but not easily, and involve a moderate but not high loss-​to-​total value ratio. In this book breaches of this type will be referred to as economically significant breaches. An economically significant breach should and does give the promisee the right to suspend his performance unless the breach is cured by the promisor within a reasonable time after the promisee notifies

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the promisor that she is in breach, and that the promisee will suspend his performance unless the breach is promptly remediated and will terminate the contract if remediation does not occur shortly thereafter.

I V.   O P P O RT U N I S T I C  BR EA CH The term opportunism is widely used but not well-​defined. In this book, the term opportunistic breach will be used to mean a breach that is committed, not inadvertently, as where the promisor simply misinterprets the contract or where the breach results from a third party’s fault, but deliberately, for the purpose of realizing a greater gain than she would realize through performance. Robert Hillman has argued that the courts should try to keep contractual relationships together by obliging a promisee to accept a fresh offer by a breaching promisor to perform, provided that acceptance of the offer would reduce the promisee’s damages, the promisee can comply with the fresh offer, the promisor’s fresh offer is the best available offer, the promisee is free to pursue his rights under the original contract even after accepting the fresh offer, and the promisor gives adequate assurance that she will perform under the offer.7 However, where a party opportunistically fractures a relationship the courts cannot put the relationship back together and should not try to do so. If A and B are partners and A breaks B’s nose with a punch, nothing would justify a court in trying to keep the relationship together with an injunction. If A and B are married and A is unfaithful, nothing would justify a court in forcibly trying to keep the relationship together by refusing to grant a divorce decree. Similarly, an opportunistic breach by a promisor wrongfully fractures the contractual relationship, and the courts should not forcibly try to keep the contractual relationship together against the promisee’s will.

V.   C UR E If a promisor commits a breach that was neither material nor opportunistic, and the breach is curable, that is, if the effect of the breach is reversible, she should be able to avoid the imposition of an augmented sanction by curing the breach promptly after the promisee gives her notice that she is in breach, that accordingly the promisee will suspend his performance under the contract, and that unless she promptly cures the breach he will terminate the contract. The principle of cure is justified by efficiency and fairness. In terms of efficiency, as stated by Robert Hillman, “A policy that permits cure of breach and generally fosters further dealing between the contracting parties after contract breakdown, and which leaves the injured party whole, is therefore desirable.”8 In terms of fairness, as stated by Joseph Perillo, “a rule that requires the aggrieved party to itemize defects and to allow cure is consistent with civilized norms 7.  Robert A. Hillman, Keeping the Deal Together after Material Breach—​Common Law Mitigation Rules, the UCC, and the Restatement (Second) of Contracts, 47 U. Colo. L. Rev. 553, 555 (1976). 8.  Supra note 6.

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of behavior.”9 The principle of cure may also prevent forfeiture where it is unclear whether a breach is material. The principle of cure should not apply to economically immaterial or opportunistic breaches because economically immaterial breaches do not give rise to augmented sanctions. Opportunistic breaches fracture the parties’ relationship. Generally speaking, the principle of cure was not recognized under classical contract law, on the ground that once a breach occurs the contract is over.10 In contrast, modern contract law accords recognition to the principle of cure. The principle was introduced into modern contract law by UCC Section 2-​508 as a method for avoiding the perfect-​tender rule that otherwise applied to a breach of a contract for the sale of goods.11 Under Section 2-​508(2), “Where the buyer rejects a non-​conforming tender which the seller had reasonable grounds to believe would be acceptable with or without money allowance the seller may if he seasonably notifies the buyer have a further reasonable time to substitute a conforming tender.” Section 2-​508(2) is a radical departure from classical contract law because it allows a seller who failed to make a perfect tender within the time specified in the contract to make a substituted tender after that time, provided the seller had reasonable grounds to believe that the tender would be acceptable. A leading and instructive case on cure, albeit one that is addressed to cure as a limit on the perfect-​tender rule is T.W. Oil Inc. v. Consolidated Edison Co.12 In January 1974, T.W. Oil purchased a cargo of fuel oil whose sulfur content was represented as no greater than 1 percent. While the oil was still at sea, en route to the United States in the tanker MT Khamsin, plaintiff received a certificate from the foreign refinery where the oil had been processed, stating that the sulfur content was .52 percent. On January 24, plaintiff entered into a contract with Con Ed for sale of the oil which was described as having a sulpher contect of .5 percent. Under the contract, delivery was to take place between January 24 and January 30, and payment was subject to confirmation of quality and quantity by a designated independent testing agency. At this time, Con Ed was authorized to buy and burn oil with a sulfur content of up to 1 percent, and could mix oils containing less than 1 percent sulfur to maintain that figure. When the Khamsin arrived on January 25, its cargo was discharged into Con Ed storage tanks. In due course, the independent testers reported that the oil had a sulfur content of .92 percent. On this basis, Con Ed rejected the shipment. Negotiations to adjust the price failed. By February 20, plaintiff had offered a price reduction roughly responsive to the difference between .5 and .92 percent in sulfur readings, but Con Ed rejected this proposition out of hand even though it could use oil with .92 percent sulfur. Instead, Con Ed insisted on paying no more than the latest prevailing market price, which was 25 percent below the market price when Con Ed contracted with T.W. Oil and agreed to buy the oil. The next day, February 21, plaintiff offered to cure the defect with a substitute shipment of conforming oil scheduled to arrive on February 28 on the Appollonian Victory. On February 22, Con Ed rejected this proposal too. The Khamsin and Appollonian oil was subsequently sold 9.  Calamari & Perillo, supra note 1, at 375. 10.  See William H. Lawrence, Cure after Breach of Contract under the Restatement (Second) of Contracts: An Analytical Comparison with the Uniform Commercial Code, 70 Minn. L. Rev. 713, 717–​18 (1986). 11.  See Chapter 51, infra. 12.  443 N.E.2d 932 (N.Y. 1982).

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to third parties at the best price obtainable. Plaintiff sued Con Ed for breach of contract, and recovered a verdict of $1,385,513, the difference between the original contract price and the amount received from the resale of the oil. The Court of Appeals affirmed: . . . [W]‌e focus on subdivision [UCC 2-​508 (2)] . On its face, taking its conditions in the order in which they appear, for the statute to apply (1) a buyer must have rejected a nonconforming tender, (2) the seller must have had reasonable grounds to believe this tender would be acceptable (with or without money allowance), and (3) the seller must have “seasonably” notified the buyer of the intention to substitute a conforming tender within a reasonable time. In the present case, none of these presented a problem. The first one was easily met for it is unquestioned that, at .92%, the sulfur content of the Khamsin oil did not conform to the .5% specified in the contract and it was rejected by Con Ed. The second, the reasonableness of the seller’s belief that the original tender would be acceptable, was supported not only by unimpeached proof that the contract’s .5% and the refinery certificate’s .52% were trade equivalents, but by testimony that, by the time the contract was made, the plaintiff knew Con Ed burned fuel with a content of up to 1%, so that, with appropriate price adjustment, the Khamsin oil would have suited its needs even if, at delivery, it was, to the plaintiff ’s surprise, to test out at .92%. Further, the matter seems to have been put beyond dispute by the defendant’s readiness to take the oil at the reduced market price on February 20 . . . . As to the third [requirement,] the conforming state of the Appollonian oil is undisputed, the offer to tender it took place on February 21, only a day after Con Ed finally had rejected the Khamsin delivery and the Appollonian substitute then already was en route to the United States, where it was expected in a week and did arrive on March 4, only four days later than expected. Especially since Con Ed pleaded no prejudice (unless the drop in prices could be so regarded), it is almost impossible . . . to quarrel with the finding that the remaining requirements of the statute also had been met.13

Following the lead of UCC Section 2-​508, Restatement Second Section 322 adopted a principle of cure that is applicable to all contracts, not only contracts for the sale of goods. This Section provides that “it is a condition of each party’s remaining duties to render performances to be exchanged under an exchange of promises that there be no uncured material failure by the other party to render any such performance due at an earlier time.” Where cure is justifiable it gives the promissee a little breathing space to repudiate a non-​ opportunistic breach before the promisee invokes an augmented sanction.

V I .   T H E I N T E R E S T OF   T HE PR OM I S OR An important issue is whether the promisor’s interest should be taken into account in determining whether an augmented sanction should be applied. Most authorities take the view that it should, to avoid forfeiture by the promisor. For example, in Jacobs & Youngs, Inc. v.  Kent,14 Cardozo said that in determining whether termination is permissible “We 13.  Id. at 937–​38. 14.  129 N.E. 889, 891 (N.Y. 1921).

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must weigh the purpose to be served, the desire to be gratified, the excuse for deviation from the letter, the cruelty of enforced adherence.” Similarly, Restatement Second Section 241(b) provides that one element in determining whether a breach justifies the promisee in suspending or eventually terminating the contract is the extent to which the breaching party will suffer forfeiture. In the case of a material breach, the position that the remedy of termination is designed to protect the promisee by discharging his obligations under the contract, and allowing him to swap out his future relationship with the promisor with an economic equivalent elsewhere does not take the promisor’s interest into account. This is preferable to the position of Cardozo and Restatement Second. For one thing, a breaching promisor will seldom suffer forfeiture under modern law, because usually she will be entitled to restitution for any benefit she conferred prior to the breach. By way of analogy, in Kryer v. Driscoll,15 a substantial-​ performance case,16 Kryer had agreed to construct a home for the Driscolls for $49,835. At the end of construction the Driscolls refused to pay the unpaid balance of the contract price because Kryer had breached the contract in several respects. Kryer then brought suit for the unpaid balance. The proposition that a party in breach, even material breach, can sue for restitution for benefit conferred is supported by most authorities and many although not all of the cases. However, a party in breach may be denied restitution on several grounds, including (1) he cannot establish that the defendant will get a windfall if he is not required to pay restitution, (2) the breach was in bad faith, (3) the contract has a valid condition discharging the defendant from an obligation to pay for the performance rendered, and (4) the contract has a valid liquidated damage clause allowing the defendant to retain the performance on breach as liquidated damages. The Wisconsin Supreme Court held that Kryer had not substantially performed the contract but that he had a right to recover in restitution for the benefit conferred. The court went on to hold that where the promisor’s performance is incomplete but remediable, the benefit that the promisor conferred on the promisee should be measured by the unpaid contract price less the cost of completion plus any additional harm to the promisee: In this case the Driscolls have a house which now meets the conditions of the contract with adjustments made for delay in performance and for minor faulty work. It would be unjust to allow them to retain the $10,968. They should not receive a windfall because of the plaintiff ’s breach. The trial court found the dwelling was reasonably worth the purchase price and thus the amount found due the plaintiff by the court does not exceed the benefit actually received by [the] Driscolls.17

This measure of benefit conferred is identical to expectation damages. Furthermore, the interest of the promisor is taken into account, albeit indirectly, by another rule: if a promisee terminates a contract on the ground that the promisor has committed a material breach and the court determines that the promisor’s breach was not material, the

15.  159 N.W.2d 680 (Wis. 1968). 16.  On substantial performance, see Chapter 51, infra. 17.  Kryer, 159 N.W.2d at 683.

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promisee’s termination is unjustified and therefore itself constitutes a material breach. For example, in Walker & Co v.  Harrison,18 Harrison had a dry-​cleaning business and Walker was in the business of selling, renting, and servicing advertising signs and billboards. The parties entered into an agreement under which Walker would construct and install an advertising-​ pylon sign on Harrison’s property and rent it to Harrison for thirty-​six months at $148.50 per month. The contract provided that Walker would maintain and service the sign, and that “this service is to include cleaning and repainting of sign in original color scheme as often as deemed necessary by lessor to keep sign in first class advertising condition. . . .” Under Paragraph G of the contract, upon a default in payment by Harrison, Walker could terminate the contract and recover all amounts due under the balance of the lease. The sign was completed and installed in late July 1953. Shortly thereafter the sign was hit with a tomato, rust was visible on the sign’s chrome, there were little spider cobwebs in the sign’s corners, and some children’s sayings were written on the pylon. Harrison repeatedly called on Walker to fix these problems, but no fixes were forthcoming. On October 8, Harrison notified Walker that he was terminating the contract. Walker replied, “Unless we receive both the September and October payments by October 25th, this entire matter will be placed in the hands of our attorney for collection in accordance with paragraph G. . . .” Harrison made no additional payments, and Walker sued him for the entire balance due under the contract, $5,197. The court held for Walker: . . . Repudiation is one of the weapons available to an injured party in the event the other contractor has committed a material breach. But the injured party’s determination that there has been a material breach, justifying his own repudiation, is fraught with peril, for should such determination, as viewed by a later court in the calm of its contemplation, be unwarranted, the repudiator himself will have been guilty of material breach and himself have become the aggressor, not an innocent victim. . . . Granting that Walker’s delay (about a week after defendant Herbert Harrison sent his telegram of repudiation Walker sent out a crew and took care of things) in rendering the service requested was irritating, we are constrained to agree with the trial court that it was not of such materiality as to justify repudiation of the contract . . . 19

The rule applied in Walker dampens the ardor of a promisee to terminate a contract on the ground of material breach where the materiality of the breach is questionable.

V I I .   S UM M A RY The sanctions that should be available for breach performance by a promisor, over and above conventional expectation damages, must be considered across four dimensions: the likelihood of future performance by the promisor, the economic significance of the breach, whether the

18.  81 N.W.2d 352 (Mich. 1957). See also R.J. Berke & Co. v. J.P. Griffin, Inc., 367 A.2d 583, 586–​87 (N.H. 1976); Restatement Second § 374, ill. 1; Andersen, supra note 5, at 1116–​20. 19.  Walker, 81 N.W.2d at 355–​56.

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breach was opportunistic, and the principle of cure. If the promisor repudiates the contract, the breach is material, or the nature of the breach indicates that future performance the promisor probably will not be forthcoming, the promisee should have the right to suspend or terminate performance of the contract and sue for breach of the entire contract. If a breach is not material the promisor should be entitled to cure the breach, but if the breach is not cured within a reasonable time, the promisee should have the right to terminate the contract and to sue for damages for breach of the entire contract. If a breach is material or opportunistic the promisor should not have the right to cure the breach, and thereby prevent the promisee from invoking augmented sanctions, because a promisee should not be forced to continue to work with a promisor who has intentionally fractured the contractual relationship.

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The Principle of Substantial Performance I .   I N T R O DUCT I ON A promisor who has committed a material breach of contract cannot bring suit under the contract to recover expectation damages. However, if the promisor conferred a benefit on the promisee prior to her breach she should be able to and normally can recover restitutionary damages based on the value of the benefit. Suppose a promisor who has committed a breach that is not material seeks to recover expectation damages, subject to an offset for damages resulting from breach. Limiting the promisor to restitutionary damages in such a case could entail a significant disadvantage to the promisor because it is usually much easier to prove expectation damages than restitutionary damages. There are good reasons this disadvantage should not be imposed on a promisor when her breach was not material and her performance, although imperfect, was substantial. Denial of expectation damages on the ground that the promisor has committed an immaterial breach is usually not required by the contract itself, and if the parties had addressed the issue when the contract was made it is unlikely they would have agreed that any imperfection in performance, no matter how immaterial, would bar a suit for expectation damages. Indeed, in the case of complex performances, such as construction, it is often virtually impossible to render a performance that is completely defect-​free, and minor defects can ordinarily be cured either by the promisor or by a third party at the promisor’s expense. Moreover, a rule that barred suit for expectation damages in such cases would incentivize promisees to opportunistically exploit and perhaps even provoke a breach by the promisor.1 Accordingly, a promisor who has rendered substantial although imperfect performance and has not been fully paid should be entitled to bring suit for expectation damages, subject to an offset for damages resulting from her breach. This is the principle of substantial performance, and that principle is the law, apart from a limited exception concerning contracts for the sale of goods (See Section II below).

1.  See Charles J. Goetz & Robert E. Scott, The Mitigation Principle: Toward a General Theory of Contractual Obligation, 69 Va. L. Rev. 967, 1010 (1983).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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II.   TH E T E S T F O R   W HAT CONS T I T UT ES S U B S TA N T I A L P E R F OR M A NCE The next question is: What should be the test for whether a party who is in breach has nevertheless substantially performed and therefore can recover expectation damages, subject to an offset for damages resulting from her breach? The primary element in such a test should be the extent to which the breach deprived the promisee of the benefit he reasonably expected from the contract. Restatement Second sets out a multifactor test to determine whether substantial performance has occurred, and gives pride of place to the extent to which the breach deprived the promise of the benefit he reasonably expected.2 The second element in the Restatement Second test is the extent to which the promisee can be adequately compensated for the benefit he reasonably expected to receive. This second element is essentially an elaboration of the first, because the promisee will not be deprived of the benefit he reasonably expected to receive if he can easily remediate the promisor’s breach by contracting with an equally capable replacement promisor. Both of these elements focus on the effect of the breach on the promisee. However, some regard should also be given to the effect on the promisor of a determination that substantial performance did not occur. Accordingly, a third element of the test for substantial performance, also embodied in Restatement Second Section 241, should be the extent to which the promisor would suffer a forfeiture if she can only sue for restitutionary damages.

I II.   T H E E F F E C T O F  WI L L F UL NES S Under classical contract law a promisor could not invoke the principle of substantial performance if her breach was willful. This rule has gradually been losing force, as the meaning of willfulness for this purpose has evolved. Under an early view willfulness was essentially defined as a deliberate, as opposed to an inadvertent, deviation from the contract. This seems to have been what Cardozo had in mind when he suggested in Jacob & Youngs v. Kent that “the willful transgressor must accept the penalty of his transgression.”3 In contrast, in Vines v.  Orchard Hills,4 Judge Ellen Peters took a very forgiving view of what constitutes willfulness. Mr. and Mrs. Vines had contracted to buy, from Orchard Hills, a condominium in Connecticut, where Mr. Vines worked, for $78,000, and had paid $7,800 as a down payment. Before the closing date Mr. Vines’s employer transferred him to New Jersey. He and his wife therefore decided not to take title to the condominium, and sued to recover their deposit under the law of restitution. Despite the fact that the Vines’s breach was deliberate rather than inadvertent the court held that the breach was not willful, presumably because although it was deliberate it was not opportunistic. Modern contract law, as embodied in Restatement Second 2.  See Restatement (Second) of Contracts §§241 (listing factors that are significant in determining whether a breach is material), 237 cmt. d (“[t]‌he considerations in determining whether performance is substantial are those listed in § 241 for determining whether a failure is material”) (Am. Law Inst. 1981). 3.  Jacob & Youngs, Inc. v. Kent, 129 N.E. 889, 891(N.Y. 1921) (emphasis added). 4.  Vines v. Orchard Hills, Inc., 435 A.2d 1022, 1027 (Conn. 1980).

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Section 241(e), goes much further, by focusing on “the extent to which the behavior of the [promisor] . . . comports with standards of good faith and fair dealing.” This is the proper test. As stated in Vincenzi v. Cerro:5 We have in several cases approved the common statement that a contractor who is guilty of a “willful” breach cannot maintain an action upon the contract. . . . The contemporary view, however, is that even a conscious and intentional departure from the contract specifications will not necessarily defeat recovery, but may be considered as one of the several factors involved in deciding whether there has been full performance. . . . The pertinent inquiry is not simply whether the breach was “willful” but whether the behavior of the party in default “comports with standards of good faith and fair dealing”. . . . Even an adverse conclusion on this point is not decisive but is to be weighed with other factors, such as the extent to which the owner will be deprived of a reasonably expected benefit and the extent to which the builder may suffer forfeiture, in deciding whether there has been substantial performance.

IV.   C O N T R A C T S F O R  T HE S A L E OF   GOODS A.  COMMON LAW BACKGROUND Prior to the adoption of the Uniform Commercial Code the principle of substantial performance was not applied to contracts for the sale of goods. Instead, those contracts were governed by the perfect-​tender rule, which allowed a buyer to reject goods that failed to conform to the contract in any respect.6 As Learned Hand put it, the rule in sale-​of-​goods contracts allowed no leeway for any imperfections, so that there was no room for the doctrine of substantial performance.7 The perfect-​tender rule made a little sense, but not enough. The little sense it made was that forfeiture by the promisor is less likely in goods cases than services cases. Typically, services are rendered to the service-​purchaser’s property or person. As a result, if a service-​purchaser had the right to refuse to pay for the services on the ground that they were not perfect, the service-​ provider ordinarily could not retrieve the services and resell them. In contrast, if a buyer of goods refuses to accept a tender on the ground that the goods are not perfect, the seller can take the goods back and resell them elsewhere. Nevertheless, at least where the imperfection is small a seller may unjustifiably lose out under the perfect-​tender rule even in a sale-​of-​goods case. If the buyer rejects goods on the basis of a small imperfection the seller must spend time and money finding another buyer and transporting the goods from the first buyer to the second. Furthermore, after one buyer rejects goods other buyers may perceive the goods as tainted, and on the basis of this perception may be willing to pay only a discounted price. In short, the perfect-​tender rule, allowing a buyer to reject goods on the basis of slight imperfections, was unjustified.

5.  442 A.2d 1352, 1354 (Conn. 1982). 6.  A leading case was Norrington v. Wright, 115 U.S. 188 (1885). 7.  Mitsubishi Goshi Kaisha v. J. Aron & Co., 16 F.2d 185, 186 (2d Cir. N.Y. 1926).

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B. THE UCC UCC Section 2-​601 nominally adopts the perfect-​tender rule for contracts for the sale of goods:  “Subject to the provision of this Article on breach in installment contracts . . . if the goods or the tender of delivery fail in any respect to conform to the contract, the buyer may . . . reject [them].” However, other Sections of the UCC strip away most of the significance of Section 2-​601. 1. installment contracts . 

First, Section 2-​601 is by its terms inapplicable to installment contracts, that is, contracts that require or authorize the delivery of goods in separate lots to be separately accepted. Instead, installment contracts are governed by UCC Section 2-​612. Under that Section a buyer normally cannot reject an installment on the ground that it is imperfect unless the imperfection substantially impairs the value of the installment and cannot be cured. Furthermore, a nonconformity or default with respect to one or more installments does not justify the buyer in treating the entire installment contract as breached unless the nonconformity or default substantially impairs the value of the entire contract. 2. revocation of   acceptance . 

Next, the perfect-​tender rule set out in UCC Section 2-​601 applies only where a buyer rejects goods; it does not apply where a buyer accepts goods, later discovers a defect, and then seeks to revoke his acceptance. That case is governed by Section 2-​608. Under that Section a buyer may revoke his acceptance of nonconforming goods only if the nonconformity substantially impairs the goods’ value to him and he accepted the goods “(a) on the reasonable assumption that its non-​conformity would be cured and it has not been seasonably cured; or (b) without discovery of such non-​conformity if his acceptance was reasonably induced either by the difficulty of discovery before acceptance or by the seller’s assurances.” 3. good faith . 

Under UCC Section 1-​304 “Every contract or duty within [the UCC] imposes an obligation of good faith in its performance and enforcement.” Under Section 1-​201(20) good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing. A buyer who seizes on a minor defect to justify a rejection, which is really based on the fact that the contract is no longer favorable to him, should not be deemed to have satisfied the obligation to act in good faith. As stated in Printing Center of Texas, Inc. v. Supermind Publishing Co.,8 “Evidence of circumstances which indicate that the buyer’s motivation in rejecting the goods was to escape the bargain, rather than to avoid acceptance of a tender which in some respect impairs the value of the bargain to him, would support a finding of rejection in bad faith. . . . Thus, evidence of rejection of the goods on account of a minor defect in a falling market would in some instances be sufficient to support a finding that the buyer acted in bad faith when he rejected the goods.”9

8.  669 S.W.2d 779 (Tex. App. 1984). 9.  Id. at 784.

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The perfect-​tender rule of UCC Section 2-​601 is also significantly undercut by Section 2–​508. Section 2-​508(1) provides that “Where any tender or delivery by the seller is rejected because non-​conforming and the time for performance has not yet expired, the seller may seasonably notify the buyer of his intention to cure and may then within the contract time make a conforming delivery.” Section 2-​508(2) goes much further, by allowing a seller to cure even after the time performance has expired if “the seller had reasonable grounds to believe [the tender] would be acceptable with or without money allowance” and seasonably notifies the buyer of his intent to cure. T.W. Oil, Inc. v. Consolidated Edison Co.10 is a leading case under Section 2-​508. During the fuel shortage resulting from the Arab oil embargo in early 1974, T.W. Oil purchased a cargo of fuel oil, then on the high seas, which it intended to resell. The oil’s sulfur content was represented to T.W. Oil as no greater than 1 percent. While the oil was still en route to the United States in the tanker MT Khamsin, T.W. Oil received a certificate from the foreign refinery at which the oil had been processed, stating that the sulfur content of the oil was .52 percent. Thereafter, but before the Khamsin reached port, T.W. Oil entered into a contract with Con Ed for sale of the oil. Delivery was to take place between January 24 and January 30, with payment subject to confirmation of quality and quantity by a designated independent testing agency. Following a trade custom to round off sulfur content, the contract specifications described the sulfur content of the Khamsin oil as .5 percent. The Khamsin arrived on January 25, and its cargo was discharged into Con Ed storage tanks. The independent testing agency reported that the oil had a sulfur content of .92  percent, and on February 14 Con Ed rejected the shipment. T.W. Oil then offered a price reduction that was roughly correlated to the difference in market value between a .5 percent and a .92 percent sulfur reading. Con Ed rejected this proposal because it was insistent on paying no more than the then-​ market price of oil, which had fallen 25 percent below the contract price. Next T.W. Oil offered to cure the defect in the sulfur content with a substitute shipment of conforming oil that was scheduled to arrive on the Appollonian Victory on February 28, a month after the delivery date under the original contract. Con Ed rejected this proposal too. T.W. Oil then sold the Khamsin and Appollonian cargos to third parties, sued Con Ed, and recovered a verdict for $1,385,513, the difference between the contract price of $3,360,667 and the amount that T.W. Oil received from the sale of the Khamsin oil. The New York Court of Appeals held that Con Ed’s rejection of T.W.’s offer to cure was improper: based on Con Ed’s practice, a .92 percent sulfur content was within the range of contemplation of reasonable acceptability to Con Ed, and seasonable notice of its intention to cure had been given. [F]‌or [Section 2-​508] to apply . . . the seller must have had reasonable grounds to believe this tender would be acceptable (with or without money allowance), and . . . the seller must have “seasonably” notified the buyer of the intention to substitute a conforming tender within a reasonable time. . . . [T]‌he reasonableness of the seller’s belief that the original tender would be acceptable, was supported not only by unimpeached proof that the contract’s .5% and the refinery certificate’s .52% were trade equivalents, but by testimony that, by the time the contract was made, the plaintiff knew Con Ed burned fuel with a content of up to 1%, so that, with appropriate price adjustment, the Khamsin oil would have suited its needs even if, at delivery, it was, to the plaintiff ’s surprise,

10.  443 N.E.2d 932 (N.Y. 1982).

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to test out at .92%. Further, the matter seems to have been put beyond dispute by the defendant’s readiness to take the oil at the reduced market price on February 20. . . . [Furthermore], the conforming state of the Appollonian oil is undisputed, the offer to tender it took place on February 21, only a day after Con Ed finally had rejected the Khamsin delivery and the Appollonian substitute then already was en route to the United States, where it was expected in a week and did arrive on March 4, only four days later than expected. . . .11

The last word on the status of the perfect-​tender rule under the UCC belongs to the principal author of Article 2, Karl Llewelyn, as reported in a talk by Grant Gilmore: There was a considerable controversy in the early days of the Code as to why the Code had, apparently, although stating [a]‌strong substantial performance role in Section 2-​612 with respect to installment contracts, restated what many people considered [the] exploded theory of perfect tender in Section 2-​601. I think at that point few people realized how much substantial performance there was buried in other, apparently unrelated, sections of the code to cut back Section 2-​601. There was considerable tendency in the academic discussions of the problem in law review articles to say that Section 2–​601 was all wrong and what the draftsman ought to have done was to have adopted a straight substantial performance rule all the way through. I remember hearing Professor Llewellyn discuss this problem once. He put it this way: He said that one of his advisers in the early years of drafting the sales article had been a Mr. Hiram Thomas of Boston, a Boston lawyer, for whom Llewellyn had great admiration, indeed reverence. Llewellyn said there was one meeting at which Hiram Thomas explained why it was that the perfect tender rule of Section 2-​601 was right with respect to ordinary contracts and the substantial performance rule of Section 2-​612 was right with respect to installment contracts. Anyone who heard Mr. Thomas that day, said Llewellyn, would be in no doubt that both sections were right. Unfortunately, said Llewellyn, he had since forgotten exactly what it was that Mr. Thomas said, and Mr. Thomas had since died, so that there was no way of reconstructing just why it was that Section 2-​601 was a good section of its type and Section 2-​612 was a good section of its type. But Professor Llewellyn was adamant that they were both right and that Mr. Thomas had once known the reason. (Laughter)12

_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​

The doctrine of substantial performance bears an obvious relationship to the doctrine of mater­ ial breach. Both doctrines reflect the idea that although all breaches give rise to damages, some breaches may have other consequences as well. And both doctrines ordinarily distinguish between what could colloquially be called major or very important breaches, on the one hand, and minor or unimportant breaches, on the other. It has been said that the two doctrines are the opposite sides of the same coin: if a party has substantially performed, then any breach she may have committed is not material; if a party has committed a material breach, then her performance cannot be substantial. This view is exemplified in Restatement Second § 237, Illustration 11: A contracts to build a house for B, for which B promises to pay $50,000 in monthly progress payments equal to 85% of the value of the work with the balance to be paid on completion. When

11.  Id. at 937–​38. 12.  Comments of Grant Gilmore, in ALI–​ABA, Advanced ALI–​ABA Course of Study on Banking and Secured Transactions under the Uniform Commercial Code 145 (1968).

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A completes construction, B refuses to pay the $7,500 balance claiming that there are defects that amount to an uncured material breach. If the breach is material, A’s performance is not substantial and he has no claim under the contract against B, although he may have a claim in restitution (§ 374). If the breach is not material, A’s performance is said to be substantial, he has a claim under the contract against B for $7,500, and B has a claim against A for damages because of the defects.

This opposite-​sides-​of-​the-​same-​coin view may hold true in many cases but it is not true in all cases, and it masks an important difference between the doctrines of substantial performance and material breach. This difference can be brought out with a simple illustration. Suppose A and B are parties to a contract that A has breached in some way. If A has more or less completed his performance except for the breach, and B refuses to pay the contract price minus damages resulting from the breach on the ground that A has committed the breach, A would invoke the doctrine of substantial performance and sue B for the contract price minus damages. In contrast, if there is some disruption in A’s performance before she has more or less completed performance, and B terminates the contract, A may be unable to invoke the doctrine of substantial performance but may be able to assert that her breach was not sufficiently material to justify termination of the contract by B, so that B himself has committed a material breach. Similarly, suppose A commits a minor breach very early in her performance, and in response B terminates the contract. There is no question here of A invoking the principle of substantial performance, but A might be able to sue B for material breach on the ground that A’s breach was insufficiently material to justify termination. In short, the principle of material breach is related but not identical to the principle of substantial performance. The principle of substantial performance addresses the issue, when can a party who has breached a contract nevertheless bring suit under the contract. The principle of material breach addresses the issue, in the face of a breach by one party when can the nonbreaching party suspend the contract, terminate the contract, or sue for total breach.

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THE PRINCIPLE OF GOOD FAITH IN CONTRACT LAW

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The Principle of Good Faith in Contract Law It is a set tled principle of c on tr act l aw that a c on tr acti n g

party must perform his or her contractual duties in good faith.1 So, for example, Restatement Second Section 205 provides that “Every contract imposes upon each party a duty of good faith and fair dealing in its performance and it enforcement.” Comparably, UCC Section 1-​304 provides that “Every contract or duty within the Uniform Commercial Code imposes an obligation of good faith in its performance and enforcement.” The meaning of the duty of good faith is complex. At a minimum, a party must have acted in a way that he believed was proper, which is a subjective test. However, this subjective test is overlaid with several objective tests. First, it is not enough that an actor actually believed that her conduct was proper; her belief must be honest in the sense that it has some basis in social or critical morality. Next, although an actor’s belief need not be reasonable to be in good faith, it must at least be rational. Judge Friendly described this element in Sam Wong & Son v. New York Mercantile Exchange,2 where he stated that good faith presupposed “a minimal requirement of some basis in reason—​[although] not a showing that the . . . action constituted the optimal response. Absent some basis in reason, action could hardly be in good faith even apart from ulterior motive.”3 Finally, the duty of good faith should include or be accompanied by the observance of reasonable commercial standards of fair dealing—​another objective test.4 The principle of good faith has attracted unwarranted criticism. The critics object that the principle gives the court the power to remake the terms of a contract based “upon what might seem ‘fair and in good faith’ by each fact finder.”5 This criticism significantly overstates the extent of discretion the principle confers on the court. The principle merely gives the court license to find an obligation to be implicit in a contract based on the express terms of an agreement, the parties’ course of performance, their course of dealing, custom, the context of a contract more 1.  Mark P. Gergen is the coauthor of this chapter. 2.  735 F.2d 653 (2d Cir. 1984). 3.  Id. at 678 n.32. 4.  Under UCC § 1-​201(20) good faith means “honesty in fact and the observance of reasonable commercial standards of fair dealing.” 5.  English v. Fischer, 660 S.W.2d 521, 522 (Tex. 1983).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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generally, and the shared objectives of the parties as embodied in the contract. Courts that abuse this license are properly subject to criticism. But critics of the principle object to the license that it confers upon courts as a general matter. They have failed to make the case that the license has been abused in practice. Often the principle of good faith is used to prevent a party to a contract from abusing a discretionary power that he possesses under the contract. This use of the principle should be utterly uncontroversial when the discretionary power is possessed for a specific purpose and the party uses the power to achieve some other purpose, in order to advance his interests at the expense of the interests of the other party to the contract. For example, in Greer Properties, Inc. v. LaSalle Nat’l Bank6 a contract for the purchase and sale of land required the seller to clean up environmental waste while giving the seller the power to terminate the contract if cleanup turned out to be “economically impracticable.” The court held that it would be bad faith for the seller to invoke this clause to cancel the sale in order to sell the land for a higher price. Similarly, it is well established that when an obligation to accept performance is conditioned on the obligor’s satisfaction with the performance it is breach of contract for the obligor to reject performance in bad faith.7 The principle of good faith also has been used to prevent a party from abusing a general power to terminate a contract for the specific purpose of cheating the other party of a promised benefit. For example, it has been held bad faith for an employer to discharge an at-​will employee to avoid paying the employee an otherwise-due promised bonus.8 The obligation of good faith is implicit in the express terms of the parties’ agreement in these cases. The obligation is implicit in a term that creates a discretionary power when the parties did not intend the power to be absolute. In such cases the term good faith is being used in a way that is close to its ordinary use. Good faith means sincerity in its Latin form bona fide. Sincerity requires an object to which one can be true. In such cases the object is the purpose of the discretionary power, and good faith is exercising the power for the sincere reason of achieving that purpose. Sometimes the principle of good faith is used as a basis for finding an obligation to be implicit in an agreement based on the parties’ course of performance, their course of dealing, or custom. Nanakuli Paving & Rock Co. v. Shell Oil Co.9 is a leading case. Nanakuli, a paving company, had contracted to do a major paving project for the government. With no warning, Shell almost doubled the price of asphalt (from $44 to $76), trying to pass through a large increase in the price of petroleum, a major component of asphalt. The written contract gave Shell power to do this, because it required Nanakuli to pay the posted price (that is, the price posted by Shell for sale to all buyers) at the time of delivery. However, the parties’ practice and the custom in the industry had been for asphalt suppliers (including Shell) and aggregate suppliers to “price protect” paving companies and not pass through a price increase to a paving company, which worked under fixed price contracts. “Price protection” means that a supplier will not increase

6.  874 F.2d 457, 458, 460 (7th Cir. 1989). 7.  The test of good faith can be one of honesty or reasonableness depending on the character of the performance. See Morin Bldg. Prods. Co. v. Baystone Construction, Inc., 717 F.2d 413, 415 (7th Cir. 1983). 8.  Jordan v. Duff & Phelps, Inc., 815 F.2d 429, 438–​39 (7th Cir. 1987)); Fortune v. Nat’l Cash Register Co., 364 N.E.2d 1251, 1258 (Mass. 1977). 9.  664 F.2d 772, 805–​06 (9th Cir. 1981).

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the price charged to a contractor. Instead, the supplier will apply the posted price that is in place at the time the contractor made a bid long enough to allow the contractor to order the relevant commodity needed on the job. The court found price protection to be a term of the contract under the rules of interpretation in UCC Section 1-​201, and in the alternative that Shell’s action was a violation of the duty of good faith imposed by UCC Section 1-​304. In Sanders v.  FedEx Ground Package Systems, Inc.10 the principle of good faith is used in both of these ways, both to imply an obligation from custom and to constrain the exercise of a discretionary power. Sanders was an independent contractor who owned a FedEx route. He tried to purchase two routes that were owned by two other independent contractors, but a local manager refused to approve either purchase unless Sanders relinquished the route he owned. In the second instance the local manager ran the route Sanders had sought to purchase until another purchaser could be found. The jury found the refusal to approve the second purchase to be a breach of the principle of good faith. The New Mexico Supreme Court affirmed. The written contract between Sanders and FedEx did not give Sanders the right to purchase routes from other independent contractors. However, Sanders was able to show this right by his testimony and by custom, which he established with the testimony of other FedEx independent contractors. Under the custom FedEx had the power to disapprove a transfer of a route on the ground the purchaser was not qualified, and FedEx abused this power when it refused to approve the transfer to Sanders without justification. One criticism of the principle of good faith is that it is “actually an interpretive rule” that is “duplicative because the existing interpretive rules authorize courts to make precisely these evaluations,” and so it has “no meaningful role . . . to play.”11 Nanakuli Paving and Sanders show that there is something to this criticism. The breach of the principle of good faith was an alternative ground for the result in Nanakuli Paving alongside the interpretive rules. And the first step of the analysis in Sanders—​the finding that a FedEx independent contractor had the right to purchase a route from another independent contractor if qualified—​could be done as a matter of interpretation. The second step could then be explained in positive terms (Sanders was qualified and so had the right to purchase the route) rather than negative terms (FedEx acted in bad faith in refusing to approve the purchase), eliminating any need to refer to bad faith on the part of FedEx. The principle of good faith may be redundant with the rules of interpretation in these cases. But so what? We don’t throw out a new chocolate bar because it duplicates one we already have. Why get angry at a doctrine because it’s duplicative? Probably because you just don’t like the idea of good faith. Too bad. Redundancy can be a good thing in complicated systems in the law, just as it can be a good thing in engineering. In Nanakuli Paving and Sanders, the availability of the claim for breach of the principle of good faith reduced the risk that the court would reject the plaintiffs’ claims because the contract rights the plaintiffs asserted (to price protection and to purchase a route if qualified) did not appear in the text of the written contracts. The principle of good faith also reminds courts (and parties) that when a contract confers a discretionary power on a party this typically is for a purpose, and that it is a breach of contract for a party to exercise a discretionary power for an illegitimate purpose.

10.  188 P.3d 1200 (N.M. 2008). 11.  Alan Schwartz & Robert E. Scott, The Common Law of Contract and the Default Rule Project, 102 Va. L. Rev. 1523, 1577 (2016).

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In any event, the principle of good faith does work in some cases that cannot be done, or that cannot be as easily done, using the rules of interpretation. When an actor’s conduct in performance is really egregious the court can hold the conduct to be in bad faith without the court having to specify the point at which the actor’s conduct crossed the line between what is permissible and what is impermissible. Seggebrush v.  Stosar12 illustrates. A  lessee of a service station agreed to pay to the lessor a rent of 1¼¢ per gallon of gasoline sold on the premises. Two years into the five-​year lease, the lessee built a service station on adjacent property and began to sell gasoline there while making minimal sales at the leased station. The court held this to be a breach of contract, without invoking the principle of good faith. Instead the court found a tacit promise that “the lessee undertakes to operate the premises in such a way as to reasonably produce the rental contemplated by the parties at the time the contract was entered into.”13 The principle of good faith is superior to interpretation as a ground for the result in Seggebrush v. Stosar because interpretation requires the court to specify the content of the lessee’s performance obligation (as the court did), whereas the principle of good faith merely requires the court to conclude that the lessee’s performance violates the principle. The performance obligation the court found to be a tacit promise probably imposes a greater obligation on the lessee than the parties intended. It would have been easy to include an explicit term to require the lessee to make a “reasonable effort” to sell gasoline on the premises. Presumably the parties did not include such a term in the lease because the lessee wanted a free hand to manage the service station. But the lessee’s discretion is not absolute. The amorphousness of the principle of good faith allows the court to find a breach of the principle without having to specify the lessee’s performance obligation. The lessee’s conduct was egregious because the only consequence of the lessee building the service station on the adjacent property was to reduce the rent paid to the lessor to near zero. There was no change in the volume of gasoline sold. The principle of good faith also is superior to rules of interpretation as a tool for addressing unusual conduct in performance of a contract. There is unlikely to be a custom or a tacit understanding between the parties when the conduct at issue in a case is unusual. The principle of good faith enables a court to find unusual misconduct in performance to be a breach of contract without having to pretend to justify the decision by reference to intent or to custom. Market Street Associates v. Frey14 is such a case. The GE Pension Trust owned a shopping center through a twenty-​five-​year sale-​leaseback agreement. Presumably the sale-​leaseback was a device to transfer the considerable tax benefits of the investment in the shopping center to taxpaying investors. Market Street owned the leasehold interest, which had six years to run when the events that led to the litigation occurred. Under paragraph 34 of the sale-​leaseback contract the lessee, Market Street, could request the lessor, the pension trust, to finance improvements costing at least $250,000. If such a request was made, then the pension trust agreed to negotiate in good faith to provide financing, and, if negotiations failed, then after sixty days, the lessee had an option to repurchase the property for the original price increased by six percent per annum. In 1988, Orenstein, a manager of Market Street, requested Erb, a manager of the pension trust, to provide $2 million financing, but did not mention the contingent buy-​out provision. Ornstein replied that it was not interested in financing projects of less than $7 million. After sixty days, Market Street notified the pension 12.  33 N.E.2d 159 (Ill. 1941). 13.  Id. at 160. 14.  941 F.2d 588 (7th Cir. 1991).

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that it was exercising its option to buy back the property at a price of $1 million plus six percent per annum, calculated under the contract, which presumably was less than the market value of the property at the time. The pension trust refused to sell and Market Street brought suit for specific performance. The district court held for the pension trust on the ground that Market Street acted in bad faith by failing to mention paragraph 34 to the Pension Trust. When the Pension Trust refused to sell the property, Market Street brought a suit to compel specific performance. The district court dismissed the suit on a motion for summary judgment, holding Market Street to have violated the principle of good faith by failing to bring paragraph 34 to Erb’s attention. The Court of Appeals, in an opinion by Judge Posner, endorsed the application of the principle, although holding that the issue of bad faith could not be determined on a motion for summary judgment because it turned on Orenstein’s state of mind, specifically whether Orenstein believed that Erb was unaware of the buy-​out option and might not learn about it. Judge Posner explained: “If Orenstein believed that Erb knew or would surely find out about [the buy-​out option], it was not dishonest or opportunistic to fail to flag that paragraph, or even to fail to mention the lease.”15 In Market Street Associates Judge Posner explained the purpose of the principle of good faith in economic terms. Its purpose “is to forbid the kinds of opportunistic behavior that a mutually dependent cooperative relationship might enable in the absence of the rule.” To this end, the court should strive “to give the parties what they would have stipulated for expressly if at the time of making the contract they had had complete knowledge of the future and the costs of negotiating and adding provisions to the contract had been zero.” This resembles interpretation but the inquiry is into the parties’ predicted intent, and not their actual or likely intent.

15.  Id. at 598. On this view Orenstein would not have violated the principle of good faith if he did not lay a trap for Erb, but instead took advantage of Erb’s unexpected mistake in not realizing that the refusal to provide the requested financing would trigger the buy-​out option. This is debatable. The law of unilateral mistake might preclude Orenstein from taking advantage of Erb’s error, which is in the nature of a mechanical error and is not an error in judgment.

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f i f t y - ​t h r e e

Express Conditions I .   A N I N T R ODUCT I ON T O   E X P R E S S CONDI T I ONS Promises are one basic building block of contracts. Express conditions are another. In everyday language the term condition has various meanings. One meaning is state, as in “state of affairs.” Thus we say, “the patient’s condition (state) is good” or “the human condition (state) is tragic.” In contract law the term express condition normally refers to an explicit contractual provision that: (1) a party to a contract, although bound, does not come under a duty to perform unless and until a designated state of affairs or condition occurs or fails to occur; or (2) if a designated state of affairs or condition occurs or fails to occur a party’s duty to perform is suspended or terminated. (For ease of exposition, in the balance of this chapter the term occurrence will be used to include a specified nonoccurrence.) The occurrence of a state of affairs described by an express condition may lie outside the control of either party. For example, Corporations A and B may agree to merge on condition that the Internal Revenue Service rules that the merger will be tax-​free. Alternatively, the occurrence or nonoccurrence may lie partly or wholly within the control of only one of the parties. For example, in Scott v. Moragues Lumber Co.1 Scott and Moragues agreed that if Scott purchased a certain vessel he would charter it to Moragues. Here the express condition—​Scott’s purchase of the vessel—​was wholly within Scott’s control. Similarly, an express condition may qualify the obligations of both parties, as in the merger example, or may qualify the obligations of only one party, as where a buyer agrees to purchase a home on condition that a termite inspection shows that the home is termite-​free. There are several critical distinctions between promises and express conditions. One distinction concerns the meaning of each type of expression. A promise is a commitment to bring about a specified state of affairs or a commitment that a specified state of affairs will not occur. In contrast, an express condition is not a commitment. Instead, it qualifies a commitment by providing that a party is not obliged to perform a commitment unless a specified state of affairs (such as approval of a transaction by the Internal Revenue Service) occurs or fails to occur. Indeed, one reason why parties may use an express condition rather than a promise is that neither party is willing to make a commitment that the relevant state of affairs will or will not 1.  80 So. 394 (Ala. 1918).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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occur. In the merger case, for example, normally neither A nor B would be willing to make a commitment that the Internal Revenue Service will issue a favorable ruling. Under standard contract-​law terminology a promise is either performed or breached whereas an express condition is either fulfilled or not fulfilled. A second distinction between promises and express conditions concerns the sanctions for breach of a promise and for nonfulfillment of an express condition. The normal sanction for breach of a promise is damages. In contrast, the normal sanction for nonfulfillment of an express condition is not damages, because neither party promises that an express condition will be fulfilled,2 but suspension or termination of the contract by the party in whose favor the condition runs. Termination, in particular, is a very powerful sanction, because if a contract is justifiably terminated by one party the other party loses both the value of the contract and the agreed price of any work he has performed prior to termination (although he may have a right to a restitutionary recovery for any benefit conferred by that work). A third distinction between promises and express conditions is the manner in which sanctions for breach of a promise and nonfulfillment of a condition is normally invoked. The sanction for breach of a promise is normally invoked by bringing a suit for judicial relief. In contrast, the sanction for nonfulfillment of an express condition is normally invoked by self-​help termination of the contract, although the propriety of the termination is reviewable in court.

II.   T H E E F F E C T OF   I M PER F ECT F U L F I L L ME NT OF   A N E X P R E S S C O NDI T I ON Still another critical distinction between promises and express conditions concerns the effects of substantial but imperfect performance of a promise and of an express condition. If a promise is substantially performed, then even though the promise is not perfectly performed the promisor normally can sue for expectation damages, with an offset for damages resulting from the breach (see Chapter 13). In contrast, the traditional rule is that if an express condition is not perfectly fulfilled then even though the condition is substantially fulfilled the party in whose favor the condition runs has the right to terminate the contract. This rule will be referred to in this book as the perfect-​fulfillment rule. The perfect-​fulfillment rule is exemplified by Oppenheimer & Co. v. Oppenheim, Appel, Dixon & Co.3 Oppenheimer held a lease on the thirty-​third floor of One New York Plaza. In December 1980 Oppenheimer agreed to sublease the floor, for the remaining three years of its lease, to Oppenheim, Appel, which was already leasing space on the twenty-​ninth floor and was seeking to expand. A proposed sublease was attached to the parties’ agreement, but the agreement provided that the sublease would be executed only upon the satisfaction of certain conditions. One condition was as follows:  on or before January 2, 1987, Oppenheim Appel would submit to 2.  See, e.g., Merritt Hill Vineyards, Inc. v.  Windy Heights Vineyard, Inc., 460 N.E.2d 1077, 1081–​82 (N.Y. 1984). 3.  660 N.E.2d 415 (N.Y. 1995).

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Oppenheimer its plans for construction of a telephone-​communication-​linkage system between the twenty-​ninth and thirty-​third floors (“the tenant work”). Once these plans were submitted Oppenheimer had until January 30—​later extended to February 28—​to deliver to Oppenheim Appel the prime landlord’s written consent to the tenant work. If Oppenheim Appel had not received the prime landlord’s written consent by that date both the agreement and the sublease were to be deemed null and void and neither party was to have any rights against or obligations to the other. Oppenheimer did not deliver the prime landlord’s written consent to the tenant work by February 28. Instead, on that day Oppenheimer’s lawyer orally told Oppenheim Appel’s lawyer that the prime landlord had consented to the tenant work. The next day, Oppenheim Appel’s lawyer informed Oppenheimer that the agreement and sublease were null and void because of Oppenheimer’s failure to timely deliver the prime landlord’s written consent. (The prime landlord’s written consent was eventually delivered to Oppenheimer on March 20.) Oppenheimer then sued Oppenheim Appel for breach of contract. The jury found that Oppenheimer had substantially performed the consent-​ of-​ the-​ landlord condition, and awarded Oppenheimer damages of $1.2  million. The trial judge vacated the verdict on the ground that the doctrine of substantial performance has no application to conditions. The Appellate Division reversed on the ground that Oppenheimer’s failure to deliver the landlord’s written consent on the due date was inconsequential. The Court of Appeals reinstated the trial court’s decision on the ground that the principle of substantial performance was inapplicable to express conditions: If the parties “have made an event a condition of their agreement, there is no mitigating standard of materiality or substantiality applicable to the non-​occurrence of that event” (Restatement [Second] of Contracts § 237, comment d). “Substantial performance in this context is not sufficient . . . and if relief is to be had under the contract, it must be through excuse of the non-​ occurrence of the condition to avoid forfeiture . . . Here, it is undisputed that plaintiff has not suffered a forfeiture or conferred a benefit upon defendant.”4

The perfect-​fulfillment rule applied to express condition is unjustified, because just as the limits of cognition often prevent parties from fully appreciating the operation of liquidated-​ damages provisions (see Chapter  23), so too do those limits often prevent parties from fully appreciating the operation of express conditions. As in the case of liquidated-​damages provisions, bounded rationality plays an important role here. Most persons are likely to be unaware of both the legal distinction between the substantial but imperfect performance of promises and the substantial but imperfect fulfillment of express conditions, and the potentially draconian consequences of failure to perfectly fulfill an express condition. Furthermore, because parties normally expect to fulfill conditions, the consequences of less-​than-​perfect fulfillment will seem remote at the time the contract is made. As a result, parties are likely to view the costs of fully deliberating on the operation of an express condition as unduly high. Finally, the limits of cognition are likely to diminish a contracting party’s understanding of express conditions. The availability heuristic is likely to lead a contracting party to give undue weight to his present intention to perfectly fulfill an express condition, which is vivid and concrete, as compared to the possibility that future circumstances may lead to imperfect fulfillment, 4.  Id. at 419.

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which is pallid and abstract. Moreover, the tendency to underestimate risks will likely cause a contracting party to underestimate the risk that an express condition will not be perfectly fulfilled and that a draconian sanction will result. As with liquidated damages, the cases illustrate how express conditions raise issues of the limits of cognition. For example, in Holiday Inns of America, Inc. v. Knight,5 Holiday Inns and Knight (or more accurately, their predecessors in interest) entered into a contract on September 30, 1963, under which Knight granted Holiday Inns an option to purchase certain real estate for $198,633. The contract required Holiday Inns to make an initial payment of $10,000 and then, to keep the option alive, additional $10,000 payments on July 1 of each of the next four years. The contract further provided that “failure to make payment on or before the prescribed date will automatically cancel this option without further notice” (the time condition). Holiday Inns could exercise the option by giving written notice to Knight by April 1, 1968, unless the option was cancelled by Knight under the time condition. Holiday Inn’s purpose in making this contract was to secure the potential advantage of an increase in the value of the optioned property. Holiday Inns made large expenditures to develop a major residential and commercial center on land adjacent to the optioned property, which caused the optioned property to substantially increase in value. On June 30, 1966, Holiday Inns mailed Knight a $10,000 check for the 1996 installment. Knight received the check on July 2 and returned it to Holiday Inns, stating that the option contract was cancelled due to Holiday Inn’s failure to pay the 1966 installment by July 1 as required by the time condition. Holiday Inns sued for a declaratory judgment that the contract was still in effect. The California Supreme Court so held, on the ground that termination of the contract because the time condition was not perfectly fulfilled would result in a forfeiture: . . . On the basis of risk allocation, it is clear that each payment of the $10,000 installment was partially for an option to buy the land during that year and partially for a renewal of the option for another year up to a total of five years. With the passage of time, plaintiffs have paid more and more for the right to renew, and it is this right that would be forfeited by requiring payment strictly on time. At the time the forfeiture was declared, plaintiffs had paid a substantial part of the $30,000 for the right to exercise the option during the last two years. Thus, they have not received what they bargained for and they have lost more than the benefit of their bargain. In short, they will suffer a forfeiture of that part of the $30,000 attributable to the right to exercise the option during the last two years.6

The result was correct: it seems highly unlikely that Holiday Inns would have agreed ex ante that if an annual payment was one day late it would lose the value of the option and of all the payments it had made. Accordingly, the governing principle should be as follows: the imperfect fulfillment of an express condition should trigger a right to terminate a contract only if the nonfulfillment is significant and it is likely that the parties would have agreed that the sanction of termination could be exercised in the circumstances that actually arose. This principle will be referred to in this book as the express-​condition principle. Modern contract law gives effect to this principle

5.  450 P.2d 42 (Cal. 1969). 6.  Id. at 45.

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through a cluster of interrelated exceptions to the perfect-​fulfillment rule and through artificial rules of interpretation.

I I I .   E X C E P T I ONS T O  T HE P E R F E C T-​F U L FI L L M ENT   R UL E A. FORFEITURE The perfect-​fulfillment rule normally does not trigger a right to terminate a contract where termination would result in a forfeiture. This exception to the rule is codified in Restatement Second Section 229: “To the extent that the non-​occurrence of a condition would cause disproportionate forfeiture, a court may excuse the non-​occurrence of that condition unless its occurrence was a material part of the agreed exchange.” The Comment to Section 229 defines forfeiture as “the denial of compensation that results when the obligee loses his right to the agreed exchange after he has relied substantially, as by preparation or performance on the expectation of that exchange.” The Comment continues, “In determining whether the forfeiture is disproportionate, a court must weigh the extent of the forfeiture by the obligee against the importance to the obligor of the risk from which he sought to be protected and the degree to which that protection will be lost if the non-​occurrence of the condition is excused to the extent required to prevent forfeiture.” The Comment also makes clear that application of the forfeiture principle depends on the actual result of enforcing an express condition, rather than on the situation at the time the contract is formed. Accordingly, the forfeiture principle, like the liquidated-​damages principle (see Chapter 23) is explicitly based on a second-​look or ex post approach. As stated in the Comment to Section 229: Although both this Section and § 208, on unconscionable contract or term, limit freedom of contract, they are designed to reach different types of situations. While § 208 speaks of unconscionability “at the time the contract is made,” this Section is concerned with forfeiture that would actually result if the condition were not excused. It is intended to deal with a term that does not appear to be unconscionable at the time the contract is made but that would, because of ensuing events, cause forfeiture.

Illustration 1 to Section 229 exemplifies the forfeiture principle as follows: A contracts to build a house for B, using pipe of Reading manufacture. In return, B agrees to pay $75,000 in progress payments, each payment to be made “on condition that no pipe other than that of Reading manufacture has been used.” Without A’s knowledge, a subcontractor mistakenly uses pipe of Cohoes manufacture which is identical in quality and is distinguishable only by the name of the manufacturer which is stamped on it. The mistake is not discovered until the house is completed, when replacement of the pipe will require destruction of substantial parts of the house. B refuses to pay the unpaid balance of $10,000. A court may conclude that the use of Reading rather than Cohoes pipe is so relatively unimportant to B that the forfeiture that would result from denying A the entire balance would be disproportionate, and may allow recovery by A subject to any claim for damages for A’s breach of his duty to use Reading pipe.

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The forfeiture exception is amply, although not unanimously, supported by case law. Holiday Inns, discussed above, is a leading example. Similarly, in Hegeberg v.  New England Fish Co.7 Alaska salmon packers entered into a contract with a fishermen’s union, which provided that the fishermen would be paid an agreed-​upon minimum wage plus a bonus if an appraisal tribunal concluded that the fishermen were entitled to an additional amount. The tribunal so concluded, but its report, which was due by August 24, was filed two days late. The packers argued that the tribunal’s determinations were not binding because the time condition had not been fulfilled. The Washington Supreme Court rejected this argument on the ground that termination of the contract for this reason would result in a forfeiture: As has been frequently held, the imposition of an unjust or unreasonable penalty or forfeiture out of all proportion to the consequences of a breach will not be enforced. In the case at bar, the strict enforcement of the time limitation . . . would partake of the nature of a forfeiture, taking into consideration the money paid by the parties to the contract for the expenses of the appraisement, and the fact that a season’s work was performed by the fishermen, in reliance upon the prospective appraisement. . . .8 Even in Oppenheimer, a poster child for the perfect-​fulfillment rule, the court implicitly approved the forfeiture exception—​“If relief is to be had under the contract, it must be through exercise of the non-​occurrence of the condition to avoid forfeiture. . . .”9—​although the court concluded that on the facts of the case the exception did not apply:In determining whether a particular agreement makes an event a condition courts will interpret doubtful language as embodying a promise or constructive condition rather than an express condition. This interpretive preference is especially strong when a finding of express condition would increase the risk of forfeiture by the obligee. . . . Interpretation as a means of reducing the risk of forfeiture cannot be employed if “the occurrence of the event as a condition is expressed in unmistakable language. . . .” Nonetheless, the nonoccurrence of the condition may yet be excused by waiver, breach or forfeiture. The Restatement posits that “[t]‌o the extent that the nonoccurrence of a condition would cause disproportionate forfeiture, a court may excuse the non-​occurrence of that condition unless its occurrence was a material part of the agreed exchange” (Restatement [Second] of Contracts § 229).10

B.  LACK OF PREJUDICE Another exception to the perfect-​fulfillment rule, recognized by many courts, is that imperfect fulfillment of a condition will not give rise to a right to terminate the contract if the nonfulfillment did not materially prejudice the party in whose favor the condition ran. For example, in Aetna Casualty and Surety Co. v. Murphy,11Murphy terminated his lease of an office in late November 1982. The manner in which Murphy dismantled the office caused damages to the landlord. Aetna, the landlord’s insurer, paid for the damages, became subrogated to the landlord’s rights, and 7.  110 P.2d 182 (Wash. 1941). 8.  Id. at 187. 9.  Oppenheimer, 660 N.E.2d at 419. 10.  Id. at 418. 11.  538 A.2d 219 (Conn. 1988).

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sued Murphy. Murphy was insured against Aetna’s claim under a policy issued by Chubb, and Murphy sued Chubb under that policy. The Chubb policy provided that “in the event of an [insured] occurrence, written notice . . . shall be given by or for the insured to [Chubb] . . . as soon as practicable,” and that “If claim is made or suit is brought against the insured, the insured shall immediately forward to [Chubb] every demand, notice, summons, or other process received by him or his representative.”12 Murphy did not give Chubb notice of Aetna’s claim until January 1986. Chubb refused to pay on the ground that Murphy failed to give Chubb notice as soon as practicable, Murphy sued Chubb, and Chubb moved for summary judgment. The court said: . . . [E]‌nforcement of these notice provisions will operate as a forfeiture because the insured will lose his insurance coverage without regard to his dutiful payment of insurance premiums. [Furthermore], the insurer’s legitimate purpose of guaranteeing itself a fair opportunity to investigate accidents and claims can be protected without the forfeiture that results from presuming, irrebuttably, that late notice invariably prejudices the insurer. . . . . . . [A]‌proper balance between the interests of the insurer and the insured requires a factual inquiry into whether, in the circumstances of a particular case, an insurer has been prejudiced by its insured’s delay in giving notice of an event triggering insurance coverage. If it can be shown that the insurer suffered no material prejudice from the delay, the nonoccurrence of the condition of timely notice may be excused. . . . Literal enforcement of notice provisions when there is no prejudice is no more appropriate than literal enforcement of liquidated damages clauses when there are no damages.13

(However, the court held that Chubb was nevertheless entitled to summary judgment because the burden of establishing lack of material prejudice must be borne by the insured, and Murphy had failed to make the requisite showing.)

C.  CASES IN WHICH THE PURPOSE OF THE CONDITION WAS ACHIEVED Imperfect fulfillment of an express condition also should be and normally is excused where the purpose of the condition was achieved. For example, in Great American Ins. Co. v. C.G. Tate Construction Co.14 Great American had issued a policy to Tate Construction that obliged Great American to defend and indemnify Tate in connection with any incident covered by the policy. It was a condition to Great American’s obligations that Tate give notice of a covered incident as soon as practicable. An automobile accident occurred that might have been covered by the policy. Tate did not give notice to Great American as soon as practicable because it believed that its personnel had not caused the accident. Later, however, Tate sued Great American under the policy. The court held for Tate, despite nonfulfillment of the notice condition, on the ground that “the interpretation of the notice provision will be guided more by its purpose—​the reason for its inclusion in the insurance contract—​than by its seemingly conclusive terms.”15 12.  Id. at 220. 13.  Id. at 222–​23. 14.  279 S.E.2d 769 (N.C. 1981). 15.  Id. at 774.

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Similarly, Restatement Second Section 229, Illustration 2 provides: A, an ocean carrier, carries B’s goods under a contract providing that it is a condition of A’s liability for damage to cargo that “written notice of claim for loss or damage must be given within 10 days after removal of goods.” B’s cargo is damaged during carriage and A knows of this. On removal of the goods, B notes in writing on the delivery record that the cargo is damaged, and five days later informs A over the telephone of a claim for that damage and invites A to participate in an inspection within the ten day period. A inspects the goods within the period, but B does not give written notice of its claim until 25 days after removal of the goods. Since the purpose of requiring the condition of written notice is to alert the carrier and enable it to make a prompt investigation, and since this purpose had been served by the written notice of damage and the oral notice of claim, the court may excuse the non-​occurrence of the condition to the extent required to allow recovery by B.

D. IMPRACTICABILITY Imperfect fulfillment of an express condition is also normally excused where fulfillment was impracticable. For example, in Royal-​Globe Insurance Co. v. Craven16 Royal-​Globe had insured Craven against losses caused by uninsured motorists. The policy required Craven to notify the police and Royal-​Globe within twenty-​four hours of any loss. Craven was injured by an uninsured motorist, but did not give the required notice because he was in intensive care during the first twenty-​four hours after the accident. The court held that Craven’s nonfulfillment of the time condition was excused. Similarly, Illustration 2 to Restatement Second Section 230 provides: A, an insurance company, insures the property of B under a policy providing that no recovery can be had if suit is not brought on the policy within two years after a loss. A loss occurs. B lives in a foreign country and is prevented by the outbreak of war from bringing suit against A for two years. A’s duty to pay B for the loss is not discharged and B can maintain an action on the policy when the war is ended.

The impracticability exception is often conflated with the forfeiture exception, as exemplified by Illustration 2 to Restatement Second Section 271: A, an insurance company, issues to B a policy of accidental injury insurance which provides that notice within 14 days of an accident is a condition of A’s duty. B is injured as a result of an accident covered by the policy but is so mentally deranged that he is unable to give notice for 20 days. B gives notice as soon as he is able. Since the giving of notice within 14 days is not a material part of the agreed exchange, and forfeiture would otherwise result, the non-​occurrence of the condition is excused and B has a claim against A under the policy.

The doctrine of impracticability is applicable to promises as well as to express conditions, but the doctrine operates differently in the two contexts. In the case of promises, the doctrine of

16.  585 N.E.2d 315 (Mass. 1992).

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impracticability is normally a defense to a suit by a promisee for expectation damages, so that if the doctrine is applicable the promisor is normally excused from performing. In the case of express conditions, impracticability typically excuses nonfulfillment, so that if the doctrine is applicable a promisor may be obliged to perform despite nonfulfillment of an express condition to her duty to perform.

E. TRIVIALITY Imperfect fulfillment of a condition should not and often does not trigger a right to terminate the contract where the nonfulfillment is trivial. So in Hegeberg, the Alaska salmon-​packers case, in which the tribunal’s report was filed two days late, the court said: Upon no theory can it be contended that, within reasonable limits, the time element, in so far as the filing of the report was concerned, was of the least consequence. . . . Certainly the slight delay in filing the report may well be described in the words of Professor Williston as “an inconsiderable trifle, having no pecuniary importance,” . . . and the strict enforcement of the time provision of the contract, which . . . would involve an extreme forfeiture or penalty, the time element forming no essential part of the exchange of appellants’ agreement to work in consideration of respondents’ promises to pay, should not be adjudged unless required by law.17

Similarly, the Williston treatise states that “Nowhere would a departure from full performance of a condition be regarded as important if the departure were an inconsiderable trifle having no pecuniary importance[.]‌”18

IV.   IN T E R P R E TAT I O N OF   A CONT R A CT UA L P R O V I S I O N A S   A PR OM I S E O R A S   A N E X P R ES S CONDI T I ON In addition to the many exceptions to the perfect-​fulfillment rule, the courts often avoid the impact of the rule by interpreting provisions that seem to be express conditions as promises, or by distorting the meaning of express conditions. So, for example, Restatement Section 227 provides: (1) In resolving doubts as to whether an event is made a condition of an obligor’s duty, and as to the nature of such an event, an interpretation is preferred that will reduce the obligee’s risk of forfeiture, unless the event is within the obligee’s control or the circumstances indicate that he has assumed the risk.

17.  Hegeberg v. New Eng. Fish Co., 110 P.2d 182, 187–​88 (Wash. 1941). 18. 5 Samuel Williston & Walter H.  E. Jaeger, Williston on Contracts § 805, at 839–​40 (3d ed. 1961).

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(2) Unless the contract is of a type under which only one party generally undertakes duties, when it is doubtful whether (a)  a duty is imposed on an obligee that an event occur, or (b)  the event is made a condition of the obligor’s duty, or (c) the event is made a condition of the obligor’s duty and a duty is imposed on the obligee that the event occur, the first interpretation is preferred if the event is within the obligee’s control. . . .

This approach is commonly applied to two types of contractual provisions: pay-​when-​paid provisions and provisions that a promisee will be liable only if he is satisfied with the promisor’s performance. The interpretations of such provisions are little more than techniques for avoiding the perfect-​fulfillment rule.

A.  PAY-​WHEN-​PAID PROVISIONS Contracts between general contractors and subcontractors often include pay-​ when-​ paid (or pay-​if-​paid) provisions, which provide that the general contractor will pay the subcontractor if and when the general contractor is paid by the contracting authority or owner for the subcontractor’s work. These provisions are commonly framed as conditions but interpreted as promises. For example, in Koch v. Construction Technology, Inc.19 CTI, a general contractor for the Memphis House Authority, entered into a painting subcontract with Koch. The subcontract provided that “partial payments [by CTI to Koch] . . . shall be made when and as payments are received by CTI from the Housing Authority.” CTI paid Koch less than the amount he was owed for work he had performed, and Koch sued CTI to recover the balance. CTI responded that it had not been paid in full by the Housing Authority and that payment by the Housing Authority was a condition to CTI’s obligation to pay Koch. The Tennessee Supreme Court held for Koch: [I]‌t is well-​established that condition precedents are not favored in contract law, and will not be upheld unless there is clear language to support them. . . . Furthermore, this general rule applies with particular force in the context of “pay when paid” clauses, for . . . an overwhelming majority of jurisdictions do not construe such clauses so as to release the general contractor from all obligation to make payment to the subcontractor in case of nonperformance by the owner. Rather, these clauses are most often construed as simply affecting the timing of payments that the general contractor is required to make to the subcontractor, regardless of whether the owner performs or not. These courts refuse to shift the risk of the owner’s nonperformance from the general contractor to the subcontractor unless the language clearly indicates that the parties intended to do so.20 -​. . . [W]‌e conclude that the language here does not evidence the parties’ intention to shift the risk of the owner’s nonperformance from the general contractor to the subcontractor with sufficient clarity to qualify as a condition precedent.21

19.  924 S.W.2d 68 (Tenn. 1996). 20.  Id. at 71. 21.  Id. at 72–​73.

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Similarly, in Thos. J. Dyer Co. v. Bishop International Engineering Co.22 a contract between a general contractor and a subcontractor provided that “no part of the subcontract price shall be due until five days after Owner shall have paid [the general contractor] therefor . . .” The court held that the general contractor was liable to the subcontractor even though the owner had not paid the general: The solvency of the owner is a credit risk necessarily incurred by the general contractor. . . . [A subcontractor] is primarily interested in the solvency of the general contractor with whom he has contracted. He looks to him for payment. Normally and legally, the insolvency of the owner will not defeat the claim of the subcontractor against the general contractor. Accordingly, in order to transfer this normal credit risk incurred by the general contractor from the general contractor to the subcontractor, the contract between the general contractor and the subcontractor should contain an express condition clearly showing that to be the intention of the parties.23

B.  CONDITIONS OF SATISFACTION Many contracts provide that one party, A, will render a specified performance and the other party, B, will pay for the performance if but only if he is satisfied with it. Under a straightforward interpretation of such a provision B’s satisfaction is a condition to his obligation to pay under the contract (although B might be obliged to make payment under the law of restitution for any benefit that A has conferred upon him). In some cases this type of condition is properly interpreted to require B’s actual satisfaction. The issue in these cases is what B actually believed, not what B said he believed. For example, in McCartney v. Badovinac24 a diamond had been stolen from Mrs. Ragsdale. Her husband accused Mrs. McCartney of the theft. Mr. McCartney then hired Badovinac, a private detective, to investigate. Badovinac was to receive $500 for his services when he had “to the satisfaction of the said McCartney” determined whether the diamond was stolen, and if so, who had taken it. Badovinac’s investigations led him to the discomfiting conclusion that Mrs. McCartney had stolen the diamond, and he put his proofs before Mr. McCartney. McCartney refused to pay and Badovinac brought suit. McCartney testified that he was not satisfied that his wife was the thief, but the trial judge found that Badovinac had clearly established that Mrs. McCartney had taken the diamond and that McCartney’s answers on the stand were “a mere subterfuge and pretext,”25 and gave judgment for Badovinac. On appeal, the judgment was affirmed.

22.  303 F.2d 655 (6th Cir. 1962). 23.  Id. at 660–​61 (citations omitted). Other courts have struck down pay-​when-​paid provisions under mechanic’s lien laws. These laws are complex, but essentially they provide that persons who contribute labor or material to the construction or repair of property have a lien (that is, a security interest) in the property for the value of their contribution. Lien laws often include anti-​waiver provisions, under which the lien rights cannot be waived except under narrow circumstances. Various courts have held that a pay-​ when-​paid provision is in substance a waiver of such rights, and is therefore invalid under the statutory anti-​waiver provisions. See, e.g., WM. R. Clarke Corp. v. Safeco Ins. Co., 938 P.2d 372, 376–​79 (Cal. 1997); West-​Fair Elec. v. Aetna Cas. & Sur. Co., 661 N.E.2d 967, 971 (N.Y.1995). 24.  160 P. 190 (Colo. 1916). 25.  Id. at 191.

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Similarly, in Forman v. Benson,26 Buyer made an offer to purchase certain real estate owned by Seller. The purchase price was to be paid over a ten-​year period. Before accepting the offer Seller expressed concern about Buyer’s creditworthiness. Seller’s broker thereupon added the following provision to the offer: “subject to seller’s approving buyer’s credit report.” Seller accepted Buyer’s offer, but thereafter refused to convey the property on the ground that he was not satisfied with buyer’s credit. Buyer sued. The court held for Buyer on the ground that Seller’s stated dissatisfaction was not genuine: . . . [The trial court found] that between the time the contract was executed and the time the offer was rejected, defendant [the seller] attempted to renegotiate the purchase price of the building as well as the interest rate. . . . [W]‌e hold that while defendant may have had a basis in his personal judgment for rejecting plaintiff ’s credit (i.e., outstanding debts and a $2,000 loss reflected in an income tax return), his attempted renegotiation demonstrates that his rejection was based on reasons other than plaintiff ’s credit rating and was, therefore, in bad faith.27

Suppose, however, that B is actually not satisfied with A’s performance. Under a straightforward interpretation of a satisfaction condition B would have no contractual obligation to A because the condition to B’s duty to perform would not have been fulfilled. However, the general rule, embodied in Restatement Second Section 228, is that “When it is a condition of an obligor’s duty that he be satisfied with respect to the obligee’s performance or with respect to something else, and it is practicable to determine whether a reasonable person in the position of the obligor would be satisfied, an interpretation is preferred under which the condition [is fulfilled if] a reasonable person in the position of the obligor would be satisfied.” Under a frequently used alternative formulation, “the reasonable person standard is employed when the contract involves commercial quality, operative fitness, or mechanical utility which other knowledgeable persons can judge. . . . The standard of good faith is employed when the contract involves personal aesthetics or fancy.”28 Morin Building Products Co. v. Baystone Construction, Inc.29 is a leading case. GM hired Baystone to build an addition to a plant. Baystone in turn hired Morin to supply and erect aluminum walls for the addition. The contract between Baystone and Morin required that the exterior siding of the wall be of “aluminum type 3003, not less than 18 B & S gauge, with a mill finish and stucco embossed surface texture to match finish and texture of existing metal siding.” The contract further provided that (1) “all work shall be done subject to the final approval of the Architect or Owner’s [General Motors’] authorized agent, and his decision in matters relating to artistic effect shall be final, if within the terms of the Contract Documents”; and (2) “should any dispute arise as to the quality or fitness of materials or workmanship, the decision as to acceptability shall rest strictly with the Owner, based on the requirement that all work done or materials furnished shall be first class in every respect. What is usual or customary in erecting other buildings shall in no wise enter into any consideration or decision.”30 26.  446 N.E.2d 535 (Ill. App. Ct. 1983). 27.  Id. at 540. 28.  Ind. Tri-​City Plaza Bowl, Inc. v. Estate of Glueck, 422 N.E.2d 670, 675 (Ind. Ct. App. 1981); see also Action Eng’g v. Martin Marietta Aluminum, 670 F.2d 456, 460–​61 (3d Cir. 1982). 29.  717 F.2d 413 (7th Cir. 1983). 30.  Id. at 414.

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Morin put up the walls. Viewed in bright sunlight from an acute angle, the exterior siding did not give the impression of having a uniform finish, and GM’s representative rejected the addition to the plant on that ground. Baystone then removed the siding, hired another subcontractor to replace it, and refused to pay Morin the balance of the contract price, $23,000. Morin brought suit. The Seventh Circuit, in an opinion by Judge Posner, held for Morin: . . . There was much evidence that General Motors’ rejection of Morin’s exterior siding had been totally unreasonable. Not only was the lack of absolute uniformity in the finish of the walls a seemingly trivial defect given the strictly utilitarian purpose of the building that they enclosed, but it may have been inevitable; “mill finish sheet” is defined in the trade as “sheet having a nonuniform finish which may vary from sheet to sheet and within a sheet, and may not be entirely free from stains or oil . . .” Some cases hold that if the contract provides that the seller’s performance must be to the buyer’s satisfaction, his rejection, however unreasonable, of the seller’s performance is not a breach of the contract unless the rejection is in bad faith. . . . But most cases conform to the position stated in section 228 of the Restatement (Second) of Contracts . . . We do not understand the majority position to be paternalistic; and paternalism would be out of place in a case such as this, where the subcontractor is a substantial multistate enterprise. The requirement of reasonableness is read into a contract not to protect the weaker party but to approximate what the parties would have expressly provided with respect to a contingency that they did not foresee, if they had foreseen it. Therefore the requirement is not read into every contract, because it is not always a reliable guide to the parties’ intentions. In particular, the presumption that the performing party would not have wanted to put himself at the mercy of the paying party’s whim is overcome when the nature of the performance contracted for is such that there are no objective standards to guide the court. It cannot be assumed in such a case that the parties would have wanted a court to second guess the buyer’s rejection. . . . The building for which the aluminum siding was intended was a factory—​not usually intended to be a thing of beauty. That aesthetic considerations were decidedly secondary to considerations of function and cost is suggested by the fact that the contract specified mill finish aluminum, which is unpainted. . . . Whether Morin’s siding achieved a reasonable uniformity amounting to satisfactory commercial quality was susceptible of objective judgment; in the language of the Restatement, a reasonableness standard was “practicable.” . . . The contract expressly required [the contractor] to use aluminum having “a mill finish . . . to match finish . . . of existing metal siding.” The jury was asked to decide whether a reasonable man would have found that Morin had used aluminum sufficiently uniform to satisfy the matching requirement. This was the right standard if, as we believe, the parties would have adopted it had they foreseen this dispute. It is unlikely that Morin intended to bind itself to a higher and perhaps unattainable standard of achieving whatever perfection of matching that General Motors’ agent insisted on, or that General Motors would have required Baystone to submit to such a standard. Because it is difficult, maybe impossible, to achieve a uniform finish with mill finish aluminum, Morin would have been running a considerable risk of rejection if it had agreed to such a condition, and it therefore could have been expected to demand a compensating increase in the contract price. This would have required General Motors to pay a premium to obtain a freedom of action that it could not have thought terribly important, since its objective was not aesthetic.

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If a uniform finish was important to it, it could have gotten such a finish by specifying painted siding.31

Just so.

V.   C O N D I T I O N S PR ECEDENT AN D C O N D I T I O N S S UBS EQUENT Express conditions are often classified as either conditions precedent or conditions subsequent. (A third class of express conditions, conditions concurrent, will be discussed briefly in Chapter 47.) The distinction between these two kinds of express conditions is normally stated in something like the following terms: Where a designated state of affairs must occur before a party to a contract comes under a duty to perform, the condition is precedent. Where, on the other hand, a party has already come under a duty to perform and will be relieved from that duty by the occurrence or nonoccurrence of a designated state of affairs, the condition is subsequent. Accordingly, a duty to perform arises when a condition precedent is satisfied, and is discharged when a condition subsequent is triggered. The standard illustrations of this distinction are provisions commonly contained in insurance policies. For example, a common provision in life-​insurance policies is that the insurer will not be liable unless proof of death is made within a designated period, such as ninety days after death. This condition would ordinarily be described as precedent because the insurer does not come under a duty to pay unless timely proof of death has been made. Another common provision is that suit against the insurer must be brought within a designated period, such as one year from the date of death. This condition would ordinarily be described as subsequent, because the lapse of a year operates to relieve the insurer from a duty that previously existed. Little should or does turn on the distinction between conditions precedent and conditions subsequent, because in practice cases are usually decided simply according to the situation at the time suit is brought. For example, in determining whether a proof-​of-​death condition was fulfilled, a court would ask whether the plaintiff had presented the required proof in a timely manner. In determining whether a provision requiring suit to be brought within a designated period had been fulfilled, a court would ask whether the plaintiff had brought suit within the period. But this being so, what is the practical significance of the distinction between conditions precedent and conditions subsequent? Holmes answered this question by asserting that the distinction has no practical significance and in fact does not exist: “When a man sues, the question is not whether he had a cause of action in the past, but whether he has one then.”32 Under this view, whether a plaintiff has a cause of action is judged by the situation that exists when he brings his suit, and therefore all conditions are conditions precedent. Against this view it has been argued that the distinction between conditions precedent and conditions subsequent is important for certain problems of civil procedure. For example, suppose a life-​insurance policy requires notice of death within ninety days. At least two important sets of procedural questions can arise:

31.  Id. at 414–​16. 32.  Oliver Wendell Holmes, Jr., The Common Law 317 (1881).

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(1) Which party has the burden of pleading the facts with respect to this issue? Is a complaint subject to demurrer if the plaintiff fails to allege that he gave timely notice to the insurer, or is this a matter that must be raised in the answer? (2) Which party has the burden of proving the relevant facts? Assume the complaint alleges that the plaintiff timely gave a required notice, and the answer denies this allegation but sets up no other defense to the plaintiff ’s claim. At the trial, neither party introduces any evidence on this issue. Who gets judgment? Or suppose that both parties introduce evidence bearing on the issue, but the trier of fact considers the evidence evenly balanced, and cannot decide which side is right. In these cases, the outcome of the litigation will depend upon who has the burden of proof, or, in Wigmore’s phrase, the risk of non-​persuasion.

Obviously these procedural issues are of considerable practical importance, and it is therefore asserted against Holmes’s view that the distinction between conditions precedent and conditions subsequent must be retained because these issues may turn on the distinction. If a condition is precedent then it is natural to put the burdens of pleading and proof on the plaintiff. because he has no case unless the condition has occurred, and therefore it is up to him to allege and prove that it did occur. On the other hand, if the condition is subsequent then it is natural to put the burdens of pleading and proof on the defendant because the defendant is attempting “to get out of something,” and it is up to her to show that she is excused from liability. This makes a persuasive case for retaining the distinction between conditions precedent and subsequent until the questions, how conditions are actually phrased and how courts actually distribute procedural burdens, are answered with particularity. For example, as to the actual phrasing of conditions, a provision requiring proof of death within ninety days could be expressed as follows: “In case proof of death is not made within ninety days, this policy shall become void and the insurer shall be released from all liability thereon.” Here the condition is phrased in condition-​subsequent terms—​it speaks of a release from liability. However, this is not a typical condition subsequent where the insurance company could once have been sued without notice and then later gains immunity from suit by the insured’s failure to give timely notice. Instead, the company could not have been sued unless proof of death had been timely given. A common way out of this dilemma is to say that in such cases the condition is subsequent in form but precedent in fact. But this leaves unresolved the question: What is the effect of such a condition on the burdens of pleading and proof? If the parties have seen fit to phrase the condition in terms of an excuse from liability, is that itself a sufficient reason for placing those burdens on the defendant? Does the form in which the condition is expressed show an intention that makes it appropriate to treat the defendant as if it were getting out of an existing obligation? This example shows that a provision that is normally regarded as a condition precedent can easily be put in the form of a condition subsequent. In the same way, a provision that is normally regarded as a condition subsequent can easily be put in the form of a condition precedent. For example, take the following provision: “It shall be a condition precedent to the liability of the insurer that suit shall be brought within one year of the insured’s death.” Here the condition is precedent in form but subsequent in fact, because the insurer will be liable unless and until one year from the insured’s death elapses. Once again, this leaves unresolved the only practical question, that is, the manner in which the burdens of pleading and proof are to be allocated in the case of such a condition.

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If we look more closely at the considerations that should and normally do determine the distribution of these burdens, it is apparent that neither the form nor the substance of the distinction between conditions precedent and subsequent should be controlling. Instead, the problem is one of forensic fairness and convenience. Accordingly, statutes and court rules commonly relieve a plaintiff from the burden of pleading the fulfillment of a condition without regard to whether the condition is precedent or subsequent. For example, New York Civil Practice Law and Rules 3015(a) provides that “[t]‌he performance or occurrence of a condition precedent in a contract need not be pleaded. A denial of performance or occurrence shall be made specifically and with particularity. In case of such denial, the party relying on the performance or occurrence shall be required to prove on the trial only such performance or occurrence as shall have been so specified.” Similarly, Federal Rules of Civil Procedure Rule 9(c)—​as well as state codes of procedure that are based on the Federal Rules—​provides that “[i]n pleading the performance or occurrence of conditions precedent, it is sufficient to aver generally that all conditions precedent have been performed or have occurred. A denial of performance or occurrence shall be made specifically and with particularity.” The effect of rules such as these is to place the burden of pleading on the defendant. If the defendant wishes to raise the issue whether a particular condition was fulfilled, it must allege with specificity that the condition was not fulfilled. Rules such as these owe their existence in part to the fact that contract litigation is now often based on long printed standardized documents, the terms of which are not negotiated, but instead are imposed by one party on the other—​a familiar example being insurance policies. Such contracts customarily contain a long list of conditions that limit the liability of the party who drafted the contract. To require the plaintiff to allege in detail that all of these conditions had been fulfilled would not only encumber the record needlessly, but would impose on the plaintiff ’s attorney the difficult task of seeing to it that each allegation in the complaint engages each condition of the contract. As to the burden of proof, as distinguished from the burden of pleading, reforms through statutes or rules of court are less common, and the situation is more complicated. However, applying the principles that have generally been developed for the allocation of that burden, the following factors should and normally will be influential:



(1) Whether placing the burden on a party would require him to prove a negative—​that something did not happen. This factor mitigates toward placing the burden of proof on the other party because it is easier to prove an affirmative than a negative. (2) Whether the relevant facts are peculiarly within the knowledge of one party. In such a case, the burden of proof should be placed on that party. (3) Whether the contract is a standardized form. This furnishes a reason for imposing procedural burdens on the party who drafted the agreement.

None of these factors is controlling; there is not and probably cannot be any single principle to govern the allocation of the burdens of pleading and proof. The important point is that for the most part these three factors are based on functional considerations and reduce the significance of whether a condition is precedent or subsequent.

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consisting of a bargain made between strangers transacting on a perfect market, and was static rather than dynamic: it focused almost exclusively on a single instant in time—​the instant of contract formation—​rather than on dynamic processes such as the course of negotiation and the evolution of contractual relationships. However, in the real world, contracts, particularly contracts between firms, are only sometimes made between strangers transacting on a perfect market, and almost always encompass not only a present but a past and a future. Often it is not easy to say where the past of a contract ends and its present begins (because, for example, the process of concluding a deal is often a rolling process) or where the present of a contract ends and its future begins (because, for example, a contract is partly what it was at the time of contract formation and partly what it becomes thereafter). Accordingly, if contract law is to effectuate the objectives of parties to promissory transactions it must reflect the reality of contracting by adopting dynamic rules that parallel that reality rather than static rules that deny that reality, that are not based on the strangers-​in-​a-​perfect-​market paradigm. An important school of thought known as relational-​contract theory, founded by Ian Macneil1 and subscribed to by others, properly rejects the stranger-​in-​a-​perfect-​market paradigm and the static conception of classical contract law. Instead, relational-​contract theory is based on a paradigm of a contractual transaction between actors who are in an ongoing and dynamic relationship. This rejection of basic assumptions of classical contract law is all to the good. So is the identification of relational contracts as an economic and sociological entity. However, constructing a body of relational-​contract law requires more than rejecting assumptions of classical contract law. It also requires the formulation of a body of legal rules applicable to, and only to, relational contracts. This is a place to which relational-​contract theory has not gone and cannot go, because that theory has not crafted and cannot craft a definition that adequately distinguishes relational and non-​relational contracts in a way that identifies a body of special and well-​specified contracts for treatment under a body of special and well-​specified rules. To put this differently, if there is to be a body of contract-​law rules that governs only relational contracts it is imperative to establish a definition of relational contracts that centers on one or more characteristics that meaningfully distinguish relational and non-​relational contracts and does so in a way that justifies the application of a special body of contract-​law rules to relational contracts, as so defined. 1.  See, e.g., Ian R. Macneil, The New Social Contract (1980).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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One characteristic on which such a definition might turn is long duration. Indeed, as Goetz and Scott have pointed out “Although a certain ambiguity has always existed, there has been a tendency to equate the term ‘relational contract’ with long-​term contractual involvements.”2 Thus, the phrase “long-​term contracts” is often employed as virtually synonymous with the phrase “relational contracts.” But as Goetz and Scott also point out “temporal extension per se is not the defining characteristic” of relational contracts.3 For example, a long-​term lease of capital equipment, such as aircraft, may require almost no contact between the parties after the contract is signed, so long as the required payments are made. In contrast, a two-​week contract to remodel a kitchen may be highly relational, as may be a one-​day contract between a photographer and a portrait sitter. Although long duration is not a defining characteristic of relational contracts it might be treated as an independent variable in contract law, so that there would be special rules for all long-​term contracts regardless of whether they are relational. John Stuart Mill, who argued that “laissez faire . . . should be the general practice” and “that every departure from it, unless required by some great good, is a certain evil,”4 nevertheless concluded: [An] exception to the doctrine that individuals are the best judges of their own interest, is when an individual attempts to decide irrevocably now what will be best for his interest at some future and distant time. The presumption in favour of individual judgment is only legitimate, where the judgment is grounded on actual, and especially on present, personal experience; not where it is formed antecedently to experience, and not suffered to be reversed even after experience has condemned it. When persons have bound themselves by a contract, not simply to do some one thing, but to continue doing something . . . for a prolonged period, without any power of revoking the engagement . . . [any] presumption which can be grounded on their having voluntarily entered into the contract . . . is commonly next to null.5

Although Mill did not elaborate on his reason for this view, a reason is not hard to find. As discussed in Chapter 11, modern behavioral economics has established that actors are subject to certain systematic limits on cognition. These limits become increasingly salient as the duration of a contract increases. For example, actors systematically give too little weight to future benefits and costs as compared to present benefits and costs.6 Thus Feldstein concludes that “some or all individuals have, in Pigou’s . . . words, a ‘faulty telescopic faculty’ that causes them to give too little weight to the utility of future consumption.”7 Similarly, actors systematically underestimate most risks, and often wrongly take the sample consisting of present events to be representative and therefore predictive of future events. As Arrow observes, based on the work of cognitive psychologists “it is a plausible hypothesis that individuals are unable to recognize that there will be many surprises in the future; in short, as much other evidence tends to 2.  Charles J. Goetz & Robert E. Scott, Principles of Relational Contracts, 67 Va. L. Rev. 1089, 1091 (1981). 3.  Id. 4.  John Stuart Mill, Principles of Political Economy 950 (W.J. Ashley ed., new ed. Longmans, Green and Co. 1929) (1848). 5.  Id. at 959–​60. 6.  See Martin Feldstein, The Optimal Level of Social Security Benefits, 100 Q. J. Econ. 303, 307 (1985). 7.  Id.

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confirm, there is a tendency to underestimate uncertainties.”8 In fact, empirical evidence shows that actors often not only underestimate but ignore low-​probability risks. And the longer the duration of a contract—​the more future it has—​the greater the number of surprises and the underestimation of low-​probability risks. For all these reasons it might be desirable to make special rules for contracts of long duration. Even if this is so, however, long duration does not of itself make a contract relational. Goetz and Scott, having properly rejected long duration as a test for whether a contract is relational, proposed another definition: “A contract is relational to the extent that the parties are incapable of reducing important terms of the arrangement to well-​defined obligations.”9 However, parties to a contract are almost never capable of reducing all of the important terms of their arrangement to well-​defined obligations, as illustrated by the famous passage by Francis Lieber, “Fetch Some Soupmeat,” set out in Chapter 27. Still another approach to the problem of definition has been to define relational contracts as those contracts that are not “discrete.” This approach of course requires a definition of discrete contracts. Vic Goldberg has defined a discrete contract as a contract “in which no duties exist between the parties prior to the contract formation. . . .”10 However, even in the case of contracts that involve intensive personal interaction no duties may exist between the parties prior to contract formation. Macneil himself sometimes treats discreteness as one end of a spectrum rather than as a definition. Under this approach a contract is characterized as lying at the discrete end of the spectrum if it has less of certain characteristics—​for example, less duration, less personal interaction, less future cooperative burdens, and less in the way of units of exchange that are difficult to measure—​ and as lying at the relational end of the spectrum if it has more of these characteristics.11 A spectrum approach is certainly acceptable if we view relational contracts from only a sociological and economic perspective. However, the enterprise of contract law entails the formulation of rules, and a spectrum approach is inadequate to that enterprise because it cannot be operationalized. Under a spectrum approach many or most contracts will have both relational and discrete elements. Accordingly, except for the relatively few cases that lie at one end of the spectrum, there would be no way to know whether the general rules of contract law or special rules of relational contract law should be applied in any given case. Rules whose applicability depends on how many relational indicia a contract has, and of what kind, would be rules in name only. Indeed, trying to imagine a discrete contract, Macneil is driven to a fantastic extreme: [A]‌t noon two strangers come into town from opposite directions, one walking and one riding a horse. The walker offers to buy the horse, and after brief dickering a deal is struck in which delivery

8.  See Kenneth J. Arrow, Risk Perception in Psychology and Economics, 20 Econ. Inquiry 1, 5 (1982). 9.  Goetz & Scott, supra note 2, at 1091. 10.  Victor P. Goldberg, Towards an Expanded Economic Theory of Contract, 10 J. Econ. Issues 45, 49 (1976). This definition must mean that no contractual duties exist prior to contract formation. As Macneil has pointed out, in discussing this definition, if no duties of any kind exist between the parties prior to a contractual exchange, “then theft by the stronger party is more likely to occur than is exchange.” Ian R. Macneil, Economic Analysis of Contractual Relations: Its Shortfalls and the Need for a “Rich Classificatory Apparatus,” 75 Nw. U. L. Rev. 1018, 1020 (1981). 11.  See Ian R. Macneil, Contracts: Exchange Transactions and Relations 12–​13 (2d ed. 1978) [hereinafter Exchange Transactions and Relations].

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Relational Contracts of the horse is to be made at sundown upon the handing over of $10. The two strangers expect to have nothing to do with each other between now and sundown; they expect never to see each other thereafter; and each has as much feeling for the other as has a Viking trading with a Saxon.12

In the end, Macneil admitted that a discrete contract is “an impossibility”13 and characterizes discrete contracts as “entirely fictional.”14 But if discrete contracts cannot be defined, then neither can relational contracts. _​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​_​ What is striking about the numerous efforts to define relational contracts and the failure of all these efforts is that a straightforward definition of relational contracts is readily at hand: a relational contract is one that involves not merely an exchange but also a relationship between the contracting parties. Correspondingly, a discrete contract is a contract that involves only an exchange and not a relationship. Macneil himself has sometimes favored such a definition. For example, in The New Social Contract Macneil defines a discrete contract as “one in which no relation exists between the parties apart from the simple exchange of goods.”15 Such a definition not only can be operationalized, but also reflects the everyday, common sense meaning of the term relational. Once such a definition has been adopted, however, it can easily be seen that discrete contracts are close to nonexistent because virtually all contracts, no matter how straightforward, either create or reflect a relationship. Consumer contracts commonly involve ongoing relationships even when they are made with huge bureaucratic organizations: Most shoppers at Macy’s have shopped there before and expect to shop there again, so that neither Macy’s nor the shoppers perceive each purchase as an isolated non-​relational transaction. Even contracts on perfect spot markets are likely to involve traders or brokers who have continuing relationships of some sort. One reason for the overthrow of classical contract law is that it was tacitly based on the empirically incorrect premise that most contracts are discrete. Ironically, however, relational contract theory has made a comparable empirical mistake. Insofar as relational-​contract theory supports the idea that there should be a body of special rules to govern relational

12.  Exchange Transactions and Relations, supra note 11, at 13. Similarly, Williamson gives as an example of a discrete contract a purchase of a bottle of local spirits from a shopkeeper in a remote area of a foreign country who one never expects to visit again nor to recommend to one’s friends. Oliver E. Williamson, Transaction-​Cost Economics: The Governance of Contractual Relations, 22 J.L. & Econ. 233, 247 (1979). The same is true of another example given by Macneil: “A purchase of nonbrand name gasoline in a strange town one does not expect to see again.” Exchange Transactions and Relations, supra note 11, at 13. These examples all serve to show that the legal category, relational contracts, is empty. 13.  See Ian R. Macneil, Contracts: Adjustment of Long-​Term Relations under Classical, Neoclassical, and Relational Contract Law, 72 Nw. U. L. Rev. 854, 883 (1978). 14.  Macneil, supra note 1, at 11. Macneil eventually tried to locate relational contract law in specific statutes such as “ERISA, OSHA, other workplace regulations, wage and hours legislation, . . . the NLRA, LMRA, and a wide range of law governing unions and other aspects of collective bargaining.” Ian R. Macneil, Relational Contract Theory: Challenges and Queries, 94 Nw. U. L. Rev. 877, 897 (2000). However, these statutes are just that—​statutes. They are neither promises nor contracts and have little or no place in contract law. 15.  Macneil, supra note 1, at 10.

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contracts it is tacitly based on the incorrect premise that relational contracts are a special subcategory of contracts as a class. Once relational contracts are properly defined, however, and it is recognized that all or almost all contracts are relational, it is easy to see that relational contracts are not a special subcategory of contracts and therefore cannot and should not be governed by a body of special contract-​law rules. There can be no special law of relational contracts because the two categories, contracts and relational contracts, are virtually one and the same. Consider, in this connection, some of the special rules that are proposed for relational contracts in the relational-​contracts literature. (1) Rules that, in the case of relational contracts, would soften or reverse the bite of the rigid offer-​and-​acceptance format of classical contract law and the corresponding intolerance of classical contract law for indefiniteness, agreements to agree, and agreements to negotiate in good faith. (2) Rules that would impose upon parties to a relational contract a broad obligation to perform in good faith. (3) Rules that would broaden the kinds of unexpected circumstances (impossibility, impracticability, and frustration) that excuse a party’s nonperformance. (4) Rules that would keep a relational contract together. (5) Rules that would impose upon parties to a relational contract a duty to bargain in good faith to make equitable price adjustments when changed circumstances occur, and perhaps would even impose upon the advantaged party a duty to accept an equitable adjustment proposed in good faith by the disadvantaged party. These rules, and others like them, can be separated into two broad classes: rules that are good for all contracts and therefore should be general principles of contract law, and rules that are not good for any contracts. For example, the relational-​contract literature is correct in pointing to the deficiencies of classical contract law concerning the rigid offer-​and-​acceptance format of classical contract law and, more particularly, the intolerant treatment in classical contract law of indefiniteness, agreements to agree, and agreements to negotiate in good faith. If parties believe they have a deal, indefiniteness should rarely be a defense, and if parties agree to agree or to negotiate in good faith, that is a deal. All this holds true, however, for all contracts (see Chapter 52). Correspondingly, there should be and is an obligation to perform contracts in good faith, but this obligation also should and does apply to all contracts. Similarly, the principles that determine when unexpected circumstances should serve as an excuse should and do apply to all contracts. Indeed, some of the best-​known unexpected circumstances cases, such as Taylor v. Caldwell16 and Krell v. Henry,17 involved contracts that entailed little or nothing in the way of a relationship. On the other hand, the concept that courts have power to readjust ongoing contracts to reflect unexpected circumstances should be sparingly applied. Similarly, although the rules of contract law should operate to prevent one party from opportunistically employing an insubstantial breach or the nonfulfillment of an insignificant condition as a contrived excuse for breaking a deal, the concept that legal rules can keep a living relationship together against the will of one party is quixotic. A relationship compelled by law against the wishes of one party is not a living relationship, or at best is a highly impoverished relationship. Moreover, in the case of long-​term contractual relationships that involve intense personal interaction, the concept that parties should be legally forced to stay locked in the relationship ignores the teachings of behavioral economics. By virtue of the nature of such relationships it 16.  (1863) 122 Eng. Rep. 309; 3 B. & S. 826. 17.  [1903] 2 KB 740 (C.A.) (Eng.).

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will be almost impossible to predict, at the time when the contract is made, what contingencies may affect the relationship’s future course. Furthermore, at the time when such a contract is made, each party is likely to be unduly optimistic about the likelihood of the relationship’s long-​ term success and about the willingness of the other party to avoid opportunistic behavior during the course of the relationship. Finally, the parties to such a contract are likely to give undue weight to the state of their relationship at the time when the contract is made, which is vivid, concrete, and instantiated; to erroneously take the state of their relationship at that point as representative of the relationship’s future state; and to give too little thought to, and place too little weight on, the risk that the relationship will go bad. Accordingly, to compel the continuation of intensive relationships would be to invite opportunistic exploitation by the party with the upper hand. The solution to the problems presented by such contracts is not to hold the relationship together by legal force but to allow either party to readily dissolve the relationship on fair terms even if the right to dissolve is not written into the contract.

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fifty-f ​ ive

Third-​Party Beneficiaries A rec urring and dif f icu lt prob l em i n c on tr act l aw i s as

follows: A and B make a contract. Performance of the contract would benefit another person, C, who is not a party to the contract. A breaches the contract and C does not get the benefit he would have obtained if the contract had been performed. Can C bring suit against A under the contract? In analyzing this problem, nomenclature is important. In this chapter the term third-​party beneficiary (or sometimes beneficiary) will be used to mean a person who is not a party to a contract but who would benefit from performance, whether or not the person has power to bring suit under the contract. The term promisor (or sometimes A) will be used to mean a person who has made a legally enforceable promise whose performance would benefit a third-​party beneficiary. The term promisee (or sometimes B) will be used to mean the person to whom that promise is made. The term contract will be used to mean an enforceable agreement between a promisor and a promisee which, if performed, would benefit a third-​party beneficiary. The term contracting parties will be used to mean the promisor and the promisee taken together.

I.   T H E D E V E L O P M ENT OF   T HE L AW GO V E R N I N G T H E   ENF OR CEA BI L I T Y O F   C O N T R A CT S BY  T HI R D-​ PA RT Y B E N EF I CI A R I ES A.  EARLY ENGLISH AND AMERICAN LAW The modern law of third-​party beneficiaries did not arise until early in the twentieth century, and did not begin to mature until the 1930s. It took much time for contract law to emerge as a body of coherent principles, and it is not surprising that the principles governing the rights of third parties were especially late in coming. Nevertheless, in retrospect it appears that such principles were ready to emerge in the mid-​eighteenth century until the rise of classical contract law put a temporary end to their development. In England, for example, the tendency

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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up to the early eighteenth century had been to allow suit by a third party.1 Dutton v. Poole,2 decided in 1677, was an important case illustrating this tendency. Father was preparing to sell a wood to raise dowries for his younger children, including Daughter.3 Eldest Son, who stood to inherit the wood as Father’s heir, promised Father that he would pay £1000 to Daughter if Father would forbear from selling the wood.4 The court held that Daughter could enforce the contract.5 Dutton v. Poole was somewhat ambiguous because Chief Justice Scroggs suggested that because of the close relationship of father and child the promise to a father might be treated as a promise to his daughter.6 However, in Martyn v. Hind,7 decided a century later in 1776, Lord Mansfield said that “[a]‌s to the case of Dutton v. Poole, it is [a] matter of surprise, how a doubt could have arisen in that case.”8 In Pigott v. Thompson,9 decided in 1802, a note (apparently by the reporter) said: With respect to the right of a third person to sue upon a parol promise made to another for his benefit, there is great contradiction among the older cases. . . . But in Dutton v. Poole, the point seems to have been very fully considered and very solemnly decided. . . . In that case, indeed, some stress was laid upon the nearness of relationship between the Plaintiff ’s wife and her father, to whom the promise was made; but another case [Martyn v. Hind] has since occurred to which that reason does not apply.10

American courts tended to follow a similar course. New  York was fairly typical. In 1806 a New  York court, citing Dutton v.  Poole and Pigott v.  Thompson, stated, “[W]‌e are of [the] opinion, that where one person makes a promise to another for the benefit of a third person, that third person may maintain an action on such promise.”11 Farley v. Cleveland,12 decided in 1825, was for many years the leading New York case. B had given Third Party a promissory note for $100. Subsequently, B sold fifteen tons of hay to A in exchange for A’s promise to pay B’s debt

1.  See Peter Karsten, The “Discovery” of Law by English and American Jurists of the Seventeenth, Eighteenth, and Nineteenth Centuries: Third-​Party Beneficiary Contracts as a Test Case, 9 Law & Hist. Rev. 327, 334–​35 (1991). 2.  (1677) 83 Eng. Rep. 523; 2 Lev. 210. 3.  See id. at 523; 2 Lev. at 210. 4.  See id. 5.  See id. at 524; 2 Lev. at 212. 6.  See id. 7.  (1776) 98 Eng. Rep. 1174; 2 Cowp. 437. 8.  Id. at 1177; 2 Cowp. 443. 9.  (1802) 127 Eng. Rep. 80; 3 Bos. & Pul. 147. 10.  Id. at 81–​82 n.(a). Some English cases decided during this early period reached a different result. See, e.g., (1669) Bourne v. Mason, 86 Eng. Rep. 5, 6; 1 Ventris 5, 6–​7; (1723) Crow v. Rogers, (K.B. 1723) 93 Eng. Rep. 719, 720; 1 Strange 592. 11.  Schermerhorn v. Vanderheyden, 1 Johns. 139, 140 (N.Y. Sup. Ct. 1806). 12.  4 Cow. 432 (N.Y. Sup. Ct. 1825), aff ’d without opinion, 9 Cow. 639, 640 (N.Y. Sup. Ct. 1827).

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to Third Party. The court permitted Third Party to sue A.13 A strong majority of other states,14 including Massachusetts,15 generally followed the same course as New York during this period.

B.  LAWRENCE V. FOX The general approach of the American courts through the mid-​nineteenth century is reflected in the now-​famous case of Lawrence v. Fox,16 decided in 1859 by the New York Court of Appeals. This case falls into the category that is known today as creditor-​beneficiary cases. These are cases in which A contracts with B to discharge B’s preexisting obligation to a third party.17 In Lawrence v.  Fox, Holly owed $300 to Lawrence.18 Holly then loaned $300 to Fox in exchange for Fox’s promise to pay $300 to Lawrence in satisfaction of Holly’s debt.19 Fox failed to pay. A divided court held that Lawrence could bring suit against Fox.20 Although Lawrence v. Fox is often celebrated today as a landmark case that established the power of a third-​party beneficiary to bring suit,21 in reality the case was not very remarkable for its time. The cases described above show that Lawrence v. Fox broke little or no new ground in New York and that the picture nationwide was little different. In an exhaustive survey of appellate decisions Peter Karsten found that American courts had allowed third-​party beneficiaries to enforce contracts in 72 percent of the cases decided prior to Lawrence v. Fox.22 Indeed, Lawrence v. Fox was not very influential in its time.23 On the contrary, almost immediately after the case 13.  See id. at 432, 439. Similarly, in Ellwood v. Monk, 5 Wend. 235 (N.Y. Sup. Ct. 1830), A promised B to pay, on B’s behalf, various debts that B owed to T. The court relied on Farley to hold that T could sue A. See id. at 236–​37. In Barker v. Bucklin, 2 Denio 45 (N.Y. Sup. Ct. 1846), the court (citing “A writer in the American Jurist,” No. 43, at 16, 17) said, “It is now well settled [by this court], as a general rule, that in cases of simple contracts, if one person makes a promise to another, for the benefit of a third, the third may maintain an action upon it, though the consideration does not move from him.” Id. at 53. In Delaware & Hudson Canal Co. v. Westchester County. Bank, 4 Denio 97, 98 (N.Y. Sup. Ct. 1847), the court reiterated this rule almost verbatim. 14.  See Karsten, supra note 1, at 340. 15.  Brewer v.  Dyer, 61 Mass. (7 Cush.) 337, 340 (1851); Hall v.  Marston, 17 Mass. (17 Tyng) 575, 579 (1822); Arnold v. Lyman, 17 Mass. (17 Tyng) 400, 404 (1821); Felton v. Dickinson, 10 Mass. (10 Tyng) 287, 290 (1813); see also Crocker v. Higgins, 7 Conn. 342, 347 (1829) (citing cases from England, New York, and Massachusetts); Bohanan v. Pope, 42 Me. 93, 96 (1856) (citing with approval the Massachusetts cases cited infra); McCarty v. Blevins, 13 Tenn. (5 Yer.) 195, 196 (1833); But see Butterfield v. Hartshorn, 7 N.H. 345, 347–​48 (1834) (holding that third-​party beneficiary may not recover due to lack of privity). 16.  20 N.Y. 268 (1859). 17.  See generally infra Section III(B). 18.  See 20 N.Y. at 269. 19.  See id. 20.  See id. at 275. 21.  See, e.g., Lawrence M. Friedman, History of American Law 405–​06 (3d ed. 2005); Anthony Jon Waters, The Property in the Promise: A Study of the Third Party Beneficiary Rule, 98 Harv. L. Rev. 1109, 1112, 1115 (1985). 22.  See Karsten, supra note 1, at 331, 333. 23.  A  footnote in the first edition of Williston on Contracts listed chronologically, within jurisdictions, the cases that had recognized a direct action by third-​party beneficiaries. Lawrence v. Fox was given an

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was decided its holding was drastically limited in New York, and the limitations on its holding stood for some time thereafter.24 Accordingly, the modern celebrity of Lawrence v. Fox has resulted neither from its novelty nor its immediate impact, both of which were minimal. Instead, that celebrity has resulted in large part from the fact that the case is a good pedagogical tool. When the tide began turning back in favor of third-​party beneficiaries, the courts rescued Lawrence v. Fox from near-​obscurity and began to treat it as a leading case. Subsequently, Lawrence v. Fox became a standard in casebooks. In historical context, however, what is striking about Lawrence v. Fox is not how far it advanced the law, which was very little, but how this now-​celebrated case was almost drowned within ten or fifteen years by the rising tide of classical contract law. The court in Lawrence v. Fox split three ways, and the three opinions put the relevant doctrinal issues on the table in a fairly explicit way. Eight judges participated in the decision. Six judges held in favor of Lawrence. Two judges, in an opinion by Judge Comstock, dissented on the doctrinal ground that a third-​party beneficiary cannot bring suit under a contract because he is not in privity with the promisor and has given no consideration for the promise. The plaintiff, Judge Comstock said, “had nothing to do with the promise on which he brought this action. It was not made to him, nor did the consideration proceed from him. . . . In general, there must be privity of contract. The party who sues upon a promise must be the promisee, or he must have some legal interest in the undertaking.”25 The six judges who held that Lawrence could bring suit under the contract had difficulty in meeting Judge Comstock’s doctrinal argument. Judges Johnson and Denio held for Lawrence on the untenable ground that in making the contract with Fox, Holly had acted as Lawrence’s agent. Judge Gray, joined by three colleagues, held for Lawrence but was unable to say exactly why. “[I]‌f . . . it could be shown,” Judge Gray concluded, “that a more strict and technically accurate application of the rules applied, would lead to a different result (which I by no means concede), the effort should not be made in the face of manifest justice.”26 The inability of the majority to jump the axiomatic hurdles set by Judge Comstock was not unusual. Other courts that held in favor of third-​party beneficiaries during this period often resorted to justifications based on clumsy fictions, such as presumed assent or a unity of interest between the third party and the promisee.27 That even judges sympathetic to third-​party

undistinguished mention in the middle of the New  York cases. See 1 Samuel Williston, Williston on Contracts § 381, at 712 n.27 (1920). Corbin remarked that “[t]‌he decision in Lawrence v. Fox can hardly . . . be said to have created a new rule of law.” 4 Arthur L. Corbin, Corbin on Contracts, § 827, at 303 (1951). 24.  See, e.g., Garnsey v. Rodgers, 47 N.Y. 233, 240 (1872) (“[A]‌ll that the case of Lawrence v. Fox decides is, that where one person loans money to another, upon his promise to pay it to a third party to whom the party so lending the money is indebted” the creditor can bring suit under the contract.). 25.  Lawrence v. Fox, 20 N.Y. at 275 (Comstock, J., dissenting). 26.  Id. 27.  For example, in Arnold v. Lyman, 17 Mass. (17 Tyng) 400 (1821), the Massachusetts court allowed suit by a third-​party beneficiary on the ground that “the assent of the [third party] creditors made them parties to the promise; and this assent is sufficiently proved, as respects the plaintiffs, by their bringing an action upon the contract.” Id. at 405.   A few opinions, however, did break through the doctrinal barrier to a lesser or greater extent. For example, in Brewer v.  Dyer, 61 Mass. (7 Cush.) 337 (1851), the court said that the right of a third-​party

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beneficiaries had difficulty in meeting the axiomatic objections raised by Judge Comstock soon became telling, because almost immediately after Lawrence v. Fox was decided, contract law became dominated by the formal reasoning of classical contract law.

C.  CLASSICAL CONTRACT LAW One tacit premise of the classical contract law was that contract law should be developed in axiomatic fashion. Another was that persons would not readily engage in contracting if they faced the threat of high liability. A third was that standardized rules, whose application is unrelated to the intentions of the parties or the particular circumstances of the transaction, were preferable to individualized rules, whose application depends on situation-​specific variables that are concerned with intention and circumstances. Given these premises it is not surprising that classical contract law would be hostile to third-​ party beneficiaries. The classical school regarded the doctrines of privity and consideration as axiomatic, and was unable to reconcile suits by third-​party beneficiaries with these doctrines. Furthermore, allowing third-​party beneficiaries to bring suit seemed to threaten a significant expansion of promisors’ liability. Finally, if there was no general barrier to suits by third-​party beneficiaries, an individualized inquiry would often be required to determine whether any given third party could enforce a contract. With the rise of classical contract law the doctrinal objections to suits by third-​party beneficiaries soon began to dominate the field. So, for example, Langdell concluded axiomatically that “[the proposition] that a person for whose benefit a promise was made, if not related to the promisee, could not sue upon the promise . . . is so plain upon its face that it is difficult to make it plainer by argument.”28 Holmes reached the same result by the same axiomatic method: “The fact that a consideration was given yesterday by A to B, and a promise received in return, cannot be laid hold of by X, and transferred from A to himself. The only thing which can be transferred is the benefit or burden of the promise, and how can they be separated from the facts which gave rise to them? How, in short, can a man sue or be sued on a promise in which he had no part?”29 The third great American commentator of the classical school, Williston, appreciated “that justice requires some remedy to be given” to at least certain third-​party beneficiaries,30 but had enormous difficulty in reconciling that conclusion with the axioms of contract law as he held them to be. In the first edition of his treatise Williston tried to reconcile this conflict by

beneficiary “does not rest upon the ground of any actual or supposed relationship between the parties, as some of the earlier cases would seem to indicate [citing Dutton v. Poole]; nor upon the reason that the defendant, by entering into such an agreement, has impliedly made himself the agent of the plaintiff; but upon the broader and more satisfactory basis, that the law, operating on the act of the parties, creates the duty, establishes the privity, and implies the promise and obligation, on which the action is founded.” Id. at 340. In Bohanan v.  Pope, 42 Me. 93 (1856), the court said that “where a party for . . . consideration . . . [contracts] . . . to pay money or do some other act for the benefit of a third person, if there be no other objection to his recovery than a want of privity between the parties, that person may maintain an action for breach[.]‌” Id. at 96. 28.  Christopher C. Langdell, A Summary of the Law of Contracts 79 (2d ed. 1880). 29.  Oliver W. Holmes, Jr., The Common Law 307 (2009). 30. 1 Williston on Contracts § 354 at 683.

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concluding that because a third-​party beneficiary is not a party to the contract, as a matter of legal principle the third party could not bring suit in a court of law, but on grounds of justice in appropriate cases a third-​party beneficiary should be allowed to bring suit in a court of equity.31 The American case law after the middle of the nineteenth century proceeded in a fashion that was generally parallel to these views. In England the law had begun to shift even earlier,32 and Tweddle v. Atkinson,33 decided in 1861, rejected Dutton v. Poole in all but form. In Tweddle, A and B were the fathers of a newlywed couple, Husband and Wife. A and B promised each other to pay certain sums to Husband, and expressly agreed that Husband should have a right enforceable at law. A, the Wife’s father, died without paying the promised amount, and Husband sued A’s executor to enforce the contract. The court held for the executor on the ground of lack of privity.34 Dutton v. Poole, Justice Blackburn said, “cannot be supported.”35 During the latter part of the nineteenth century some American states also reversed course. The most notable of these states was Massachusetts, which, like England, began a holdout against third-​party beneficiaries that persisted long after the tide had turned elsewhere. Unlike England and Massachusetts, New York did not completely turn its back on third-​party beneficiaries in the latter part of the nineteenth century, but it did severely limit the ambit of Lawrence v. Fox. Judge Gray’s opinion in that case, although unsteady in its reasoning, clearly took the position that lack of privity and lack of consideration were not barriers to suits by third-​party beneficiaries. Subsequent New  York cases dramatically cut back on that position. Although the New  York courts continued to allow suit by creditor beneficiaries, with only very limited exceptions they refused to allow suit by any other third-​party beneficiaries, and pared the holding of Lawrence v. Fox down to a bare minimum. For example, in the important case of Vrooman v. Turner, B owned property that had been mortgaged to T, but B was not personally liable on the mortgage. B sold the property to A, who promised to pay the mortgage. The court held that T could not enforce A’s promise. The requirements of consideration and privity with the promisor, the court said, could be dropped only when there was an obligation or duty previously owed by the promisee to the third party.36 Such a preexisting legal obligation would create “a privity by substitution” with the promisor,37 which in turn would permit the transaction to be characterized as one of either agency (“the [promisee] being regarded as the agent for the third party, who, by bringing his action adopts his acts”38) or of trust (“the promisor being regarded as having received money or other things for the third party”39). Over the next twenty years New York

31.  See id. at 682–​89. Later, as the Reporter for Restatement (First), Williston included in the Restatement a rule that allowed third-​party beneficiaries to bring suit even in courts of law, see text accompanying notes 68–​75, but he regarded the rule as an “anomaly.” See Proceedings, May 14, 1927, 5 A.L.I. Proc. 385 (remarks of Reporter Williston). 32.  See Karsten, supra note 1, at 337. 33.  (1861) 121 Eng. Rep. 762; 1 B. & S. 393. 34.  See id. at 763–​64; 1 B. & S. 397–​99. 35.  Id. at 764; 1 B. & S. 399; accord (1833) Price v. Easton, 110 Eng. Rep. 518, 519; 4 B. & AD. 433, 434–​35; Gandy v. Gandy, (1885) 30 Ch D 57 (C.A.) (Eng.). 36.  See Vrooman v. Turner, 69 N.Y. 280, 283–​84 (1877). 37.  Id. at 284. 38.  Id. at 285. 39.  Id.

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continued to reject the general approach of Lawrence v. Fox while accepting its narrow holding. In 1884, for example, in Wheat v. Rice40 the court said, “We prefer to restrict the doctrine of Lawrence v. Fox within the precise limits of its original application.”41 The submergence of third-​party-​beneficiary law under the doctrinal wave of classical contract law in the last part of the nineteenth century was mistaken on both normative and doctrinal grounds. The central vice of classical contract law was that, as between the values of doctrinal stability and normative desirability, classical contract law put almost all of its chips on the former and few or none on the latter. This vice was particularly apparent in the third-​ party-​beneficiary area, in which courts under the influence of classical contract law applied the doctrines of consideration and privity as objections to enforcement by third parties without even attempting to provide a normative underpinning for that result. Furthermore, the objections were mistaken even on a doctrinal level, because the doctrines of privity and consideration were virtually irrelevant to the third-​party-​beneficiary problem. The privity objection, that a plaintiff “must have some legal interest in the undertaking,” was circular, because the very question to be resolved was whether a third-​party beneficiary had a legal interest in the undertaking. The lack-​of-​consideration objection was also wide of the mark. The purpose of the requirement of consideration in contract law is to screen out those promises that are legally enforceable from those that are not. A  suit by a third-​party beneficiary, however, assumes the existence of a legally enforceable contract between the promisor and the promisee, and therefore assumes that consideration has been given. The question therefore is not whether an enforceable promise has been made—​it has—​but who can enforce the promise. That question may often be difficult to answer, but it is not a question of consideration.42 Finally, if the privity and consideration objections were well taken, they would have barred actions by all third-​party beneficiaries. Although England and Massachusetts did take this approach, New York and most other states allowed at least some types of third-​party beneficiaries to bring suit.

40.  97 N.Y. 296 (1884). 41.  Id. at 302; accord Lorillard v. Clyde, 25 N.E. 917, 919 (N.Y. 1890) (“[T]‌he courts have repeatedly said that the principle of [Lawrence v. Fox] should be limited to the cases having the same essential facts.”); Durnherr v. Rau, 32 N.E. 49, 50 (N.Y. 1892).   Despite the strictures of cases such as Wheat, the New  York courts during this period allowed enforcement by third-​party beneficiaries in at least two categories of cases that did not involve creditor beneficiaries. One of these categories involved the recurring leitmotif (going back to Dutton v. Poole) of a close familial relationship between the promisee and the beneficiary. For example, in Todd v. Weber, 95 N.Y. 181 (1884), a child was born out of wedlock, and the putative father promised the child’s relatives that he would provide for the child’s care. The court allowed the child to enforce the contract. Todd, supra, at 195. The second category involved cases in which a third-​party beneficiary would benefit from performance of a contract made by a government entity. See Rigney v. New York Cent. & H.R.R. Co., 111 N.E. 226, 228 (N.Y. 1916); Smyth v. City of New York, 96 N.E. 409, 411–​12 (N.Y. 1911); Pond v. New Rochelle Water Co., 76 N.E. 211, 214 (N.Y. 1906); Little v. Banks, 85 N.Y. 258, 264, 267 (1881). The New York courts also allowed suit by a third-​party beneficiary to whom the promise was directly made, see Rector v. Teed, 24 N.E. 1014, 1016 (N.Y. 1890), but in this kind of case the privity objection arguably did not apply. 42.  Even Williston, who took the position that enforcement of contracts by third-​party beneficiaries was not justified in principle due to a lack of privity, admitted that consideration was not a problem: “[I]‌n a developed system of contract law there seems to be no good reason why A should not be able for a consideration received from B to make an effective promise to C.” 1 Williston on Contracts § 354, at 682.

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D.  THE BEGINNINGS OF MODERN THIRD-​PARTY BENEFICIARY LAW Given the double mistake of the classical-​contract-​law objections to enforcement of contracts by third-​party beneficiaries it was only a matter of time until those objections eroded and then collapsed. In New York, the erosion was sharply marked by Buchanan v. Tilden,43 decided in 1899. A made a contract with B under which A agreed to pay $50,000 to B’s wife in exchange for B’s obtaining a loan for A. The court held that B’s wife could bring an action against A, partly on the ground that there was a unity of interest between husband and wife, but also on the ground that the moral duty owed by a husband to a wife would satisfy the preexisting-​obligation requirement of cases such as Vrooman.44 Then in 1918 the New York Court of Appeals decided the pivotal case of Seaver v. Ransom.45 This case involved the category now known as donee-​beneficiary cases, in which an objective of the contracting parties is to give effect to the promisee’s donative intent by obliging the promisor to render a performance that will benefit the third party as a gift from the promisee.46 There the contracting parties were Mrs. Beman and her husband, Judge Beman. Judge Beman had drawn a will for Mrs. Beman when she was about to die. The will left a house owned by Mrs. Beman to Judge Beman for life, with the remainder to a charity. When the will was read to Mrs. Beman she said she wanted to leave the house to her niece, Marion. Mrs. Beman’s strength was waning, and although Judge Beman offered to write another will, she was afraid she would not hold out long enough to sign it. Judge Beman therefore promised that if Mrs. Beman would sign the original will he would leave Marion enough in his own will to make up the difference. When Judge Beman died it was found that his will made no provision for Marion, and Marion brought suit against Judge Beman’s executors. The court held that Marion could enforce the contract.47 Unlike Buchanan v. Tilden, the court in Seaver could not easily rely on a unity of interest between the promisee-​aunt and the beneficiary-​niece. Rather, the court based its holding, more squarely than it had in Buchanan, on the ground that a preexisting moral obligation owed by the promisee to the third-​party beneficiary sufficed to allow enforcement of the contract by the third party: The constraining power of conscience is not regulated by the degree of relationship alone. The dependent or faithful niece may have a stronger claim than the affluent or unworthy son. No sensible theory of moral obligation denies arbitrarily to the former what would be conceded to the latter. We might consistently either refuse or allow the claim of both, but I cannot reconcile a decision in favor of the wife in Buchanan v. Tilden, based on the moral obligations arising out of near relationship, with a decision against the niece here on the ground that the relationship is too remote for equity’s ken.48 43.  52 N.E. 724 (N.Y. 1899). 44.  See id. at 727–​28. 45.  120 N.E. 639 (N.Y. 1918). 46.  See infra Section III(A). 47.  120 N.E. at 641–​42. See infra Section III(A) for further discussion of Seaver. 48.  120 N.E. at 641.

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As in Lawrence v. Fox, however, the court was not certain precisely how to support its result as a doctrinal matter: If Mrs. Beman had left her husband the house on condition that he pay the plaintiff $6,000, and he had accepted the devise, he would have become personally liable to pay the legacy, and plaintiff could have recovered in an action at law against him, whatever the value of the house. That would be because the testatrix had in substance bequeathed the promise to plaintiff. . . . The distinction between an implied promise to a testator for the benefit of a third party to pay a legacy and an unqualified promise on a valuable consideration to make provision for the third party by will is discernible, but not obvious. . . . The equities are with the plaintiff, and they may be enforced in this action. . . . 49

Notwithstanding its doctrinal hesitation, Seaver represents a crucial transition between the restrictive rules of classical contract law that governed third-​party beneficiaries in the late nineteenth and early twentieth centuries and the general principle of modern contract law that began to emerge around the 1920s and have steadily evolved since then. In form, Seaver looked backward to classical contract law. Classical contract law tended either to deny the right of a third-​party beneficiary to enforce a contract, or, at best, to allow enforcement only by third parties who fell within specific, well-​defined, and standardized categories—​most prominently, third parties to whom the promisee owed a preexisting legal obligation. Seaver too only allowed enforcement by a third-​party beneficiary to whom the promisee owed a preexisting obligation, although the concept of obligation was expanded to include moral obligation. In substance, however, Seaver looked forward to modern contract law. The recognition of preexisting moral obligations as a basis for enforceability was inherently much more expansive, less standardized, and more openly dependent on social propositions than was the earlier restriction to preexisting legal obligations. Furthermore, recognition of this large new category set the stage for the creation of a general principle that could both explain and go beyond specific categories such as creditor beneficiaries. Accordingly, the ruling in Seaver, although tied to classical contract law in form, in substance bore the seeds of the modern expansion of the law governing third-​party beneficiaries. This expansion received its single most important expression fifteen years later, with the publication of Restatement First, Section 133, which provided: (1) Where performance of a promise in a contract will benefit a person other than the promisee, that person is . . . : (a) a donee beneficiary if it appears from the terms of the promise in view of the accompanying circumstances that the purpose of the promisee in obtaining the promise of all or part of the performance thereof is [i]‌to make a gift to the beneficiary or [ii] to confer upon him a right against the promisor to some performance neither due nor supposed or asserted to be due from the promisee to the beneficiary; (b) a creditor beneficiary if no purpose to make a gift appears from the terms of the promise in view of the accompanying circumstances and performance of the promise will satisfy an actual or supposed or asserted duty of the promisee to the beneficiary . . . ;

49.  Id. at 641–​42.

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(c) an incidental beneficiary if neither the facts stated in Clause (a)  nor those stated in Clause (b) exist.50

Sections 135 and 136 of Restatement First then went on to provide that a donee or creditor beneficiary had legally enforceable rights under a contract, but an incidental beneficiary did not.51 The nomenclature and scheme of Restatement First can be reformulated in the following terms: There are two well-​established basic categories of third-​party beneficiaries who can enforce contracts. One basic category consists of cases in which the object of the promisee is to bring about the payment of a legal obligation he owes to the beneficiary. This category is covered in Section 133(1)(b), and in such cases the third party is labeled a creditor beneficiary. The second basic category consists of cases in which the object of the promisee is to make a gift to the beneficiary. This category is covered in Section 133(1)(a)[i]‌, and in such cases the third party is labeled a donee beneficiary. In cases falling outside these two well-​established categories, sometimes the Restatement First scheme would allow the beneficiary to enforce the contract, and sometimes it would not. When the purpose of the promisee is to confer a right on the beneficiary, enforcement would be permitted. Section 133(1)(a)[ii] also and confusingly labels the beneficiary in these cases a donee beneficiary, although no intent to make a gift is required. In all other cases enforcement is inappropriate. Section 133(1)(c) labels the beneficiary in these cases an incidental beneficiary, so that the term incidental beneficiary is a synonym for unenforceability by the beneficiary. The terminology of Restatement First was very awkward, because the term donee beneficiary was used to describe both true donees, to whom the promisor intended to make a gift, and beneficiaries who could enforce the contract but were not true donees.52 Despite the awkward nature of this nomenclature, Restatement First initiated the modern law of third-​party beneficiaries by taking two critical steps. First, the Restatement pushed aside by brute force the doctrinal objections to enforcement by third-​party beneficiaries. Second, by expanding the class of donee beneficiaries well beyond true donees, Restatement First set the stage for movement away from a category-​based body of third-​party-​beneficiary law toward a body of law in which enforceability by third-​party beneficiaries would be determined by a general principle. But what is that principle?

I I .  T H E T H I R D-​PA RT Y-​ B E N E F I C I A RY PR I NCI PL E It is easy to see why some third-​party beneficiaries should have the right to bring suit: the aim of contract law is to effectuate the intentions of contracting parties, and in certain cases allowing a third-​party beneficiary to bring suit is the best way to accomplish that aim. Recurring cases of 50.  Restatement (First) of Contracts. § 133 (Am. Law Inst. 1932) [hereinafter Restatement First] (bracketed numbers added). 51.  See id. §§ 135–​136. 52.  If the promisee had an intent to make a gift to the beneficiary, the beneficiary would fall under Section 133(1)(a)[i]‌.

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this kind are discussed in Section III. It is also easy to see why not every third-​party beneficiary should be allowed to enforce a contract. The reasons for enforcing bargain promises are complex, but the most important are that bargains enhance the wealth of the contracting parties by creating gains through exchange and that enforcement allows the contracting parties to make reliable plans.53 At its core, therefore, contract law seeks to facilitate the power of capable and well-​informed parties to further their own interests by contracting. Allowing enforcement of contracts by all third-​party beneficiaries would often conflict with those interests. For example, suppose Martial is a manufacturer of specialty toy soldiers and Access is a toy distributor. Martial purchases special paint for its soldiers from Color, and employs skilled workers on an hourly basis. At a time when Martial would have otherwise had to idle its plant for lack of business, Martial makes a contract with Access to supply highly detailed Civil War toy soldiers to take advantage of a special surge of interest in that war. Access plans to resell the toy soldiers to large retailers, including Toys ‘R We. Martial designs the soldiers and draws plans for the necessary dies, and then enters into a contract with Diemaker, who agrees to produce the dies. At the time the contract is made Diemaker knows that Martial requires the dies to fill her contract with Access, that Access plans to resell to Toys ’R We and other retailers, and that Martial has no other business in prospect. In breach of its contract Diemaker fails to deliver the dies. As a result, Martial is in breach of its contract with Access and is also forced to idle its plant for six weeks until new orders begin to come in. Martial sues Diemaker for lost profits on sales to Access. Access sues Diemaker for its lost profits on resale of the toy soldiers. So does Toys ’R We. Color sues Diemaker for lost profits on the paint it would have sold to Martial if Diemaker had performed. Martial’s workers sue Diemaker for wages they would have earned if Diemaker had performed. Access, Toys ’R We, Color, and the workers are all third-​party beneficiaries of the contract between Diemaker and Martial. Intuitively, it seems clear that these beneficiaries should not be able to bring suit against Diemaker.54 The source of the intuition lies in considerations that might be thought of as remedial, that is, considerations concerning the extent of the promisor’s liability and the impact of that liability on the contracting parties. In the hypothetical, Martial is entitled to expectation damages against Diemaker as a result of Diemaker’s breach, and these damages would be measured in large part by Martial’s lost profits. It can be assumed that the prospect of such damages affected the price Diemaker charged. If Martial had initially agreed to forgo or limit expectation damages in the event of Diemaker’s breach, Diemaker presumably would have agreed to a lower price. If Martial did not agree to forgo those damages, presumably that was partly because it wanted full expectation damages if Diemaker breached and partly because it would have viewed the contract with Diemaker as unreliable if the contract was not backed by the sanction of expectation damages. 53.  See Robert Cooter & Melvin Aron Eisenberg, Damages for Breach of Contract, 73 Cal. L. Rev. 1434, 1459–​64 (1985); Melvin Aron Eisenberg, The Bargain Principle and Its Limits, 95 Harv. L. Rev. 741, 743–​44 (1982). 54.  See Restatement (Second) of Contracts § 302 illus. 16, 19 (Am. Law Inst. 1981)  [hereinafter Restatement Second]: 16. B contracts with A to erect an expensive building on A’s land. C’s adjoining land would be enhanced in value by the performance of the contract. C [cannot bring suit under the contract]. 19. A  contracts to erect a building for C.  B then contracts with A  to supply lumber needed for the building. C . . . and B [cannot bring suit under each other’s contract].

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Suppose now that the parties had directly addressed the issue of the third parties’ rights. If upon breach Diemaker would be exposed to liability to the third parties as well as liability to Martial, Diemaker would certainly have demanded a higher price from Martial. Martial, however, would almost certainly have been unwilling to pay that higher price, because it would receive little or no corresponding benefit in return. We can therefore be fairly confident that if Martial and Diemaker had directly addressed the issue, they would have agreed that the third parties would not be able to enforce the contract. Accordingly, if the interests of the contracting parties, Martial and Diemaker, are measured by what they would have agreed to if they had addressed the issue, allowing the third parties in the hypothetical to enforce the contract would conflict with those interests. In short, although social propositions do not support a rule that no third-​party beneficiaries should be allowed to enforce contracts in their favor, neither do they support a rule that all third-​ party beneficiaries should be allowed to enforce contracts in their favor. Therefore, when Restatement First swept aside the doctrinal barriers to enforcement by third-​party beneficiaries as a class it not only cleared the way for the formulation of a general principle to determine when enforcement by third-​party beneficiaries should be permitted, but also created an urgent need for such a formulation.

A.  RESTATEMENT FIRST AND THE INTENT-​TO-​BENEFIT TEST The only general principle laid down in Restatement First was that third-​party beneficiaries who were neither creditor beneficiaries nor true donee beneficiaries could enforce contracts if but only if “the purpose of the promisee in obtaining the promise [was] . . . to confer on [the beneficiary] a right against the promisor.”55 This principle provided no guidance concerning the critical question:  How was a court to determine whether the relevant purpose was present? In the end, therefore, Restatement First’s general principle was largely empty.56 For this or other reasons, although the courts made wide use of the creditor-​beneficiary and true donee-​ beneficiary tests they tended to adopt other tests to govern other cases. The most common test was whether the promisee—​or, in some formulations, the contracting parties—​intended to benefit the third-​party beneficiary.57 This test, like the Restatement First test, was defective, because the term intent is ambiguous along at least three axes. First, intent can refer either to the parties’ actual subjective intent or to an intent that is objectively manifested.58 Second, intent can refer either to acting with a motive to achieve a given result or to choosing a course of action with knowledge that a given result is likely to follow even if the actor does not aim to achieve that result, is indifferent about achieving the result, or indeed

55.  Restatement First § 133. 56.  See David M. Summers, Note, Third Party Beneficiaries and the Restatement (Second) of Contracts, 67 Cornell L. Rev. 880, 884 (1982). 57.  See, e.g., Buchman Plumbing Co. v. Regents of the Univ. of Minn., 215 N.W.2d 479, 483 (Minn. 1974); Snyder Plumbing & Heating Corp. v. Purcell, 195 N.Y.S.2d 780, 783 (App. Div. 1960); Vogel v. Reed Supply Co., 177 S.E.2d 273, 279 (N.C. 1970). 58.  See 4 Arthur L. Corbin, Corbin on Contracts, § 776, at 14–​15, 18–​20 (1951); 2 Samuel Williston, Williston on Contracts § 356A at 835–​42 (Walter H.E. Jaeger ed., 3d ed. 1959).

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would prefer to avoid the result. Illustration  1 to Restatement Second of Torts Section 8A exemplifies this point: A throws a bomb into B’s office for the purpose of killing B. A knows that C, B’s stenographer, is in the office. A has no desire to injure C, but knows that his act is substantially certain to do so. C is injured by the explosion. A is subject to liability to C for an intentional tort.59

Third, intent can refer either to the end an actor seeks to achieve or to the means that an actor uses to achieve an end. For example, suppose that A, a country at war, stages a bombing raid on the civilian population of its enemy, B. The end that A seeks to achieve by the raid may be to kill B’s civilians (perhaps in retribution for the killing of A’s civilians) or to induce B’s surrender. In the first case killing civilians is intended as an end, and in the second case it is intended as a means, but in both cases it could be said that A intended to kill civilians. Courts that used the intent-​to-​benefit test usually failed to make clear which of the several possible meanings of intent they were using.60 Moreover, the entire enterprise of finding an intent to benefit the third party is misguided. Except in cases involving true donee beneficiaries, the intent of both contracting parties is typically to further their own interests, not the interests of the third party. Accordingly, the question whether there is an intent to benefit the third party normally cannot generate a meaningful answer. To ameliorate this difficulty some courts patched additional requirements onto the intent-​to-​ benefit test. For example, some cases imposed a requirement that the intent to benefit the third party must be “clear,” “express,” or “definite,”61 and others imposed a requirement that the intent to benefit the third party had to be found in the language of the contract itself and could not be established on the basis of surrounding circumstances.62 The former requirement was based on the erroneous assumption that contracting parties normally have a “clear,” “express,” or “definite” intent to benefit or not benefit the third party. Both requirements were inconsistent with the general principles of contract interpretation, which provide for the interpretation, rather than the negation, of unclear terms and allow courts to interpret contracts in the light of surrounding circumstances. Both requirements were also difficult or impossible to apply meaningfully and

59.  Restatement (Second) of Torts § 8A, illus. 1 (1979). 60.  See, e.g., State v. Osborne, 607 P.2d 369, 371 (Alaska 1980); Little v. Union Tr. Co. of Maryland, 412 A.2d 1251, 1253–​54 (Md. 1980); Nat’l Sur. Co. v. Brown-​Graves Co., 7 F.2d 91, 92 (6th Cir.1925); Maryland Cas. Co. v.  Johnson, 15 F.2d 253, 254–​55 (W.D. Mich. 1926); Cretex Cos. v.  Constr. Leaders, Inc., 342 N.W.2d 135, 139–​40 (Minn. 1984). 61.  See, e.g., Sec. Mut. Cas. Co. v. Pacura, 402 So. 2d 1266, 1267 (Fla. Dist. Ct. App. 1981) (clear); Donalson v. Coca-​Cola Co., 298 S.E.2d 25, 27 (Ga. Ct. App. 1982) (clear); Khabbaz v. Swartz, 319 N.W.2d 279, 285 (Iowa 1982) (express); Snyder Plumbing, 195 N.Y.S.2d at 783 (clear); Keel v. Titan Constr. Corp., 639 P.2d 1228, 1231 (Okla. 1981) (express); Kelly Health Care, Inc. v. Prudential Ins. Co. of Am., 309 S.E.2d 305, 307 (Va. 1983) (clear and definite). 62.  See, e.g., Sec. Fund Servs., Inc. v. Am. Nat’l Bank & Trust Co., 542 F. Supp. 323, 329 (N.D. Ill. 1982). Some cases that take this position make an exception that extrinsic circumstances can be utilized where the contract discloses that it was entered into for the benefit of a third-​party beneficiary but the beneficiary is not specifically identified. See Hylte Bruks Aktiebolag v. Babcock & Wilcox Co., 399 F.2d 289, 292 (2d Cir. 1968); Am. Fin. Corp. v. Comput. Sci. Corp., 558 F. Supp. 1182, 1186 (D. Del. 1983).

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consistently, and were not so applied.63 The better-​reasoned cases rejected these requirements,64 as does Restatement Second.65 Other authorities patched an additional substantive requirement onto the intent-​to-​benefit test. Some cases hold that the performance must be rendered directly to the beneficiary.66 This requirement has no rational connection to the intent-​to-​benefit test, and is both over-​and under-​inclusive. The requirement was over-inclusive, because there are many cases in which a contracted-​for performance is to be rendered to a designated third person, but that person should not be given the right to enforce the contract. For example, as a Restatement Second illustration states: “B contracts with A to buy a new car manufactured by C. C [cannot bring suit under contract], even though the promise can only be performed if money is paid to C.”67 The direct-​performance requirement was under-​inclusive, because it excludes enforcement by third-​party beneficiaries in cases in which enforcement should be and commonly is permitted. For example, when an attorney has broken a contract with a client to draft a will in favor of a designated legatee, the attorney’s performance is rendered to the client but the would-​be legatee should be and generally is entitled to bring suit under the contract.68

B.  THE RESTATEMENT SECOND TEST Against this background Restatement Second adopted a new formulation of the test for whether a third-​party beneficiary can bring suit. Terminologically, Restatement Second substituted, for the three-​part nomenclature of Restatement First, a single term, intended beneficiaries, to describe all third-​party beneficiaries who can enforce contracts. However, Restatement Second failed to follow up on its unified nomenclature by adopting a unified principle for enforceability, and the principles it did adopt are seriously flawed. These principles are set out in Section 302(1): Unless otherwise agreed between promisor and promisee, a beneficiary of a promise is an intended beneficiary if recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties and either (a) the performance of the promise will satisfy an obligation of the promisee to pay money to the beneficiary; or

63. Harry G. Prince, Perfecting the Third Party Beneficiary Standing Rule under Section 302 of the Restatement (Second) of Contracts, 25 B.C. L. Rev. 919, 923 (1984). 64.  See E.B. Roberts Constr. Co. v. Concrete Contractors, Inc., 704 P.2d 859, 865–​66 (Colo. 1985); J. Louis Crum Corp. v. Alfred Lindgren, Inc., 564 S.W.2d 544, 547 (Mo. Ct. App. 1978); Black & White Cabs of St. Louis, Inc. v. Smith, 370 S.W.2d 669, 675 & (Mo. Ct. App. 1963); Prince, supra note 63, at 928–​29. 65.  See Restatement Second § 302(1)(b). 66.  See Fid. & Deposit Co. v. Rainer, 125 So. 55, 58–​59 (Ala. 1929); Carson Pirie Scott & Co. v. Parrett, 178 N.E. 498, 501–​04 (Ill. 1931). 67.  Restatement Second § 302 illus. 17; see also Dravo Corp. v. Robert B. Kerris, Inc., 655 F.2d 503, 510–​11 (3d Cir. 1981) (holding that Dravo could not enforce a subcontract in which A agreed to construct a plant for X, A subcontracted to B the installation of ventilation systems, and the subcontract between A and B provided that B would use only Dravo ventilation units). 68.  See infra Section III(D). A variant of the direct-​performance test is that there must be an intent to confer a “direct” benefit on the third-​party beneficiary. See, e.g., Holley v. St. Paul Fire & Marine Ins. Co.,

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(b) the circumstances indicate that the promisee intends to give the beneficiary the benefit of the promised performance.69

It is not easy to determine how the drafters of Restatement Second thought Section 302 would work, but whatever the thought, the text is relentless in its focus on intent. The introductory clause depends upon the intention of the parties, Subsection 1(b) turns on the intention of the promisee, and a third-​party beneficiary who can enforce a contract is labeled an “intended beneficiary.” Unfortunately, Restatement Second is even more restrictive than Restatement First, because it imposes a new conjunctive test. Under Section 302 a third-​party beneficiary can bring suit under a contract if, but only if, the third party satisfies the requirements of both the introductory clause of the Section and either Subsection 1(a) or 1(b). The introductory clause has the look and feel of an intent-​to-​benefit test (although it is susceptible to a better interpretation, which will be discussed below70), whereas Subsections (1)(a) and (b)  are essentially counterparts of Restatement First’s creditor-​and donee-​beneficiary tests. In the end, therefore, the conjunctive test of Section 302(1) has the faults of both the intent-​to-​benefit and the Restatement First test. In an apparent attempt to remedy the deficiencies of the text of Section 302, the Comment adds a new hypothetical test: d. Either a promise to pay the promisee’s debt to a beneficiary or a gift promise involves a manifestation of intention by the promisee and promisor sufficient, in a contractual setting, to make reliance by the beneficiary both reasonable and probable. Other cases may be quite similar in this respect. Examples are a promise to perform a supposed or asserted duty of the promisee, a promise to discharge a lien on the promisee’s property, or a promise to satisfy the duty of a third person. In such cases, if the beneficiary would be reasonable in relying on the promise as manifesting an intention to confer a right on him, he is an intended beneficiary.

This test, which is absent from the text of Section 302, is of little or no use in resolving critical questions. Presumably, Comment d does not require actual reliance. Such a requirement would overthrow much of third-​party-​beneficiary law:  for example, neither Lawrence, the creditor beneficiary in Lawrence v. Fox, nor Marion, the donee beneficiary in Seaver v. Ransom, were required to establish reliance as a condition for bringing suit. Therefore, Comment d must propose an “as if ” test—​that is, under Comment d, in determining whether a third-​party beneficiary can enforce a contract the courts should ask whether reliance would have been reasonable if it had occurred. But because Comment d provides no guidance for determining when reliance would be reasonable if it had occurred, all the Comment does is to shift from a largely empty intent test to a largely empty hypothetical-​reliance test.

396 So. 2d 75, 80 (Ala. 1981); Reidy v. Macauley, 290 S.E.2d 746, 747 (N.C. Ct. App. 1982); Prince, supra note 63, at 933–​34, 990–​91. This requirement, however, is just as empty as the intent-​to-​benefit test itself, and leads to the same kind of conclusory reasoning. 69.  Restatement Second § 302(1). 70.  See infra text accompanying notes 74–​79.

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C.  THE THIRD-​PARTY-​BENEFICIARY PRINCIPLE In short, the Restatement First and Restatement Second tests are both inadequate and, indeed, largely meaningless, except for cases involving creditor and true donee beneficiaries. What principle, then, should determine whether a given third-​party beneficiary should be permitted to enforce a contract? To answer this question it is necessary to understand why third-​party beneficiaries should be able to enforce some contracts but should not be able to enforce all contracts. They should be able to enforce some contracts because allowing such enforcement is often the best means of fulfilling the objectives of the contracting parties. They should not be able to enforce all contracts because in some cases such enforcement would conflict with the interests of the contracting parties. These reasons points the way to the principle that should determine whether any given third-​party beneficiary should have power to enforce a contract. This principle, which will be referred to as the third-​party-​beneficiary principle, is as follows: A third-​party beneficiary should have the right to enforce a contract if but only if: (I) allowing the beneficiary to enforce the contract is a necessary or important means of effectuating the contracting parties’ objectives, as manifested in the contract read in the light of surrounding circumstances; or (II) allowing the beneficiary to enforce the contract is supported by reasons of policy or morality independent of contract law and would not conflict with the contracting parties’ performance objectives.

The term the contracting parties’ objectives needs some exegesis. Normally a third-​party beneficiary will bring suit only if the promisor has breached. Obviously, at that point it is not an objective of the promisor to perform. Furthermore, in one sense it is never an objective of a promisor to perform, but only to obtain what is promised to her if she performs. However, such a characterization of the promisor’s objective would be too narrow. The promisor can attain what she is promised only by joining in the enterprise that is embodied in the contract—​an enterprise designed to fulfill various objectives, some shared, some dearer to the heart of the promisor, some dearer to the heart of the promisee. Accordingly, the term the contracting parties’ objectives will be used to mean the joint objectives of the contracting parties, embodied in the contract read in the light of surrounding circumstances, that the parties either knew or should have known of at the time the contract was made. The two elements of the third-​party-​beneficiary principle may be referred to as the first and second branches of that principle. The first branch of the principle reflects the concept that at its core contract law seeks to facilitate the right of competent and duly informed parties to further their own interests by contracting. Under this branch the purpose of allowing suit by a third party is not to ensure that the third party realizes a benefit, but to ensure that the contracting parties’ performance objectives are effectuated. Unlike the intent-​to-​benefit test the focus here is on the self-​regarding interests of the contracting parties, rather than on an other-​regarding intent to benefit the third party.71

71.  See Robert Page Smith, Recent Case, Parks v. Prudential Ins. Co. of America, 103 F. Supp. 493 (E.D. Tenn. 1951), 31 Tex. L. Rev. 210, 211 (1952).

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To put this differently, under the first branch of the third-​party-​beneficiary principle the law of third-​party beneficiaries is largely conceived as remedial, rather than substantive. The question addressed by the first branch of the principle is not whether the contract creates a right in the third party, but whether empowering the third party to enforce the contract is a necessary or important means of effectuating the contracting parties’ performance objectives. Like other remedial problems, this question is seldom answered by the literal terms of the contract itself. In part, this is because it is costly to write contract terms, and it is likely to be more efficient for contracting parties to spend time on terms that describe the performance they expect to render than to spend time on terms that describe the consequences of nonperformance. Furthermore, although it is relatively easy for contracting parties to specify the performances they want it is often extremely difficult to specify the remedies they want for a breach before knowing the nature of the breach and the circumstances of the world at the time of breach. The rules that the courts apply to fill in contract gaps should be both efficient and fair. Contracts negotiated under ideal conditions—​that is, where foresight is perfect and negotiation and drafting are cost-​free—​by capable and well-​informed parties will be efficient, and enforcing the terms of such contracts would usually be regarded as fair. Accordingly, a remedial rule is fair and efficient if it corresponds to the terms that competent and well-​informed parties situated like the contracting parties would have negotiated under ideal conditions. In the context of third-​party-​beneficiary issues that determination rests largely on whether the promisee will realize the objectives that he bargained for even if the third party is not allowed to bring suit, and whether the promisor’s risk of liability will be inappropriately extended if the third party is allowed to bring suit. To put the matter simply, the question is whether it is likely that the promisor would have made the contract at the contract price if the contract had explicitly stated that the third party would be allowed to bring suit against the promisor, and whether the promisee would have made the contract at the contract price if the contract had explicitly stated that the third party would not be allowed to bring suit. Unlike the first branch of the third-​party-​beneficiary principle, which focuses exclusively on effectuating the contracting parties’ performance objectives, the second branch of the principle reflects the concept that contract law may properly give effect to policy and moral concerns that are independent of the contracting parties’ performance objectives. This is not unusual. Policy and morality have traditionally entered into contract law in a variety of ways. For example, Restatement Second Section 207 provides that “In choosing among the reasonable meanings of a promise or agreement or a term thereof, a meaning that serves the public interest is generally preferred.”72 Similarly, Restatement Second Section 204, Comment d, provides that “[W]‌here there is in fact no agreement [on a matter that falls within the ambit of a contract], the courts should supply a term that comports with community standards of fairness and policy rather than analyze a hypothetical model of the bargaining process.” Given the primacy of effectuating contracting parties’ objectives, as manifested in their contract, enforcement by a third-​party beneficiary should not be permitted if it would conflict with those objectives. If, however, there is no such conflict, and if policy or moral interests would be served by allowing a third party to enforce the contract, the rules of contract law should be shaped to allow such enforcement, just as they are shaped by policy and morality in other areas.

72.  Restatement Second § 207.

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The third-​party-​beneficiary principle, while new in its articulation, is supported by existing authority. To begin with, this principle explains the results of many or most of the modern cases better than other principles.73 Furthermore, the first branch of the principle can be thought of as a reconceptualization of the intent-​to-​benefit test, with the focus shifted from whether the promisor had a subjective intent to benefit the third party to whether allowing the third party to enforce the contract is necessary or important as a means to ensure effectuation of the contracting parties’ performance objectives. The first branch of the principle also draws support from the concept that apparently underlies the introductory clause of Restatement Second Section 302. This clause begins by stating that “a beneficiary of a promise is an intended beneficiary [and therefore can enforce the contract] if recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties. . . .”74 If Section 302 had stopped at that point it would be highly comparable to the first branch of the third-​party-​beneficiary principle. The comments of Robert Braucher, the Reporter, on the ALI floor provide some evidence that he thought Section 302 had done just that: In these cases often the problem is whether the remedy carries out the intention of the parties or is likely to interrupt what the parties were trying to do. We all know that commonly the parties to a contract do not clearly foresee and provide for what happens in the event of a breakdown of the contractual relationship. Their natural focus is on performance, not upon breach.75

Unfortunately, the drafters of Section 302 failed to see that if the introductory clause to that Section is satisfied—​if, that is, “recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties”76—​no additional test should be required. Instead, they added a conjunctive requirement under which the beneficiary must also come within a counterpart of the Restatement First creditor-​or donee-​beneficiary tests, and compounded the problem by employing a rhetoric saturated with the terminology of intent. Nevertheless, Section 302 may be seen as a bridge between the traditional intent-​to-​benefit test and the first branch of the third-​party-​beneficiary principle. The second branch of the third-​party-​beneficiary principle finds even stronger support in Restatement Second Section 302, Comment d, which states, “[C]‌onsiderations of procedural convenience and other factors not strictly dependent on the manifested intention of the parties may affect the question whether . . . recognition of a right in the beneficiary is appropriate. In some cases an overriding policy, which may be embodied in a statute, requires recognition of such a right without regard to the intention of the parties.”77 In short, the Third-​Party-​Beneficiary Principle, while new in its articulation, is not only justified by applicable social propositions but is supported by existing authority, including the

73.  See Section III, infra. 74.  Restatement Second § 302. 75.  See Thursday Afternoon Session May 18, 1967, 44 A.L.I. Proc. 308 (remarks of Reporter Robert Braucher). 76.  Restatement Second § 302. 77.  Id. § 302 cmt. d.

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results of the cases and the concept underlying the introductory clause and Restatement Second Section 302, Comment d to that section.

I II.   S O M E R E C U R RI NG T HI R D-​PA RT Y-​ B E N E F I C I A RY CAT EGOR I ES Section III illustrates the third-​party-​beneficiary principle, and shows how it explains the results of many or most of the modern cases, by examining the application of the principle to some recurring third-​party-​beneficiary problems.

A.  DONEE BENEFICIARIES A third-​party beneficiary is a donee beneficiary when an objective of the contracting parties, as manifested in the contract read in the light of surrounding circumstances, is to give effect to an intention of the promisee to make a gift to the third-​party beneficiary by obliging the promisor to render a performance that will benefit the third party. Seaver v. Ransom78 is a paradigmatic case in this area. An analysis of the facts of that case shows why donee beneficiaries should be permitted to enforce a contract under the first branch of the third-​party-​beneficiary principle. Recall that the contracting parties in that case were Judge and Mrs. Beman. A performance objective of those parties was that a gift be made to Mrs. Beman’s niece, Marion, through the instrumentality of a contract that obliged Judge Beman to leave Marion a certain amount in his will. After Mrs. Beman’s death Judge Beman broke the contract. On these facts, allowing Marion to enforce the contract was an important means of effectuating the contracting parties’ objective. If the contract could not be enforced by Marion it could have been enforced only by Mrs. Beman’s estate. Mrs. Beman’s estate, however, would have had no economic incentive to enforce the contract, because the estate would bear all the costs of enforcement while Marion would reap all the benefits. Furthermore, the estate’s expectation damages would be zero, because performance of Judge Beman’s promise would not have increased the value of the estate. Perhaps Mrs. Beman’s estate could have sued Judge Beman’s estate for unjust enrichment, but even if Mrs. Beman’s estate prevailed on that theory the suit would not effectuate the contracting parties’ objectives because Mrs. Beman’s estate, rather than Marion, would end up with the recovery. In any event, the amount by which Judge Beman was unjustly enriched (the value of a life estate in Mrs. Beman’s house) would be less than the amount he had promised to confer on Marion (the value of the house itself). A suit by the estate for specific performance would solve these problems, but again the estate would have no economic incentive to bring such a suit, and in any event specific performance is always a problematic remedy.79 A final reason for allowing Marion to enforce the contract is that such enforcement would not enlarge the liability that Judge Beman must have expected to incur at the time the contract was made. Judge Beman’s obligation under the contract was to confer upon Marion a certain 78.  120 N.E. 639 (N.Y. 1918), discussed in the text accompanying notes 45–​49, supra. 79.  See supra, Chapter 24.

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amount of money. Allowing Marion to enforce the contract would not increase his liability beyond that amount. This analysis of Seaver holds true for donee beneficiaries as a class. To begin with, many other donee-​beneficiary cases involve promises that are likely to mature only after the promisee’s death. The most common donee-​beneficiary contract is the family life-​insurance policy, which is analytically identical to Seaver v. Ransom in that a performance objective of the contracting parties is to make a gift to the beneficiary through the instrumentality of the contract, and the promisee will have died before the contract can be performed. Of course, in some donee-​beneficiary cases the promisee will not have died before the breach, but may have an altruistic interest in enforcing the contract. (Presumably, the promisee has not changed his mind, because if he has he can simply rescind the contract with the promisor. This issue is discussed below.) Even in such cases, however, at the time of the breach the promisee will not have an economic incentive to enforce the contract. Furthermore, the problem of remedy remains. The promisee’s expectation damages will often be zero; unjust enrichment might be less than the value of the promised performance; and specific performance is a problematic remedy.

B.  CREDITOR BENEFICIARIES A third-​party beneficiary is a creditor beneficiary if the promisee owed the third party a legal obligation before making the contract with the promisor, and a performance objective of the contracting parties was to arrange for the discharge of this obligation. Lawrence v. Fox80 is the paradigmatic case. An analysis of the facts of that case shows why creditor beneficiaries should be permitted to enforce the contract under the first branch of the third-​party-​beneficiary principle. Recall that Holly, the promisee in Lawrence v. Fox, owed a preexisting legal obligation—​a debt—​to Lawrence, the third-​party beneficiary. A performance objective of Holly and Fox, as manifested in their contract, was that Holly should be made economically (although not legally) free of his obligation to Lawrence, through Fox’s commitment to discharge the debt himself. Allowing Lawrence to enforce the contract against Fox was an important means of ensuring that this objective would be effectuated. Furthermore, allowing Lawrence to enforce the contract would not enlarge the liability that Fox must have expected to incur at the time the contract was made. Fox’s obligation under the contract was to pay Lawrence $300. If Lawrence was allowed to enforce the contract, Fox would only be required to pay that amount. Enforceability by creditor beneficiaries is also justified under the second branch of the third-​ party-​beneficiary principle, because it is supported by independent reasons of policy. For one thing, allowing a creditor beneficiary to bring suit under the contract reduces social costs by short-​circuiting multiple lawsuits. If a creditor beneficiary is not allowed to bring suit under the contract two suits will be involved: one suit by the beneficiary against the promisee, based on the promisee’s preexisting obligation to the beneficiary, and a second suit by the promisee against the promisor for the difference between the promisee’s debts as they are and the promisee’s debts as they would be if the promisor had performed. In contrast, if a creditor beneficiary is allowed to enforce the contract one suit will suffice.81

80.  20 N.Y. 268 (1859). This case is discussed in the text accompanying notes 16–​28, supra. 81.  See Matternes v. City of Winston-​Salem, 209 S.E.2d 481, 488 (N.C. 1974).

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Permitting enforcement by creditor beneficiaries also helps prevent unjust enrichment. This characteristic is brought out by considering the question, since the promisee owes the creditor beneficiary a preexisting obligation: Why doesn’t the creditor beneficiary sue the promisee rather than taking the more difficult path of suing the promisor? Presumably, in most cases the reason is that the promisee is not easily subject to suit—​because, for example, he is outside the jurisdiction or has become insolvent or incapacitated. If in such cases the creditor beneficiary cannot sue the promisor the promisor would often be unjustly enriched by the amount of the consideration he has received from the promisee. These policy considerations would not suffice if enforcement by creditor beneficiaries would conflict with the contracting parties’ performance objectives, but they do not.

C.  CASES IN WHICH THE PARTIES HAVE EXPLICITLY PROVIDED THAT A THIRD-​PARTY BENEFICIARY SHOULD OR SHOULD NOT BE ALLOWED TO ENFORCE THE CONTRACT There is a class of cases that is even easier to resolve than the donee-​and creditor-​beneficiary cases. This is the class of cases in which the contracting parties explicitly provide that a third-​ party beneficiary either should or should not be allowed to bring suit under the contract. Such cases are easy because they leave no doubt whether allowing the third party to enforce the contract is an important means of effectuating the contracting parties’ objectives: the parties themselves have explicitly spoken to that issue.82

D.  WOULD-​BE LEGATEES Another relatively easy class of cases involves would-​be legatees. Assume that B wishes to confer a given benefit on Third Party at the time of B’s death, by naming Third Party as a legatee in B’s will. A, an attorney, promises B to prepare a will in accordance with B’s wishes.83 Upon B’s death it becomes clear for the first time that despite A’s promise, B’s will fails to confer the desired benefit on Third Party. Third Party then sues A, the attorney-​promisor, under the contract between A and B.

82.  See, e.g., Frigidaire Sales Corp. v. Maguire Homes, Inc., 186 F. Supp. 767, 768–​69 (D. Mass. 1959) (express provision in surety bond allows third party to overcome the then-​Massachusetts rule that third parties cannot enforce contracts); India.com, Inc. v. Dallal, 412 F.3d 315, 321 (2d Cir. 2005); Honey v. George Hyman Constr. Co., 63 F.R.D. 443, 450 (D.D.C. 1974) (construction contract between contractor and subcontractor precludes third-​party claim by owner against subcontractor); Fed’l Mogul Corp. v. Universal Constr. Co., 376 So. 2d 716, 723–​24 (Ala. Civ. App.) (same); Lewis v. Globe Constr. Co., 630 P.2d 179, 185 (Kan. Ct. App. 1981) (road-​repair contract between city and contractor prohibits business owner on street from suing contractor as third-​party beneficiary); Hrushka v. Dep’t of Pub. Works & Highways, 381 A.2d 326, 327 (N.H. 1977) (contract between state and contractor precludes third-​party claim brought by employee against state). 83.  For ease of exposition, I focus on would-​be legatees, but the same analysis applies to other similarly situated persons, such as would-​be beneficiaries under trusts that include benefits to take effect on the settlor’s death.

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A would-​be legatee should be allowed to enforce such a contract against the attorney-​ promisor under the first branch of the third-​party-​beneficiary principle. A performance objective of the contracting parties, testator and attorney, is to make whatever legal arrangements are required to ensure that on the testator’s death a given benefit will be conferred on the would-​be legatee. Allowing a would-​be legatee to recover against the attorney is an important and indeed necessary means to effectuate that objective.84 The testator cannot sue the attorney, because the testator has died. The testator’s estate cannot sue the attorney because the estate has not been injured.85 Even if the estate could sue the attorney its damages would be measured only by the testator’s disappointed expectation, which would be almost impossible to measure, and in any event the recovery would end up in the hands of the estate rather than those of the would-​be legatee. Unlike the donee-​and creditor-​beneficiary cases, allowing a would-​be legatee to enforce a contract between the client and the attorney would impose a liability on the attorney that is different and much greater than the performance required under the contract, which is simply to draw up a legal instrument. However, this extension of liability is appropriate. Liability in such cases is generally comparable to the liability to which attorneys are routinely subject in non-​ testamentary cases under the law of malpractice.86 Because an attorney’s exposure to liability is greater if a would-​be legatee can enforce the contract than if he cannot, the attorney’s fee will presumably include an implicit premium for that exposure. However, testamentary clients are undoubtedly willing to pay that premium, just as non-​testamentary clients are willing to pay a premium (in the form of an apportioned amount of the attorney’s malpractice insurance premium) for attorney liability in all other cases. By virtue of that implicit premium the attorney has been compensated for taking on liability to would-​be legatees whose inheritance has been lost as a result of the attorney’s lack of due care. It is also possible that an attorney’s liability to would-​be legatees will be covered by her malpractice insurance. The modern cases generally support the conclusion that a would-​be legatee should be allowed to recover against an attorney who has failed properly to execute her client’s testamentary objectives.87 There is some conflict, however, concerning the proper theory on which the suit should be based. Many of the modern cases allow a would-​be legatee to base his suit on 84.  See Guy v. Liederbach, 459 A.2d 744, 751 (Pa. 1983); see also Lucas v. Hamm, 364 P.2d 685, 689 (Cal. 1961) (allowing legatee to sue attorney for damages when attorney was negligent in preparing will), cert. denied, 368 U.S. 987 (1962). 85.  See Heyer v. Flaig, 449 P.2d 161, 165 (Cal. 1970); Liederbach, 459 A.2d at 749. 86.  Cf. Lucas, 364  P.2d at 688 (“Although in some situations liability could be large and unpredictable in amount, this is also true of an attorney’s liability to his client.”). Indeed, in the absence of liability to a would-​be legatee there would be a gap in the law governing the accountability of lawyers. “[U]‌nless the beneficiary could recover against the attorney in such a case, no one could do so and the social policy of preventing future harm would be frustrated.” Heyer, 449 P.2d at 165; accord Liederbach, 459 A.2d at 753 (Nix, J., concurring) (“It would be unconscionable to permit admitted actionable conduct to be insulated by the fortuitous death of the person recognized in the law to have standing to prosecute such a claim, where the brunt of the injury from such conduct is born by a living party.”). 87.  See cases cited supra notes 91–​93; see also De Maris v.  Asti, 426 So. 2d 1153, 1154 (Fla. Dist. Ct. App. 1983) (an attorney is liable when, due to his negligence, a bequest to a legatee named in a will is diminished or lost; but because of concerns of evidentiary trustworthiness, an attorney is not liable to a would-​be legatee who is not named in the will). But see Maneri v. Amodeo, 238 N.Y.S.2d 302, 304 (Sup. Ct. 1963) (attorney not liable to third parties for simple negligence absent privity).

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third-​party-​beneficiary grounds,88 but others allow him to rest alternatively on negligence,89 some allow him to rest only on negligence,90 and some allow him to rest only on contract.91 This confusion is not surprising. Because the relationship between a professional and a client is consensual, a suit against a negligent professional can often be conceptualized as sounding either in malpractice, based on nonperformance of an obligation to exercise care that is imposed by law; or in breach of contract, based on nonperformance of an obligation to exercise care to which the parties implicitly agreed.92 Although the importance of allowing a would-​be legatee to recover overshadows which theory of recovery governs, the contract theory is preferable to the tort theory because it sharpens the nature of the attorney’s obligation in the would-​be legatee case. In contract cases typically each contracting party obliges itself to achieve a given result. In contrast, in most malpractice cases the obligation of the professional is not to achieve a given result but to employ an appropriate process. In the typical physician-​patient case, for example, the physician’s obligation is not to cure, but only to treat properly. Similarly, a litigator is typically not obliged to win her suit or achieve a favorable settlement, but only to handle the suit properly. Because professionals normally do not explicitly or implicitly promise to do more than use an appropriate level of skill and follow accepted protocols, in most cases a professional’s obligation is essentially the same under tort law and contract law.93 Different considerations apply, however, when an attorney drafts a will. In such cases, a lay client is justified in forming the expectation that unless the attorney states otherwise she has committed herself to achieve a certain result—​namely, to achieve the client’s stated objectives. If there is doubt whether the client’s stated objectives can be achieved—​if, for example, the client’s objectives are problematic under the Rule against Perpetuities—​the attorney is obliged to tell her client of the doubt and lay out the risks and the options. If she fails to do so, and an unexplained risk matures, the attorney should be liable for breach of her implied promise to achieve the client’s objectives. Courts that allow a would-​be legatee to sue only in negligence may easily miss that point, and focus instead on whether the attorney failed to use a required degree of skill and followed accepted protocols.

E.  SUITS BY SUBCONTRACTORS AGAINST THE SURETIES OF PRIME CONTRACTORS The rich web of contracts that are often found in construction settings gives rise to a variety of recurring third-​party-​beneficiary problems. In the typical construction setting, a private or

88.  See, e.g., Stowe v. Smith, 441 A.2d 81, 83 (Conn. 1981); Hale v. Groce, 744 P.2d 1289, 1292 (Or. 1987); Liederbach, 459 A.2d at 753 (Nix, J., concurring). 89.  See, e.g., Lucas, 364 P.2d at 688; Garcia v. Borelli, 180 Cal. Rptr. 768, 772 (Ct. App. 1982); Bucquet v.  Livingston, 129 Cal. Rptr. 514, 518 (Ct. App.  1976); Ogle v.  Fuiten, 445 N.E.2d 1344, 1348 (Ill. App. Ct. 1983). 90.  See, e.g., Heyer, 449 P.2d at 164. 91.  See, e.g., Liederbach, 459 A.2d at 750 (lack of privity is a bar to a claim for negligence). 92.  Cf. id. at 748 (client may sue attorney for malpractice under either trespass or assumpsit theory). 93.  This point puts aside peripheral rules, such as differences in the statutes of limitation for contract and tort or the availability of punitive damages, that are incidental in the sense that, as applied to the malpractice case, they turn on the form of the complaint rather than on the substance of the underlying transaction.

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public entity—​an owner—​makes a contract with a prime contractor who agrees to perform specified construction. The prime contractor, in turn, contracts with various subcontractors who agree to perform portions of the construction,94 such as electrical work or plumbing. Because contractors are often thinly capitalized, owners often require prime contractors to provide either a performance bond, under which a surety guarantees the owner that the prime contractor will perform its contract with the owner; a payment bond, under which a surety guarantees the owner that the prime contractor will pay the claims of subcontractors when they are due; or both. The third-​party beneficiary issue is whether an unpaid subcontractor can bring suit against the surety under a payment bond, a contract to which the subcontractor is not a party. In the traditional analysis of this issue the courts distinguished between payment bonds entered into by sureties with public owners and with private owners. Under this distinction subcontractors were allowed to recover under payment bonds made with public owners but not under payment bonds made with private owners.95 This distinction rested on an application of the intent-​to-​benefit test.96 The argument was as follows:  A subcontractor normally enters into a contract with the prime contractor, not with the owner. Therefore, if the prime contractor fails to pay a subcontractor the subcontractor cannot sue the owner but can sue the prime contractor. However, the usual reason the subcontractor is not paid is that the prime contractor is insolvent. Therefore, bringing suit against the prime contractor is not a viable alternative. State law usually allows persons, such as subcontractors, who perform work on a property to file a lien against the property, provided certain conditions are satisfied.97 Accordingly, although the owner of the property is not obliged to pay the subcontractor, if he fails to do so the subcontractor can foreclose on the lien and force the sale of the property to pay off the lien. Against this background, the courts reasoned that if a private owner obtained a payment bond under which a surety was obliged to pay off unpaid subcontractors the owner’s intent must have been, not to benefit the subcontractors, but to benefit himself by keeping his prop­ erty lien-​free.98 In contrast, the lien laws do not apply to public construction. Therefore, the argument went, a public owner usually will suffer no economic injury if subcontractors are not paid.99 Accordingly, the reasoning continued, if a public owner requires a prime contractor to obtain a payment bond from a surety the public owner’s intent must be to benefit not itself but the subcontractors, and under the intent-​to-​benefit test the subcontractors therefore could sue the surety.

94.  Persons who contract to supply materials used in construction—​“materialmen”—​normally (although not invariably) have a legal status comparable to subcontractors (see, e.g., Florida ex rel. Westinghouse Elec. Supply Co. v. Wesley Constr. Co., 316 F. Supp. 490, 495 (S.D. Fla. 1970) (mem.), aff ’d mem., 453 F.2d 1366 (5th Cir. 1972); James D. Shea Co. v. Perini Corp., 321 N.E.2d 831, 832 (Mass. App. Ct. 1975)). For ease of exposition, this and the following sections refer only to subcontractors. 95.  See, e.g., Nat’l Sur. Co. v. Brown-​Graves Co., 7 F.2d 91, 92 (6th Cir. 1925); Maryland Cas. Co. v. Johnson, 15 F.2d 253, 254–​55 (W.D. Mich. 1926); 1 Williston on Contracts § 372 at 702–​04. For a review of the older case law, see Cretex Cos. v. Constr. Leaders, Inc., 342 N.W.2d 135, 139–​40 (Minn. 1984). 96.  Justin Sweet & Marc M. Schneier, Legal Aspects of Architecture, Engineering and the Construction Process § 26.05A, at 734 (9th ed. 2013). 97.  Id. § 23.06B, at 660–​64, § 26.05, at 733–​34. 98.  See cases cited supra note 110. 99.  See Sweet & Schneier, supra note 96, § 26.05A, at 734.

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In contrast to the traditional analysis the modern tendency is to allow subcontractors to bring suit against sureties under payment bonds in private as well as public cases.100 This approach is supported by the third-​party-​beneficiary principle. The traditional analysis of the owner’s motivation was myopic, because private as well as public owners have self-​regarding objectives that are best effectuated by allowing subcontractors to bring suit against a surety under a payment bond. Begin with public construction. A public owner may in his own self-​interest want a payment bond to ensure that subcontractors will be paid, because subcontractors will make lower bids if they need not impound the risk of nonpayment into their costs, and if subcontractors’ bids are lower, prime contractors’ bids, which are largely based on subcontractors’ bids, will also be lower.101 It is true that the premium for a payment bond will be higher if subcontractors can enforce it, because the surety’s liability would be expanded;102 and although the cost of the higher premium will be borne by the prime contractor in the first instance that cost will be passed along to the owner when the prime contractor calculates its winning bid. However, public owners may reasonably believe that the increase in the prime contractor’s bid resulting from the surety’s higher premium will be less than the decrease in the prime contractor’s bid resulting from lower subcontractor bids if they can sue under a payment bond. The reason is that subcontractors would be likely to charge more than sureties for bearing the risk of a prime contractor’s insolvency. Subcontractors are often small and thinly capitalized, and therefore likely to be more risk-​averse than sureties. Furthermore, subcontractors are less able than sureties to determine the creditworthiness of prime contractors, and therefore are likely to include an extra margin of safety in their calculations.103 Of course, public owners may reasonably believe the contrary; but the fact that a public owner has required a payment bond tells us that it has adopted the objective of affording subcontractors assurance of payment. To effectuate that objective subcontractors should be given a right to enforce payment bonds. Essentially the same analysis applies to a private owner. It is true that in the case of private construction, unpaid subcontractors often will not lose out completely, because they may be protected under the lien laws. Despite the lien laws, however, some risk to subcontractors will remain. The lien laws are not always easy to comply with; enforcing a lien can be complex and expensive; and a private owner’s equity in a building may be less than the total claims of lienholders. Even in the case of private construction, therefore, a subcontractor who is not afforded assurance of payment is likely to impound the risk of nonpayment in his bid. Justin Sweet has pointed out still another self-​regarding motive that a private owner may have for affording subcontractors assurance of payment—​an interest in the smooth administration 100.  See, e.g., Socony-​Vacuum Oil Co. v. Cont’l Cas. Co., 219 F.2d 645, 649 (2d Cir. 1955); Daniel-​Morris Co. v. Glen Falls Indem. Co., 126 N.E.2d 750, 752–​53 (N.Y. 1955) (materialman of subcontractor allowed to enforce subcontractor’s payment bond to contractor); Jacobs Assocs. v. Argonaut Ins. Co., 580 P.2d 529, 532 (Or. 1978) (subcontractor permitted to enforce performance-​and-​payment bond); Sweet & Schneier, supra note 96, § 26.05B. But see id. § 26.05B, at 734 n.38 (citing cases in which a surety bond was written to exclude third-​party claims of materialmen or in which courts required that the bond expressly state that materialmen are obligees under bond). 101.  See Sweet & Schneier, supra note 96, § 26.05A, at 734.. 102.  If subcontractors on a public bond remain unpaid, the public owner’s loss, and therefore the surety’s liability for the owner’s damages, is likely to be zero. In contrast, the subcontractors’ losses will be substantial. Therefore, if subcontractors can enforce the bond the potential liability of the surety—​and accordingly, its premium—​will be higher than if the surety is liable only for the public owner’s damages. 103.  Alternatively, some subcontractors might simply refuse to contract if they were required to bear the risk of a contractor’s nonpayment.

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of the construction process: “[Subcontractors] should be more willing to perform properly and deliver materials as quickly as possible when they have assurance they will be paid. Though they have a right to a mechanics’ lien, the procedures for perfecting the lien and satisfying the unpaid obligation out of foreclosure proceeds are cumbersome and often ineffective. Payment bonds are preferable to mechanics’ liens.”104 A private owner may also want to afford subcontractors assurance of payment to avoid the transaction costs involved if liens are filed. In short, a private owner may reasonably believe that his costs will be lower if he affords assurance of payment to subcontractors. Allowing subcontractors to bring suit against the surety under a payment bond is an important means of effectuating that objective. How do we know whether a given payment bond reflects that performance objective? Often, the bond tells us so. For example, AIA [American Institute of Architects] Payment Bond A311 explicitly states that subcontractors can sue the surety on the bond.105 Even when a bond is not as explicit as AIA A311, the very fact that a private owner has required a payment bond normally reveals that his objective is to afford subcontractors assurance of payment. If an owner only wants to protect himself against losses resulting from the nonpayment of subcontractors he can do so by simply requiring the prime contractor to provide a performance bond. Performance bonds protect an owner against loss caused by the prime contractor’s nonperformance, and therefore normally cover losses to the owner as a result of subcontractor liens.106 Accordingly, if an owner requires a payment bond as well as a performance bond the inference is very strong that the contracting parties’ performance objectives include affording subcontractors assurance of payment.107 Suppose an owner obtains a performance bond but not a payment bond, and an unpaid subcontractor sues the surety as a third-​party beneficiary of the performance bond. A payment bond explicitly provides that subcontractors will be paid. A performance bond does not. Given the wide availability and frequent use of payment bonds the decision of an owner to obtain only a performance bond reveals that the objectives of the owner and the surety do not include affording subcontractors assurance of payment, and subcontractors therefore normally should not be allowed to enforce a performance bond.108

104.  Sweet & Schneier, supra note 96, § 26.05A, at 734. 105.  See supra text accompanying note 95. 106.  See Am. Inst. Architects, Doc. A101, Standard Form of Agreement Between Owner and Contractor art. 1 (2017) (contract documents include the General Conditions of the Contract); Am. Inst. Architects, Doc. A201, General Conditions of the Contract for Construction art. 9.6.2 (2017) (contractor shall promptly pay each subcontractor upon receipt of payment by the owner). 107.  See, e.g., Socony-​Vacuum Oil Co. v. Cont’l Cas. Co., 219 F.2d 645, 648 (2d Cir. 1955); Fid. & Deposit Co. v. Rainer, 125 So. 55, 58 (Ala. 1929); Jacobs Assocs. v. Argonaut Ins. Co., 580 P.2d 529, 531 (Or. 1978). 108.  See Cretex Cos. v. Constr. Leaders, Inc., 342 N.W.2d 135, 137–​38 (Minn. 1984): [The surety] points out that if the owner and general contractor had wished to protect third-​party materialmen they could have purchased, for a separate premium, a “labor and material payment bond,” a bond which [the surety] also sells and which is usually issued simultaneously with the performance bond. A “payment” bond expressly provides for the surety to pay the claims of third-​party subcontractors and materialmen if the general contractor fails to do so. The distinction between performance bonds and payment bonds is well recognized in the construction industry; the two bonds cover different risks and premiums are set accordingly.

Accord: Hewson Constr., Inc. v. Reintree Corp., 685 P.2d 1062, 1066 (Wash. 1984) (the bond in question guaranteed only performance, not payment).

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F.  MULTI-​PRIME CONTRACTS Another, more difficult case that arises in the construction setting involves claims among prime contractors in a multi-​prime contract. Most construction projects involve a single general or prime contractor, who contracts with the owner and is responsible for the coordination of all construction, and a number of specialized subcontractors who contract with the prime contractor. In contrast, in multi-​prime contracts an owner either contracts with several prime contractors, contracts directly with specialized contractors who normally would contract only with a prime contractor, or both. An owner may enter into a multi-​prime contract for business reasons—​for example, because the construction is divided into semi-​independent segments, such as portions of a pipeline or highway, or because it is more efficient for the owner to take on the task of coordination than to pay a prime contractor for doing so. Often, however, an owner enters into multi-​prime contracts because he is required to do so by statute.109 Because the performances of prime contractors in a multi-​prime contract tend to be closely interrelated a delay or other breach by one prime will often lead to losses by others. Assume that there are two co-​primes, Prime 1 and Prime 2. Prime 1 delays or otherwise breaches its contract with the owner and Prime 2 is injured by the breach—​for example, because the delay affects Prime 2’s ability to finish its portion of the contract on time. Can Prime 2 sue Prime 1 as a third-​ party beneficiary of the contract between Prime 1 and the owner? The general trend of the cases is to allow such suits,110 and that result is supported by the third-​party-​beneficiary principle. In some cases Prime 1 explicitly promises the owner that it will pay costs of the co-​primes that result from its delay.111 In such cases allowing Prime 2 to sue Prime 1 is the best or only way to effectuate Prime 1’s promise. In other cases each co-​prime promises the owner that it will cooperate or coordinate with the others but does not explicitly promise to pay the costs of its co-​ primes that result from the breach.112 Nevertheless, in such cases too Prime 2 should be allowed

109.  See generally Sweet & Schneier, supra note 96, § 14.06, at 361–​62 (use of separate contracts was spurred, in part, by successful legislative efforts of trade associations). Such statutes are usually adopted at the instance of contractors who would usually act as subcontractors, because subcontractors on public construction prefer to be in a direct contractual relation with the governmental entity, which typically presents little or no risk of insolvency, rather than with a prime contractor, which often presents a significant risk of insolvency. 110.  See, e.g., M.T. Reed Constr. Co. v. Virginia Metal Prods. Corp., 213 F.2d 337, 338 (5th Cir. 1954); Hanberry Corp. v. State Bldg. Comm’n, 390 So. 2d 277, 278–​81 (Miss. 1980). But see, e.g., J.F., Inc. v. S.M. Wilson & Co., 504 N.E.2d 1266, 1269–​71 (Ill. App. Ct. 1987); Buchman Plumbing Co. v. Regents of the Univ. of Minn., 215 N.W.2d 479, 483–​85 (Minn. 1974). 111.  For example, in Broadway Maint. Corp. v. Rutgers, 447 A.2d 906 (N.J. 1982), each prime contractor agreed that if it unnecessarily delayed the work of the other contractors “the Contractor shall, in that case, pay all costs and expenses incurred by such parties due to any such delays.” Id. at 910. 112.  For example, in Shea-​S & M Ball v. Massman-​Kiewit-​Early, 606 F.2d 1245 (D.C. Cir. 1979), a contract between the Washington Metropolitan Area Transit Authority and each of its co-​primes stated: The Authority may undertake or award other contracts for additional work, and the Contractor shall fully cooperate with such other contractors and Authority employees and carefully fit his own work to such additional work as may be directed by the Contracting Officer. The Contractor shall not commit or permit any act which will interfere with the performance of work by any other contractor or by Authority employees.

Id. at 1250. The court allowed suit by one co-​prime against another. Id. at 1251.

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to bring suit against Prime 1, because breach of a promise to cooperate or coordinate may cause damage to Prime 1’s co-​primes even though it does not cause damage to the owner. For example, Prime 2 may manage to complete its performance on time despite Prime 1’s delay, but only by accelerating its efforts at increased cost. In such a case because the owner has no damages the objective of the cooperate-​and-​coordinate provision may not be fully effectuated unless Prime 2 is allowed to bring suit against Prime 1. It is true that if Prime 1 is liable to Prime 2 for breach of Prime 1’s contract with the owner, Prime 1 will presumably include in its price to the owner an implicit premium that reflects its increased exposure to liability. Why would a self-​regarding owner pay that premium when Prime 1’s liability to Prime 2 seems to benefit Prime 2 rather than the owner? The answer is comparable to that developed in the analysis of surety bonds. Affording Prime 2 the right to sue Prime 1 will benefit the owner because if Prime 1 is not liable to Prime 2, Prime 2 will include in its bid an implicit premium for bearing the risk of a breach by Prime 1 that injures Prime 2. An owner may reasonably believe that the amount of this premium would exceed the amount that Prime 2 will charge for bearing only the risk of losses due to its own fault. Prime 2’s own performance is largely within its control; the performance of its co-​primes is not. Furthermore, some breaches by a co-​prime may subject the owner to liability for breach of an implied duty to coordinate and supervise the co-​primes’ activities.113 An owner may therefore have the objective of making co-​primes liable to each other for their breaches to afford an injured co-​prime a more direct target than the owner itself. Indeed, where an owner owes its co-​primes a duty to coordinate, and Prime 1 promises the owner that it will coordinate with its co-​primes, Prime 2 could simply be treated as a creditor beneficiary of that promise.114

G.  SUITS BY OWNERS AGAINST SUBCONTRACTORS Yet another recurring problem in construction settings is whether an owner can sue a subcontractor who has breached its contract with the prime. This problem assumes that, as is usually the case, the subcontractor does not have a contract with the owner. The results in these cases are mixed. Many cases have refused to permit an owner to bring suit against a subcontractor115 whereas others have either permitted such a suit,116 indicated that an owner’s right to bring suit depended on the facts of the case,117 or held that the owner could recover on some theory other

113.  See Shea-​S & M Ball, 606 F.2d at 1251; Hoffman v. United States, 340 F.2d 645, 650 (Cl. Ct. 1964). 114.  See COAC, Inc. v. Kennedy Eng’rs, 136 Cal. Rptr. 890, 893 (Ct. App. 1977); Visintine & Co. v. New York, Chi. & St. L.R.R. Co., 160 N.E.2d 311, 313–​14 (Ohio 1959). 115.  See, e.g., Pierce Assocs., Inc. v. Nemours Found., 865 F.2d 530, 535–​39 (3d Cir.); Kisiel v. Holz, 725 N.W.2d 67, 70 (Mich. App. 2006); Vogel v. Reed Supply Co., 177 S.E.2d 273, 277–​79 (N.C. 1970); Manor Junior Coll. v. Kaller’s Inc., 507 A.2d 1245, 1246–​48 (Pa. Super. Ct. 1986). 116.  See, e.g., Syndoulos Lutheran Church v. A.R.C. Indus., 662 P.2d 109, 113–​14 (Alaska 1983); Oliver B. Cannon & Son, Inc. v. Dorr-​Oliver, Inc., 336 A.2d 211, 215–​16 (Del. 1975); People ex rel. Resnik v. Curtis & Davis, Architects & Planners, Inc., 400 N.E.2d 918, 919–​20 (Ill. 1980). 117.  See Chestnut Hill Dev. Corp. v. Otis Elevator Co., 653 F. Supp. 927, 930–​31 (D. Mass. 1987).

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than third-​party-​beneficiary law, such as negligence118 or subrogation to the rights of the prime contractor.119 It might be argued that an owner is a creditor beneficiary of the contract between the prime contractor and the subcontractor, on the theory that the subcontractor has agreed to perform an obligation that the prime contractor owes to the owner. Although the question is certainly not free from doubt, the better view seems to be that taken by Corbin: “[C]‌ontracts between a principal building contractor and subcontractors. . . . are made to enable the principal contractor to perform; and their performance by the subcontractor does not in itself discharge the principal contractor’s duty to the owner with whom he has contracted. The installation of plumbing fixtures or the construction of cement floors by a subcontractor is not a discharge of the principal contractor’s duty to the owner to deliver a finished building containing those items. . . . The owner is . . . [therefore not] a creditor beneficiary. . . .”120 Many courts have tried to solve the owner-​subcontractor problem by applying the intent-​to-​ benefit test. Further illustrating the unsatisfactory nature of that test, this approach has led to inconsistent results. So, for example, in Kaiser Aluminum & Chemical Corp. v. Ingersoll-​Rand Co.121 and Lake Placid Club Attached Lodges v. Elizabethtown Builders, Inc.,122 it was held that an owner was not an intended beneficiary of the contract between the prime contractor and the subcontractor, whereas in Syndoulos Lutheran Church v. A.R.C. Industries, Inc.,123 it was held that the owner was “obviously” an intended beneficiary. Most of the cases do not go beyond a summary conclusion that the owner is or is not an intended beneficiary. The bottom line is that the law in this area is unsettled and the analysis in the cases is most charitably described as picturesque. What result under the third-​party-​beneficiary principle? Allowing the owner to sue a solvent subcontractor would ordinarily not be an important means of effectuating the performance objectives of the contracting parties, that is, the prime contractor and the subcontractor. A breach by a subcontractor will typically result in an injury to the prime contractor, because the prime contractor must either remedy the breach itself or pay damages to the owner. Accordingly, the prime contractor can normally sue the subcontractor for breach, and will have every incentive to do so. Indeed, in the normal case, allowing the owner to sue the subcontractor may conflict with the prime contractor’s administration of its contracts with subcontractors. However, in the special case where the defect in the subcontractor’s work is discovered only after the owner has paid the full contract price and the prime contractor has become insolvent, the second branch of the third-​party-​beneficiary principle is applicable. If the prime contractor was solvent, the owner would sue the prime contractor for the defective performance, the prime contractor would then sue the subcontractor for the damages it paid to the owner, and the owner would be made whole at the subcontractor’s ultimate expense. In contrast, where

118.  See, e.g., Fed. Mogul Corp. v. Universal Constr. Co., 376 So. 2d 716, 724 (Ala. Civ. App. 1979); Driscoll v. Columbia Realty-​Woodland Park Co., 590 P.2d 73, 74 (Colo. Ct. App. 1978); Juliano v. Gaston, 455 A.2d 523, 525 (N.J. Super. Ct. App. Div. 1982). 119.  See Nat’l Cash Register Co. v. Unarco Indus., Inc., 490 F.2d 285, 286–​87 (7th Cir. 1974). 120. 4 Arthur L. Corbin, Corbin on Contracts, § 779D, at 46–​47 (1951); North Carolina State Ports Auth. v. L.A. Fry Roofing Co., 240 S.E.2d 345, 354 (N.C. 1978). 121.  519 F. Supp. 60, 72–​73 (S.D. Ga. 1981). 122.  521 N.Y.S.2d 165, 166 (App. Div. 1987). 123.  662 P.2d 109, 114 (Alaska 1983).

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the prime contractor is insolvent, if the owner cannot bring suit against the subcontractor the owner’s claim against the prime contractor can be brought only against the prime contractor’s bankruptcy estate, and the prime contractor’s claim against the subcontractor can be brought only by the bankruptcy trustee.124 However, the owner normally will have little or no incentive to sue the prime contractor’s bankruptcy estate because the return in a suit against a bankruptcy estate typically constitutes only a fraction of the debt. Normally, the owner will also have little or no incentive to persuade the bankruptcy trustee to bring suit, because the proceeds of the suit would benefit the general estate, not merely the owner. The trustee, in turn, need not pursue an action that is either “burdensome” or “inconsequential.”125 The net result is that if the subcontractor does defective work and the prime becomes insolvent, the owner is likely to be left without effective redress unless he is allowed to sue the subcontractor. Accordingly, under the second branch of the third-​party-​beneficiary principle, in this special case the owner should be allowed to sue the subcontractor so as to work corrective justice.126 Because the construction process will have been completed, a suit by the owner against the subcontractor will not interfere with the normal administration of the construction process. If the subcontract contains special provisions limiting the subcontractor’s damages, such as liquidated damage clauses127 or limitations on consequential damages,128 those provisions should be taken into account in the owner’s suit, because if the owner wants to sue under the subcontract he must accept its limitations. If provisions in the contract between the owner and the prime contractor limit the owner’s rights, they too should be taken into account.

H.  GOVERNMENT CONTRACTS Many third-​party-​beneficiary cases are brought by members of the public against private actors who contracted to render to government agencies services that would, if properly rendered, benefit actors in the private sector.129 The courts have tended to give such suits special or categorical treatment. This tendency is reflected in Restatement Second Section 313(2): (2)  . . . [A]‌promisor who contracts with a government or governmental agency to do an act for or render a service to the public is not subject to contractual liability to a member of the public for consequential damages resulting from performance or failure to perform unless (a)  the terms of the promise provide for such liability; or (b) the promisee is subject to liability to the member of the public for the damages and a direct action against the promisor is consistent with the terms of the contract and with the policy of the law authorizing the contract and prescribing remedies for its breach.

124.  See 11 U.S.C. § 541(a) (2016). 125.  Id. 126.  See William K. Jones, Economic Losses Caused by Construction Deficiencies, 59 U. Cin. L. Rev. 1051, 1085–​86 (1991). 127.  See, e.g., Midwest Concrete Prods. Co. v. La Salle Nat’l Bank, 418 N.E.2d 988, 990 (Ill. App. Ct. 1981). 128.  See, e.g., Chestnut Hill Dev. Corp. v. Otis Elevator Co., 653 F. Supp. 927, 931 (D. Mass. 1987). 129.  See Prince, supra note 63, at 950–​51.

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There is no more reason to apply a categorical rule to government contracts than to any other type of contract. Instead, government contracts can and should be analyzed under the third-​party-​ beneficiary principle. However, the application of the third-​party principle to government contracts must be especially sensitive to the context of the particular transaction, because of two elements that are often highly salient in government-​contracts cases but point in opposite directions. The first element concerns the extent of the promisor’s liability. Because government contracts often benefit a large number of persons, if third-​party beneficiaries can enforce such contracts against the promisor the result may be the imposition of liability that is highly disproportionate to the benefits the promisor stood to receive under the contract. This element points against enforcement by a third-​party beneficiary. The paradigm case is H.R. Moch Co. v. Rensselaer Water Co.130 A waterworks company had made a contract with the City of Rensselaer to supply water for public buildings, flushing of sewers, street sprinkling, and fire hydrants. The hydrant service was to be furnished at the rate of $42.50 a year for each hydrant. A fire broke out while this contract was in force. The supply of water to fire hydrants did not comply with the contract, and as a result a warehouse owned by the plaintiff was destroyed and the plaintiff sued the waterworks company on the theory that the plaintiff was a third-​ party beneficiary of the company’s contract with the city. The New York court, in an opinion by Judge Cardozo, held that the plaintiff could not recover, because if members of the public could bring suit under the contract the liability of the waterworks company could be crushing: An intention to assume an obligation of indefinite extension to every member of the public is seen to be the more improbable when we recall the crushing burden that the obligation would impose. The consequences invited would bear no reasonable proportion to those attached by law to defaults not greatly different. . . . If the plaintiff is to prevail, one who negligently omits to supply sufficient pressure to extinguish a fire started by another assumes an obligation to pay the ensuing damage, though the whole city is laid low. A promisor will not be deemed to have had in mind the assumption of a risk so overwhelming for any trivial reward.131

130.  159 N.E. 896 (N.Y. 1928). 131.  Id. at 897–​98. The issue in these cases is close and the courts are divided, although H.R. Moch probably represents the general rule. Compare Cole v. Arizona Edison Co., 86 P.2d 946, 947–​48 (Ariz. 1939) (no liability); N.H. Ins. Co. v. Madera, 192 Cal. Rptr. 548, 554–​55 (Ct. App. 1983) (same); Earl E. Roher Transfer & Storage Co. v. Hutchinson Water Co., 322 P.2d 810, 813–​14 (Kan. 1958) (same) with Harris v. Bd. of Water & Sewer Comm’rs, 320 So. 2d 624, 628 (Ala. 1975) (liability); Koch v. Consol. Edison Co., 468 N.E.2d 1 (N.Y. 1984) (same); and Potter v. Carolina Water Co., 116 S.E.2d 374, 378–​79 (N.C. 1960) (same). Restatement Second endorses the result in H.R. Moch. See Restatement Second § 313 illus. 2. Some courts adopt the H.R. Moch rule in principle, but depart from it in practice by a readiness to distinguish the rule: Even at a time contemporaneous with its decision . . . the rationale upon which the Moch opinion turned was subjected to severe criticism. . . . Although Moch continues to be recognized as the majority rule, it is only grudgingly followed. . . . In fact with regard to third party beneficiary contractual rights the Moch rule is increasingly being strictly limited to its facts and subjected to exceptions. Thus, if a plaintiff can show a special benefit to himself individually in contrast to any benefit he enjoys as a member of the public generally, he may be able to bring an action as a third party beneficiary.

Town of Ogden v. Earl R. Howarth & Sons, Inc., 294 N.Y.S.2d 430, 432–​33 (Sup. Ct. 1968). In Doyle v. South Pittsburgh Water Co., 199 A.2d 875, 884–​85 (Pa. 1964), the court held, on facts comparable to H.R. Moch, that the plaintiffs had a valid complaint for negligence.

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The second element that is especially salient in government contracts is that such contracts are often executed pursuant to statutes that embody a clear public policy in favor of a defined class that includes the third-​party beneficiaries.132 This element points in favor of enforcement of government contracts by third-​party beneficiaries under the second branch of the third-​party-​ beneficiary principle, under which a third-​party beneficiary should be allowed to bring suit where the suit is supported by an independent reason of policy—​here a policy embodied in a statute—​and would not conflict with the contracting parties’ objectives. Given the possibly opposing elements of extended liability on the one hand, and public policy on the other, the issue whether third-​party beneficiaries should have the power to bring suit against a private actor who is party to a government contract cannot be properly addressed by a categorical rule. On the contrary, whether a beneficiary should be allowed to bring suit in this context depends on an individualized, highly fact-​sensitive application of the third-​ party-​beneficiary principle to the case at hand. This is illustrated by two California cases, Zigas v. Superior Court133 and Martinez v. Socoma Companies.134 Zigas v.  Superior Court concerned a contract that was entered into pursuant to the National Housing Act. That Act embodied a policy to “facilitate . . . the production of rental accommodations . . . at reasonable rents.”135 To accomplish this objective the Federal Department of Housing and Urban Development (HUD) was authorized to guarantee mortgage loans taken out by developers from banks or other lenders for the purpose of constructing new housing projects in which every effort had been made to achieve moderate rental charges.136 With such a guarantee the developer would get a cheaper interest rate on its mortgage loan because the interest rate would be based largely on the Government’s credit rather than simply on the developer’s credit. Pursuant to the Act, HUD entered into a contract with Zigas, a developer. Under the contract, HUD insured Zigas’s mortgage on an apartment building that Zigas proposed to construct, and Zigas agreed not to charge rents exceeding those on an approved rent schedule unless HUD gave prior approval. The contract authorized HUD, in the event of a breach, to apply to any court for specific performance or such other relief as might be appropriate. The contract also provided that the developer was personally liable for funds of the project coming into its hands that it was not entitled to retain under the provisions of the contract. Some time after the building had been completed and the initial leases had been signed, Zigas increased rents without HUD’s approval and the tenants brought suit against Zigas under the contract between Zigas and HUD. The court held that the tenants had the right to recover damages from Zigas as third-​party beneficiaries of the contract.137 132.  See, e.g., Holbrook v. Pitt, 643 F.2d 1261, 1273 (7th Cir. 1981) (contracts entered into by HUD to make rental payments on behalf of low-​income tenants pursuant to Section 8 of the United States Housing Act); Shell v. Schmidt, 272 P.2d 82, 89 (Cal. Dist. Ct. App. 1954) (contracts between Federal Housing Authority and builder to provide housing for war veterans pursuant to Veterans’ Emergency Housing Act). 133.  174 Cal. Rptr. 806 (Ct. App. 1981). 134.  521 P.2d 841 (Cal. 1974). 135.  174 Cal. Rptr. at 810 (quoting 12 U.S.C. § 1713(b)). 136.  See 12 U.S.C. § 1713(b) (2016). 137.  See Zigas, 174 Cal. Rptr. at 809, 812–​13. The cases discussed in the text are not the only significant government-​contract cases decided in California during this period. In particular, see City & Cnty. of San Francisco v.  Western Air Lines, Inc., 22 Cal. Rptr. 216 (Ct. App.  1962). This case concerned a contract

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Martinez v. Socoma Companies concerned contracts entered into under programs adopted, in furtherance of the federal Economic Opportunity Act, to benefit the residents of Special Impact Areas “having especially large concentrations of low income persons and suffering from dependency, chronic unemployment and rising tensions.” Pursuant to the statute the federal government entered into contracts with three manufacturers, who were the defendants in Martinez. Each manufacturer agreed to acquire and equip designated manufacturing facilities in East Los Angeles and to train and employ, for at least one year, at minimum-​wage rates, a specified number of East Los Angeles residents certified by the Government as disadvantaged. In exchange, the Government agreed to pay each manufacturer a stated amount. Each contract required the manufacturer (1)  to refund all amounts received from the Government if the manufacturer failed to acquire and equip the specified manufacturing facility, and (2) to refund a stated amount—​equivalent to the manufacturer’s compensation under the contract divided by the number of jobs the manufacturer agreed to provide—​for each employment opportunity the manufacturer failed to provide. Each contract also provided that any dispute of fact was to be determined by the Government’s contracting officer, subject to an appeal to the secretary of labor. The secretary’s decision would be final unless it was determined by a competent court to have been fraudulent, capricious, arbitrary, in bad faith, or not supported by substantial evidence. Some 2017 East Los Angeles residents were certified as disadvantaged and qualified for employment under the contracts. Plaintiffs, who were members of the class of certified persons, claimed damages for lost wages and other elements, as third-​party beneficiaries of the manufacturers’ contracts with the Government, on the ground that the manufacturers had failed to perform their contracts. The court held that the plaintiffs could not recover damages against the manufacturers.

between San Francisco and the federal government pursuant to the Federal Airport Act. Under the contract the City obtained federal funds for an airport. In return, the City promised the government, among other things, that the airport would be operated “for the use and benefit of the public, on fair and reasonable terms and without unjust discrimination.” City of San Francisco, supra, at 223. Western Air Lines defended against a suit on the ground that the City had violated the contract by charging rates that discriminated against Western. The court held that “[a]‌n examination of the act as a whole discloses that its purpose is to promote a nationwide system of public airports and not to regulate airport operations,” and that the contract made pursuant to the Act had the same objective. City of San Francisco, supra, at 224; accord Shell v. Schmidt, 272 P.2d 82, 89 (Cal. Dist. Ct. App. 1954).   For other government-​contract cases in which the third-​party beneficiary was allowed to enforce the contract, see, e.g., Holbrook v. Pitt, 643 F.2d 1261, 1273 (7th Cir. 1981) (tenants have enforceable rights under contracts between HUD and project owners); H.B. Deal & Co. v. Head, 251 S.W.2d 1017, 1020–​21 (Ark. 1952) (employees entitled to overtime compensation that employer, in contract with United States government, promised to pay). For other government-​contract cases in which the third-​ party beneficiary was not allowed to enforce the contract, see, e.g., Perry v. Hous. Auth., 664 F.2d 1210, 1215–​17 (4th Cir. 1981) (tenants have no enforceable rights under contract between local housing authority and HUD); Falzarano v. United States, 607 F.2d 506, 511 (1st Cir. 1979) (tenants in subsidized housing project were not third-​party beneficiaries of contracts between landlords and HUD). See generally Waters, supra note 21, at 1176–​92, 1200–​08 (discussing a number of government-​contract cases).

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The results in Zigas and Martinez, although apparently conflicting, are both supported by the third-​party-​beneficiary principle. The result in Zigas is supported by the first branch of the third-​party-​beneficiary principle. It is true that the contracting parties’ objectives could be effectuated even without allowing the tenants to sue, because the Economic Opportunity Act empowered the Government to obtain damages on the tenants’ behalf. However, these objectives might not have been effectuated unless the tenants were empowered to bring suit, because the Government might well choose to allocate its limited litigation resources to matters with a higher priority. The result is also supported by the second branch of the third-​party-​beneficiary principle. Allowing the tenants to bring suit furthered the policy of the Economic Opportunity Act to favor such tenants, and did not conflict with the contracting parties’ performance objectives, because the contract made Zigas liable for funds it was not entitled to retain, and Zigas’s liability to the tenants was the same as his liability to the Government. In contrast, in Martinez neither branch of the third-​party-​beneficiary principle supported enforcement of the contract by the third-​party beneficiaries. Each manufacturer was obliged to refund to the Government a prorated portion of the compensation it received from the Government for every employment opportunity the contractor failed to provide. Allowing the would-​be employees to recover expectation damages would have conflicted with this damages provision by creating the possibility of liability in excess of the provision. Indeed, the manufacturers would be subject to a kind of double liability: they would have to pay both restitutionary damages (the refund to the Government) and expectation damages (the expected lost wages). Furthermore, the contracts provided that disputes of fact were to be determined by the Government’s contracting officer, subject only to appeal to the secretary of labor, whose decision was to be final. Allowing the would-​be employees to bring suit in court would have conflicted with this provision as well. Enforcement was also not supported by the second branch of the third-​party-​beneficiary principle. It is true that enforcement would have furthered the policy of the Economic Opportunity Act to benefit residents of Special Impact Areas. Moreover, the group of potential beneficiaries, although large, was bounded. However, the second branch of the third-​party-​ beneficiary principle is applicable only if allowing the third party to enforce the contract would not conflict with the contracting parties’ performance objectives. Allowing the third-​party beneficiaries in Martinez to bring suit would have conflicted with the damages and dispute-​ resolution provisions of the contracts.

I V.   D E F ENS ES As shown in Sections I–​III, some third-​party beneficiaries should have a right to bring suit against the promisor, while others should not. For ease of exposition, in this Section a third-​ party beneficiary who has a right to bring suit will be referred to as an empowered beneficiary. The issue dealt with in this Section is: What defenses can the promisor raise if she is sued by an empowered beneficiary?

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A.  DEFENSES THE PROMISOR CAN RAISE AGAINST AN EMPOWERED BENEFICIARY THAT ARE BASED ON DEFENSES THE PROMISOR WOULD HAVE HAD AGAINST THE PROMISEE Suppose that an empowered beneficiary brings suit against a promisor, and that if the promisee had sued the promisor, the promisor would have been able to raise a given defense such as lack of consideration or fraud. Can the promisor raise the same defense against the beneficiary? The answer should be and is yes, because by analogy to the third-​party-​beneficiary principle, generally speaking the promisor should be no worse off if she is sued by the beneficiary than she would have been if she had been sued by the promisee. This rule is uncontroversial. It is supported by the cases and adopted by Restatement Second. 138

B.  MODIFICATION AND RESCISSION Suppose next that the promisor and the promisee modify or rescind the contract in a way that would, if effective, vary or eliminate an empowered beneficiary’s ability to bring suit under the contract. Under the rule just considered that the promisor can raise against the third-​party beneficiary any defense that the promisor could have raised against the promisee, the promisor should be allowed to raise a defense of modification or rescission, because modification and rescission are defenses the promisor could have against the promisee. More generally, under the third-​party-​beneficiary principle whether a third party should have the right to enforce a contract depends primarily on whether such enforcement is a necessary or important means of effectuating the contracting parties’ performance objectives. If the contract is modified or rescinded, then the contracting parties’ performance objectives are defined by the modification or rescission, and allowing the third party to enforce the original contract would defeat those objectives. Accordingly, a modification or rescission should be effective against a third-​party beneficiary except to the extent that the beneficiary justifiably relied on the contract before the modification or rescission. At the time of the adoption of Restatement First, the law in this area was unclear. Some cases adopted a general rule that the promisor could raise a defense of modification or rescission against an empowered beneficiary.139 Other cases held that an empowered beneficiary had a vested right under the contract, and the contracting parties therefore could not effectively vary or, by rescission or otherwise, eliminate the power of such a beneficiary to enforce the

138.  See Rouse v. United States, 215 F.2d 872, 873–​74 (D.C. Cir. 1954); Chiriboga v. Int’l Bank for Reconstr. & Dev., 616 F. Supp. 963, 967 (D.D.C. 1985); Alexander H. Revell & Co. v. C.H. Morgan Grocery Co., 214 Ill. App. 526, 527–​28 (App. Ct. 1919); Restatement Second § 309(1)–​(2). 139.  See, e.g., Biddel v. Brizzolara, 30 P. 609, 612 (Cal. 1883); Gilbert v. Sanderson, 9 N.W. 293, 295 (Iowa 1881); People’s Bank & Trust Co. v. Weidinger, 64 A. 179, 181 (N.J. 1906).

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contract.140 Most of these cases concerned life-​insurance policies, although a few concerned intra-​familial settlements. Against this background, Restatement First adopted two rules to govern the issue. Under Section 143 the contracting parties could vary or eliminate the power of a creditor beneficiary to enforce a contract. However, under Section 142 the contracting parties could not vary or eliminate the power of a donee beneficiary to enforce a contract.141 This rule was dramatically exemplified by Illustration 2 to Section 142: A promises B to pay A’s son, C, $1,000 a year for five years, in consideration of which B promises A to pay B’s daughter, D, who is C’s wife, the same amount. Before C or D learn of this contract A and B mutually agree to rescind it. C and D can treat the agreement of rescission as inoperative to destroy their respective rights to enforce the original contract.

The scope of the rule adopted in Section 142 was extremely wide, because under Restatement First the term “donee beneficiary” covered all empowered beneficiaries other than creditor beneficiaries. As a result, under Restatement First the contracting parties could never vary or eliminate the power of an empowered beneficiary to enforce the contract except in the case of a creditor beneficiary. This rule was unjustified, because it overrode the contracting parties’ objectives for no good reason of policy or morality. (Indeed, the rule was hard to justify even on doctrinal grounds, because it was inconsistent with the general rule that the promisor can raise, against an empowered beneficiary, a defense the promisor had against the promisee.) The unfortunate result was that just as classical contract law undervalued the position of third-​party beneficiaries, Restatement First swung to the other extreme and overvalued the position of third-​party beneficiaries. Under Restatement First that position moved from a low level, at which only a limited number of third-​party beneficiaries could enforce a contract, to a high level, at which most third-​party beneficiaries who could enforce a contract had a vested right to enforce a contract the moment the contract was made. Although some jurisdictions followed Section 142142 the rule it adopted was not supported by the weight of authority.143 In any event Restatement Second reversed Restatement First on this issue and adopted a rule very close to that suggested by the third-​party-​beneficiary principle. Under Restatement Second Section 311, contracting parties can modify or rescind a contract in a manner that varies or eliminates the right of an empowered third-​party beneficiary to bring suit unless the beneficiary, before receiving notice of the modification or rescission, either materially changes his position in justifiable reliance on the original contract, brings suit on the original contract, or manifests assent to the original contract at the request of the promisor or

140.  See, e.g., Cent. Bank v. Hume, 128 U.S. 195, 206 (1888); Filley v. Illinois Life Ins. Co., 137 P. 793, 794 (Kan. 1914); Preston v. Connecticut Mut. Life Ins. Co., 51 A. 838, 839–​40 (Md. 1902); Walsh v. Mut. Life Ins. Co., 31 N.E. 228, 230 (N.Y. 1892); Marquet v. Aetna Life Ins. Co., 159 S.W. 733, 735 (Tenn. 1913). 141.  See Restatement First §§ 142–​143. 142.  See, e.g., Logan v. Glass, 7 A.2d 116, 118–​19 (Pa. Super. Ct. 1939), aff ’d, 14 A.2d 306 (1940). 143.  See Mitchell v. Marklund, 47 Cal. Rptr. 756, 762 (Dist. Ct. App. 1965); Spates v. Spates, 296 A.2d 581, 584–​85 (Md. 1972); Camden Trust Co. v. Haldeman, 33 A.2d 611, 616 (N.J. Ch. 1943), aff ’d, 40 A.2d 601 (1945).

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promisee. The cases decided since the adoption of Restatement Second have tended to adopt the principle embodied in Section 311.144 Restatement Second Section 311 marks a considerable step forward from Restatement First Section 142. However, Restatement Second and some of the cases continue to provide the beneficiary with greater protection than is justified. To begin with, Section 311 provides undesirably broad protection to an empowered beneficiary who has relied on the contract. Certainly, the law should protect the reliance interest of an empowered beneficiary, but that interest will normally be sufficiently protected by reliance damages. In contrast, Section 311 provides that the power of the contracting parties to vary or eliminate an intended beneficiary’s power to enforce the contract terminates when the beneficiary changes his position in justifiable reliance. This language suggests—​perhaps inadvertently—​that once an empowered beneficiary justifiably relies on the contract, he can recover expectation damages. Such a rule would be mistaken. Expectation damages are an unusual remedy because, unlike most legal remedies, they do more than restore a party to his pre-​injury position. Contract law allows parties to a bargain to recover expectation damages largely because it is socially desirable to require each party to a bargain, when making a perform-​or-​breach or a precaution decision, to internalize the other party’s potential gains and losses.145 This reasoning does not apply to a third-​party beneficiary, who has not entered into a bargain. On the contrary, allowing a third-​ party beneficiary to enforce a contract against the wishes of the contracting parties conflicts with the interests of the only persons who have entered into a bargain. If an empowered beneficiary has justifiably relied on a contract, the importance of protecting that reliance outweighs the interests of the contracting parties, but only to the extent of the reliance.146 Section 311 also takes the position that the contracting parties cannot vary or eliminate an empowered beneficiary’s ability to enforce the contract once the beneficiary has brought suit. That position, although supported by some case law, is also mistaken. The act of bringing suit is simply a special kind of reliance. If an empowered beneficiary has brought suit the promisor should be liable for the beneficiary’s cost of bringing suit, but should otherwise be free to join with the promisee in varying or eliminating the beneficiary’s entitlement to any further damages.147 Some cases also state that the contracting parties cannot modify or rescind the contract after an empowered beneficiary has assented to the contract.148 The support for this position 144.  See, e.g., Karo v. San Diego Symphony Orchestra Ass’n, 762 F.2d 819, 821–​24 (9th Cir. 1985); Bridgman v. Curry, 398 N.W.2d 167, 172 (Iowa 1986). But see Hickox v. Bell, 552 N.E.2d 1133, 1144–​45 (Ill. App. Ct. 1990); Biggins v. Shore, 565 A.2d 737, 740–​42 (Pa. 1989). 145.  See Cooter & Eisenberg, supra note 53, at 1462–​64. 146.  Indeed, a rule that requires the award of expectation damages to a relying beneficiary, even when the contract has been modified or rescinded, would treat a beneficiary, to whom a promise is not directly made, better than a donative promisee to whom a promise is directly made. Under Restatement Second Section 90 if a donative promise is directly made to a promisee who then relies upon the promise, the promisee’s damages may be limited to reliance. Section 311 should parallel Section 90 in this regard. 147.  Cf. Puro v. Puro, 393 N.Y.S.2d 633, 635–​36 (Sup. Ct. 1976) (individual cannot, by act of filing suit, transform contract into an unconditional agreement to benefit him). 148.  A number of cases concern infant donee beneficiaries. See, e.g., James v. Pawsey, 328 P.2d 1023, 1028 (Cal. App. Ct. 1958); Rhodes v. Rhodes, 266 S.W.2d 790, 792–​93 (Ky. 1953). These cases adopt a syllogism that (i) a beneficiary’s rights vest upon his assent; (ii) in the case of an infant, assent is presumed; and, therefore, (iii) an infant beneficiary’s rights vest when the contract is made even if the infant does not

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is unclear. In some of the cases that take this position the statement had no significance because the beneficiary had not assented. In other cases the beneficiary had not only assented but relied,149 and these cases are better explained by reliance than by assent. In still other cases, the beneficiary’s assent was essentially an acceptance of an offer, which arguably concluded an independent contract.150 Generally speaking, assent by the beneficiary should not change his legal position unless the assent constitutes the acceptance of an offer. If the contracting parties have not made an offer to the beneficiary his assent is a virtually meaningless act. Anyone who knows that he is a third-​ party beneficiary will give assent, because the status of a beneficiary is all plus and no minus. Why treat a beneficiary who actually assents better than a beneficiary who surely would have assented once he knew that his assent would improve his legal position at no cost to himself? Accordingly, Section 311 should be interpreted to limit the effect of a beneficiary’s assent to cases in which an offer has been made to the beneficiary, an assent manifested in response to a request for assent could be viewed as an independent contract, thereby moving the situation out of the third-​party-​beneficiary category, at least if there is no problem of consideration.151

V.   D E F E N S ES T HAT T H E   P R O MI S O R WOUL D HAVE H A D A G A I N S T   T HE PR OM I S EE The first two Sections in this chapter considered the issue whether a promisor should be allowed to raise, against an empowered beneficiary, a defense that the promisor would have had against the promisee. This Section considers the more difficult issue, whether a promisor should be allowed to raise, against an empowered beneficiary, a defense that the promisee would have had against the beneficiary if the beneficiary had sued the promisee rather than the promisor. In some respects this question is very narrow, because it seldom if ever arises outside the creditor-​beneficiary context. In that context the beneficiary has a preexisting claim against the promisee, the promisee may have a defense against the claim, and the promisor may want to raise that defense if the beneficiary sues the promisor for the amount of the claim. Outside the creditor-​beneficiary context, however, the beneficiary is unlikely to have a preexisting claim against the promisee, and correspondingly the promisee is unlikely to have a defense against the beneficiary that the promisor could raise. For example, Marion, the beneficiary in Seaver

explicitly assent. The brittle nature of the syllogism, and the lack of true assent, show that these cases are best explained by a policy of solicitude for infant donees. 149.  See, e.g., Bridgman, 398 N.W.2d at 173 (Iowa 1986). 150.  See, e.g., Wolosoff v. Gadsden Land & Bldg. Corp., 18 So. 2d 568, 571–​72 (Ala. 1944). 151.  Restatement Second. § 311  cmt. h, illus. 11. Illustration  10 to Section 311(3) seems to conflict with the rest of the Section, because the beneficiary’s assent is given effect although the assent is not requested: “B contracts with A to pay C $200 [where] A owes C, and A notifies C of the contract by mail. C mails a letter to A assenting to the contract before receiving notification of a rescission by A and B. The rescission is ineffective against C.” Id. § 311 cmt. h, illus. 10.

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v. Ransom, had no preexisting claim against Mrs. Beman, the promisee, concerning the subject-​ matter of the contract. Because Marion had no such claim against Mrs. Beman, we cannot talk sensibly about whether Judge Beman could raise a defense that Mrs. Beman had against Marion. Assume, however, that the third-​party beneficiary is a creditor beneficiary, and the promisee has a defense against the third party’s claim which the promisor wishes to raise in a suit by the third party against the promisor. Restatement Second Section 309(3) provides that a promisor cannot raise, against a beneficiary, a defense the promisee could have raised against the beneficiary. The same rule was adopted in Rouse v. United States.152 Associated Contractors had installed a heating plant in Winston’s house in exchange for Winston’s $1,008 promissory note, payable in installments. Subsequently, Rouse purchased the house and agreed to assume Winston’s then-​remaining $850 obligation to Associated. Neither Rouse nor Winston paid this amount, and Associated’s assignee sued Rouse on the theory that Associated was a creditor beneficiary because Rouse had assumed Winston’s preexisting debt to Associated. Rouse defended in part on the ground that Associated had sold Winston a defective heating plant; accordingly, Winston would have had a defense against Associated, and Rouse should be able to raise that defense as well.153 The court held that Rouse could not raise the defense, quoting Williston: If the promisor’s agreement is to be interpreted as a promise to discharge whatever liability the promisee is under, the promisor must certainly be allowed to show that the promisee was under no enforceable liability. . . . On the other hand, if the promise means that the promisor agrees to pay a sum of money to A, to whom the promisee says he is indebted, it is immaterial whether the promisee is actually indebted to that amount or at all. . . . Where the promise is to pay a specific debt . . . this interpretation will generally be the true one.154 The rule adopted in Restatement Second Section 309(3), and cases such as Rouse, is unjustified. As Williston said, “If the promisor’s agreement is to be interpreted as a promise to discharge whatever liability the promisee is under, the promisor must certainly be allowed to show that the promisee was under no enforceable liability.” That is just what the promisor and the promisee would normally intend, unless the promisee had a relationship with the beneficiary that would give rise to an intent by the promisee to confer a gift on the beneficiary. Clearly, Winston had no such relationship with Associated. Furthermore, in the absence of such a relationship, and therefore of such an intent, the rule is likely to lead to unjust enrichment of the third-​party beneficiary. In Rouse, for example, Associated was unjustly enriched by Rouse’s inability to offset the cost to repair the heating plant from Associated’s claim. Winston could not sue Associated, because she did not lose any money as a result of the defect. (Rouse apparently did not get a reduction in the price of Winston’s house because the heating system was defective.) Rouse also could not sue Associated, under the decision in the case. As a result, Associated walked away with the full price of a defective heating plant. Allowing Rouse to raise Winston’s defense against Associated would have prevented this unjust enrichment.

152.  215 F.2d 872, 874 (D.C. Cir. 1954); accord Peters Grazing Assoc. v. Legerski, 544 P.2d 449, 457–​58 (Wy. 1976) (citing Rouse). 153.  Rouse, 215 F.2d at 874. 154.  Id. (quoting 2 Samuel Williston & George J. Thompson, Williston on Contracts, § 399, at 1148–​49 (rev. ed. 1936)).

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V I .   C O N C LUS I ON A third-​party beneficiary should be able to enforce a contract when it is a necessary or important means of effectuating the contracting parties’ objectives, or when such enforcement is supported by reasons of policy or morality and would not conflict with the contracting parties’ objectives. In other circumstances, third parties should not be permitted to enforce a contract. When a third party is properly empowered to bring suit against a promisor, the promisor can and should be able to raise any defenses she had against the promisee. The promisor should also be able to raise any defenses the promisee had against the third party, although this is not currently the law. In addition, the contracting parties should be able to modify and rescind their agreement, provided they reimburse an empowered third party for expenses justifiably incurred in reliance on the contract prior to the modification or rescission.

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f i f t y - ​s i x

The Statute of Frauds I .   I N T R O DUCT I ON The law does not require contracts as a class to be in writing. However, the Statute of Frauds (sometimes hereafter “the Statute”), which was adopted in England in 1677, and is in force in almost every American state, provides that certain kinds of contracts are unenforceable against the party to be charged—​that is, the party sought to be held liable—​unless the contract is evidenced by a writing or, today, an electronic equivalent, signed by that party. The original English Statute of Frauds applied to many different kinds of transactions, including contracts.1 The provisions chiefly relevant to contract law were Sections 4 and 17. In the balance of this chapter references to “the Statute of Frauds” or “the Statute” will refer to Sections 4 and 17 and their modern counterparts. The spelling and punctuation of Sections 4 and 17 have been modernized, and some liberties have been taken in the formatting and numbering of subsections. Section 4 provided: . . . [N]‌o action shall be brought (1) whereby to charge any executor or administrator upon any special promise to answer damages out of his own estate; or (2) whereby to charge the defendant upon any special promise to answer for the debt, default or miscarriages of another person; or (3) to charge any person upon any agreement made upon consideration of marriage; or (4) upon any contract or sale of lands, tenements or hereditaments, or any interest in or concerning them; or (5) upon any agreement that is not to be performed within the space of one year from the making thereof; unless the agreement upon which such action shall be brought, or some memorandum or note thereof, shall be in writing, and signed by the party to be charged therewith, or some other person thereunto by him lawfully authorized.

1.  An Act for the Prevention of Frauds and Perjuries 1677, 29 Car. 2, c. 3 (Eng.).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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Section 17 provided: [N]‌o contract for the sale of any goods, wares or merchandises for the price of ten pounds sterling, or upwards, shall be allowed to be good, except ( a)  the buyer shall accept part of the goods so sold and actually receive the same; or (b)  give something in earnest to bind the bargain, or in part-​payment; or (c) that some note or memorandum in writing of the said bargain be made and signed by the parties to be charged by such contract, or their agents thereunto lawfully authorized. [The Statute uses the terms “agreement” and “contract” interchangeably. The same usage will be followed in this chapter.]

All American states except Louisiana, Maryland, and New Mexico adopted some version of Section 4, and in Maryland and New Mexico the Statute is in force by judicial decision.2 UCC Section 2-​201, which is the modern counterpart of Section 17, has also been adopted by virtually every state. In a few instances, states omitted particular provisions of Section 4. More commonly, states have extended the original Statute by requiring additional kinds of contracts to be in writing. One common extension applies the Statute to contracts for payment of a commission to a real-​estate broker in exchange for brokerage services.3 Another common extension applies to contracts to make a will. In addition to these extensions, some American states have introduced minor changes in phraseology. For example, instead of stating that “no action shall be brought whereby to charge” a person on a contract covered by the Statute, as provided in Section 4, or that the oral contract shall not “be allowed to be good,” as provided in Section 17, a given state’s Statute of Frauds may simply provide that certain types of contracts shall be “void” unless in writing. Although the term void is probably not intended to be interpreted literally, its use may have some influence. Another difference introduced into some state Statutes was to provide that “the contract” must be in writing, instead of following the language of the original Statute, which requires only that “the agreement” or “some memorandum or note thereof ” be in writing. This difference may be significant in considering the efficacy of a memorandum other than a statement of the agreement. The Statute of Frauds is subject to a number of exceptions. Some exceptions are provided for in the Statute itself; others have been created by the courts. If a contract is of a type that is covered by the Statute and is not in writing or electronic form, or not signed by the party to be charged, the contract is said to be within the Statute, and therefore unenforceable against that party. If an exception to the Statute applies, the contract is said to be taken out of the Statute and therefore enforceable against the party to be charged even though it is not in written or other record form, not signed by the party to be charged, or both. Two modern statutes have a significant impact on the Statute of Frauds:  the Uniform Electronic Transactions Act (UETA),4 which was promulgated in 1999 by the National Conference of Commissioners on Uniform State Laws, and has been adopted by most states, and

2.  See Restatement (Second) of Contracts ch. 5, Statutory Note (Am. Law Inst. 1981) [hereinafter Restatement Second]. 3.  See Lon Fuller. Melvin Aron Eisenberg, & Mark P. Gergen, Basic Contract Law 1160 (9th ed. 2013). 4.  Unif. Elec. Transaction Act, 7A, pt. 1 U.L.A. (2017).

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the Electronic Signatures in Global and National Commerce Act (“E-​SIGN”),5 a federal statute that is generally comparable to UETA. Although normally federal statutes preempt comparable state statutes, E-​SIGN Section 7002 provides that UETA preempts E-​SIGN6 rather than the other way around. Accordingly, for ease of exposition, this chapter will focus on UETA rather than both UETA and E-​SIGN. At the heart of UETA are Sections 2(8), 2(13), and 7. UETA Section 7 provides that: (a) A record or signature may not be denied legal effect or enforceability solely because it is in electronic form. (b) A contract may not be denied legal effect or enforceability solely because an electronic record was used in its formation. (c)  If a law requires a record to be in writing, an electronic record satisfies the law. (d)  If a law requires a signature, an electronic signature satisfies the law.

UETA Section 2(8) provides that the term electronic signature means “an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted by a person with the intent to sign the record.” The Official Comment to Section 2(8) states: The idea of a signature is broad and not specifically defined. Whether any particular record is “signed” is a question of fact. Proof of that fact must be made under other applicable law. This Act simply assures that the signature may be accomplished through electronic means. No specific technology need be used in order to create a valid signature. One’s voice on an answering machine may suffice if the requisite intention is present. Similarly, including one’s name as part of an electronic mail communication also may suffice, as may the firm name on a facsimile. . . . In any case the critical element is the intention to execute or adopt the sound or symbol or process for the purpose of signing the related record. . . . It is that intention that is understood in the law as a part of the word “sign”, without the need for a definition. . . . This definition includes as an electronic signature the standard webpage click through process. . . .

UETA Section 2(13) provides that the term record means “information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.” The Official Comment to Section 2(13) states: This is a standard definition designed to embrace all means of communicating or storing information except human memory. It includes any method for storing or communicating information, including “writings.” A record need not be indestructible or permanent, but the term does not include oral or other communications which are not stored or preserved by some means. Information that has not been retained other than through human memory does not qualify as a record. As in the case of the terms “writing” or “written,” the term “record” does not establish the

5.  Electronic Signatures in Global and National Commerce Act, 15 U.S.C. §§ 7001–​7006, 7021, 7031 (2016). 6.  Id. at § 7002.

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Requirements of a Writing purposes, permitted uses or legal effect which a record may have under any particular provision of substantive law.

UETA has a terminological and a substantive impact on the Statute of Frauds. Terminologically, UETA effectively replaces the term writing with the term record. Substantively, UETA makes it much easier to satisfy the Statute of Frauds, because the term record is given a very expansive definition so as to denote any means, other than human memory, for storing information—​ including, for example, a message that was recorded on voicemail or an answering machine. In light of UETA, today the best terminology for describing the requirements of the Statute of Frauds would be to use the term record rather than writing. However, because the latter term and its cognates generally remain in state Statutes of Frauds, this chapter will use the term writing or other record.

I I .   I S T H E   S TAT UT E O F   F R A U D S JUS T I F I ED? The Statute of Frauds has the virtue of preventing fraudulent plaintiffs from making up contracts out of whole cloth, but it has the vice of allowing fraudulent defendants to escape from a contract that was in fact made. Whether the virtue outweighs the vice is open to question. To begin with, the principles by which the Statute’s drafters decided what contracts deserved the protection of a writing were based on the needs of the seventeenth century, not those of modern commerce. Accordingly, in the modern business world the Statute does not apply to many very important and complex types of contracts, but does apply to some simple and unimportant contracts, as illustrated by the next three examples: Turf I. Bertram Builder and Teresa Turf enter a complex oral agreement under which Builder promises to construct a commercial building according to certain plans and specifications, commencing work on January 1 and finishing by December 1. Turf agrees to pay Builder $15 million for the job. This important and complex contract is enforceable despite being oral because it does not come within any Section of the Statute. Turf II. After the completion of the building in Turf I, Turf enters into an oral agreement with Rock of Ages Insurance Company under which Rock of Ages insures the building against fire in the amount of $15 million, for one year effective immediately, and Turf agrees to pay a premium of $200,000. This contract is also enforceable despite being oral, because it too does not come within any Section of the Statute. Redacre. Jim Joad orally agrees with Jane Jukes that he will sell her his eroded tract, Redacre, for ten dollars. This relatively insignificant contract is unenforceable by virtue of Section 4(4) of the Statute (the sale-​of-​land provision).7

When the Statute of Frauds was introduced as a bill in the House of Lords in 1673 the bill did not attempt to designate certain kinds of contracts as requiring a writing, but instead 7.  See Restatement Second § 127.

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contemplated imposing a limitation on the recovery that could be had on any kind of oral contract. . . . [I]‌n all actions upon the case, actions of debt, or other personal actions which from and after the [blank] day of [blank] shall be commenced upon any assumpsit, promise, contract or agreement made, or supposed to be made, by parol and whereof no memorandum, note or memorial in writing shall be taken by the direction of the parties thereunto no greater damages shall at any time be recovered than the sum of [blank], any law or usage to the contrary notwithstanding.

The Lords might have done better if they had stood by the original bill, which turned on economic significance rather than categories of contracts. Interestingly, UCC Section 1-​206 restores the notion of a limit on recovery for breach of contracts to which it applies. That Section provides that with certain exceptions, including contracts for the sale of goods, a contract for the sale of personal property is not enforceable by way of action or defense beyond $5,000 in amount or value of remedy. In addition to its erratic coverage the Statute was very badly drafted. Its authors did not clearly think through the relation between the disease they sought to cure and the remedy they prescribed, most notably so with respect to contracts not to be performed within one year. Furthermore, the Statute is riddled with exceptions, many of which are fairly complex. The tangled web of judicial interpretation that has gathered about the words of the Statute and the exceptions surely deserves to be called, to paraphrase Kipling—​“filthily technical.” To the laudatory comment that every line of the Statute is worth a subsidy the apt rejoinder is that every line of the Statute costs a subsidy. In 1954 the British Parliament repealed the provisions of the English Statute of Frauds concerning special promises of executors or administrators, agreements in consideration of marriage, agreements not to be performed within one year, and contracts for the sale of goods.8 In England this leaves, from the original Statute, only promises to serve as a surety and contracts for the sale of land.9 Concerning this change, the Permanent Editorial Board for the UCC Study Group on the Revision of UCC Article 2 concluded that “Despite its ancient lineage, there is no persuasive evidence either that the statute of frauds has prevented fraud in the proof of the making of a contract or that its presence has channeled behavior toward more reliable forms of record keeping. . . . England repealed [most provisions of] the statute of frauds. . . . in 1954. Since then there has been little discussion and no reports about the impact, if any. In short, the statute of frauds has apparently sunk in England without an adverse trace.”10 Civil-​law countries generally have no counterpart to the Statute of Frauds. Internationally, Article 11 of the United Nations Convention on Contracts for the International Sale of Goods (CISG) provides that “A contract of sale need not be concluded in or evidenced by writing and is not subject to any other

8.  Law Reform (Enforcement of Contracts) Act 1954, 2 & 3 Eliz. 2, c. 34 (Eng.). 9.  However, as in the United States, after the adoption of the original Statute of Frauds England enacted statutes requiring a signed writing for certain other kinds of contracts, such as promises to repay a loan to a money lender. 10.  PEB Study Group, Uniform Commercial Code Article 2, Preliminary Report at 50–​51 (1990).

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requirement as to form.”11 Similarly, the International Institute for the Unification of Private Law Principles of International Commercial Contracts (UNIDROIT) Article 1.2.4 provides that “Nothing in these Principles requires that a contract be concluded in or evidenced by writing. It may be proven by any means, including witnesses.” Whether or not justified, the Statute of Frauds is the law, and is likely to remain so into the near and perhaps the far future, primarily because the Statute is beloved by most practicing lawyers, probably because they believe it adds to certainty, and certainty is a value that is dear to the profession’s heart. The balance of this chapter therefore will discuss the many legal rules that have evolved under the Statute, both to convey the law in this area and to illustrate the extremely technical nature of this body of law and the frequent difficulties that arise in its application.

I II.   THE L E G A L C O N S EQUENCES OF   A N AG RE E ME N T T H AT I S UNENF OR CEA BL E U N D E R   T H E S TAT UT E OF   F R A UDS What are the legal consequences of an agreement that is unenforceable under the Statute of Frauds? It is a safe guess that this problem never occurred to the Statute’s drafters. When the drafters said in Section 4 that “no action shall be brought” upon contracts of the types covered by Section 17, or that the oral contracts covered by that Section shall not “be allowed to be good,” they probably meant in both cases something roughly equivalent to “an oral contract within those sections is not good.” The occasional American legislatures that changed the wording of the Statute to make covered contracts “void” if oral probably had no clearer idea of what they were doing. A  contractual transaction may give rise to a multitude of legal consequences. It may, for example, create duties, transfer or affect rights, create a relationship with which others cannot interfere without liability, or make the parties guilty of a crime. Terms such as unenforceable and void are blind verbal jabs into a complex molecule of relationships. When they are used in legislation it is the unhappy task of the courts to decide what changes in the structure of the molecule the words were intended to bring about and what changes are in keeping with the gen­ eral purpose of the legislation. Sometimes this task is easy, as in the following example: Contract to Murder. Gilbert Gore orally agrees with Catherine Cabal that he will murder Delbert Doom in return for a conveyance of Bloodacre. The agreement is discovered before it is carried out, and Gore is indicted for criminal conspiracy. The local Statute of Frauds makes any contract for the sale of an interest in land “void.” Gore’s attorney relies on a dictionary definition of void as meaning “of no legal force or effect.” He argues that since this contract was “void” it cannot have the legal effect of making his client guilty of a crime.

This argument would be rejected. Criminal liability is a matter that is beyond the purpose of the Statute of Frauds. Although the Statute in Gore’s jurisdiction uses the word void that does not mean that entering an oral contract that is within the Statute has no legal consequences, but 11.  United Nations Convention on Contracts for the International Sale of Goods art. 11, Apr. 11 1980, S. Treaty Doc. 98–​9 (1983), 1489 U.N.T.S. 3 [hereinafter CISG].

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only that the oral contract will be deprived of those legal consequences that would be inconsistent with the purpose of the Statute. Simple and obvious as is Contract to Murder, it illustrates the difficulty the courts have faced in determining the legal effect of the unenforceable oral contract. What legal effects are inconsistent with the purpose of the Statute? One generalization is that the Statute affects only the contracting parties, so that a contract that is unenforceable under the Statute as between the parties is nevertheless a binding contract as far as third persons are concerned.12 Accordingly, persuading a party to break a contract may constitute the tort of inducing breach of contract even though the contract is within the Statute. Similarly, a person may not undo an executed transaction simply because the contract under which the person acted would have been unenforceable under the Statute if the contract had been executory. This would probably be true even if the Statute says that the oral contract is “void.”13 The following example is more troublesome: Secretarial Services. Quigley Quail orally agrees to serve Fiona Fast as secretary for six months, and Fast agrees to pay for Quail’s services by conveying Penacre to him at the end of the six months’ period. When Quail has served two months he learns that his contract is unenforceable under Section 4(4) of the Statute of Frauds (the land section). Quail discontinues performance and brings suit for the reasonable value of two months’ services. Fast asserts that she is willing to abide by the agreement, and that she stands ready to convey Penacre when Quail’s work is finished. She argues that Quail’s discontinuance of performance is a breach of the oral agreement that should disentitle him to relief. Quail argues that he should not be asked to complete his work under the contract when he has no assurance that Fast will in fact pay him.

Restatement Second Section 141(2) proposes, as a solution for this problem, that “[where] a party to a contract which is unenforceable against him refuses either to perform the contract or to sign a sufficient memorandum, the other party is justified in suspending any performance for which he has not already received the agreed return, and such a suspension is not a defense in an action for the value of performance rendered before the suspension.” Legislation that makes the enforceability of an act or transaction depend upon the observance of certain formalities may be adopted for a variety of reasons. In contract law Austin discerned two possible purposes for requiring formalities: (1) “to provide evidence of the existence and purport of the contract, in case of controversy”; and (2) “to prevent inconsiderate [not well-​thought-​through] engagements.”14 Certainly the Statute of Frauds was intended to serve the first purpose. It was an act to prevent “frauds and perjuries,” and its preamble stated that the Statute was aimed at “many fraudulent practices which are commonly endeavored to be upheld by perjury and subornation of perjury.” But if the drafters had the second purpose in mind they left no trace of it.15 Indeed, if one purpose of the Statute was to protect persons against

12.  See Restatement Second § 144. 13.  See Restatement Second § 145. 14.  John Austin, Fragments on Contracts, in 3 Lectures on Jurisprudence 128 (2d ed. 1863). 15.  Nevertheless, courts have occasionally assumed that ensuring deliberation in the making of contracts was a collateral and secondary purpose of the Statute. Thus in Warden v. Jones, (1857) 2 De G. & J. 76, 83–​ 84, the court said, “The law has . . . wisely forbidden [oral proof of contracts in consideration of marriage].

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hasty engagements the Statute would not be satisfied by a writing that repudiates the contract. However, the general rule is that a writing that sets forth an earlier oral contract but repudiates it serves as a memorandum of the contract that satisfies the Statute.16 Saying Too Much. As part of a land-​development scheme, Susan Slide wants to buy Blackacre, which is owned by Oliver Oakapple. Slide enters an oral agreement for the purchase of Blackacre for $40,000. This agreement is incorporated in an elaborate written contract, which Oakapple signs but Slide does not. When the development scheme collapses, Slide wishes to escape her obligation. Oakapple writes a letter to Slide reminding her of the contract, which he encloses, and demands performance. Slide returns the contract with a letter that reads, “It is true that I entered an oral contract with you on the terms of the enclosed written document. However, the law requires that the contract or a memorandum of it be signed by the party to be charged therewith. You will note that I did not sign this contract, and therefore I am not bound by it. Hoping this incident will teach you some law. Yours truly, Susan Slide”

The decision would go for Oakapple. Slide has provided Oakapple with a signed memorandum of the contract that will take the contract out of the Statute and permit a successful suit agains Slide.

IV.   T Y P E S O F   C O N T R A CT S T HAT A R E W I T H I N T HE  S TAT UT E A.  CONTRACTS FOR THE SALE OF AN INTEREST IN LAND Section 4(4) of the Statute covers contracts for the sale of an interest in land including, by implication, sales of interests in buildings and other improvements on land. The price, value, or extent of the interest is immaterial. In determining what constitutes an interest in land for purposes of the Statute, normally the test is how the interest is treated by the law of property. Shortcut. To obtain a shortcut from his farm to the highway, Paul Pass wants the right to drive through Bilbo Block’s land. The parties orally agree that in consideration of the payment of $1,000, Pass shall have that right during his life.

The agreement falls within Section 4(4), and is therefore unenforceable, because the agreement would give Pass an easement, which under property law is an interest in land. The language of Section 4(4) speaks of “any contract or sale” of lands (emphasis added). It might be assumed that this language covers either a contract to convey or a present conveyance Persons are so likely to be led into such promises inconsiderately, that the law has wisely required them to be manifested by writing.” 16.  See Restatement Second § 133.

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by way of a sale. However, conveyances were covered by the first three sections of the original Statute of Frauds, which are not reproduced in this chapter. In very general terms, these Sections stated that a writing is necessary to create or transfer an interest in land, except that a tenancy at will and, under certain conditions, a lease not to exceed three years, could be created orally. The substance of these provisions is very generally carried over into American Statutes of Frauds (although the exception for oral short-​term leases is usually reduced to leases of either not more than one or not more than two years). Accordingly, despite the language of Section 4(4), that Section refers only to contracts for the sale of an interest in land, not to conveyances—​with the qualification that under the Statute contracts for the sale of land include not only contracts to sell interests in land for money but also contracts to exchange land for something other than money, or to devise land by will.17

B.  CONTRACTS FOR THE SALE OF GOODS; THE UCC 1. Coverage In the United States, Section 17 of the Statute of Frauds (the sale-​of-​goods provision) was eventually superseded by UCC Section 2-​201: (1) Except as otherwise provided in this section a contract for the sale of goods for the price of $500 or more is not enforceable by way of action or defense unless there is some writing sufficient to indicate that a contract for sale has been made between the parties and signed by the party against whom enforcement is sought or by his authorized agent or broker. A writing is not insufficient because it omits or incorrectly states a term agreed upon but the contract is not enforceable under this paragraph beyond the quantity of goods shown in such writing. (2) Between merchants if within a reasonable time a writing in confirmation of the contract and sufficient against the sender is received and the party receiving it has reason to know its contents, it satisfies the requirements of Subsection (1) against such party unless written notice of objection to its contents is given within 10 days after it is received. (3) A contract which does not satisfy the requirements of Subsection (1) but which is valid in other respects is enforceable (a) if the goods are to be specially manufactured for the buyer and are not suitable for sale to others in the ordinary course of the seller’s business and the seller, before notice of repudiation is received and under circumstances which reasonably indicate that the goods are for the buyer, has made either a substantial beginning of their manufacture or commitments for their procurement; or (b) if the party against whom enforcement is sought admits in his pleading, testimony or otherwise in court that a contract for sale was made, but the contract is not enforceable under this provision beyond the quantity of goods admitted; or (c) with respect to goods for which payment has been made and accepted or which have been received and accepted. . . .

Three points are worth noting at the outset. 17.  See Restatement Second § 125 cmt. a, c, and illus.

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* UCC Section 2-​201(1) relates only to the sale of goods—​that is, physical property other than realty, or what the Official Comment to the UCC calls “movables.” Section 2-​201(1) does not relate to the sale of intangibles. * Where a writing is required by UCC Section 2-​201(1) it need only be “sufficient to indicate that a contract for sale has been made between the parties.” There is no requirement that the writing either specify the kind of goods involved or state the price. There is not even a requirement that the quantity of goods sold be stated, although this apparent looseness is illusory because the Section provides that “the contract is not enforceable . . . beyond the quantity of goods shown in such writing.” Accordingly, if no quantity is shown in the writing, the extent of enforceability is zero. If the oral agreement was for 1,000 units, while the writing says 500 units, the contract is enforceable only to the extent of 500 units.18 (Note, however, that a contract for the sale of goods that omits too many terms may be unenforceable on the ground of indefiniteness.) * UCC Section 2-​201 applies only if the price is $500 or more. However, if the price is $500 or more and Section 2-​201 is not satisfied the entire contract—​not merely that portion of the contract in excess of $500—​is unenforceable.

2. Exceptions The basic requirements of Section 2-​201(1) are subject to several very important exceptions.

a. Part Performance (Subsection (3)(c)) Section 2-​201(3)(c) provides that “A contract which does not satisfy the requirements of [Section 2-​201(1)] but which is valid in other respects is enforceable . . . with respect to goods for which payment has been made and accepted or which have been received and accepted. . . .” Even in the absence of Subsection (3)(c), if a buyer has accepted contracted-​for goods she would be liable for the value of the goods under the law of unjust enrichment. The significance of Subsection (3) (c) is that if the seller sued under the law of unjust enrichment he would be entitled to recover only the market value of the goods at the time they were accepted by the buyer, while under Subsection (3)(c) the seller can recover the contract price of accepted goods.

b.  Goods Made Specially to Order (Subsection 3(a)) Suppose A orally orders a custom-​made suit from his tailor, and agrees to pay $1,500. The tailor prepares the suit but A refuses to receive and accept it. If this contract was unenforceable a serious injustice would be done to the tailor, who will have some difficulty finding a market for the suit since it was custom-​made for A. Subsection (3)(a) deals with this problem by providing that “A contract which does not satisfy the requirements of [Section 2-​201(1)] but which is valid in other respects is enforceable . . . if the goods are to be specially manufactured for the buyer and are not suitable for 18. The UCC does not itself deal with the possibility of reforming the writing to correct a mistake. Presumably, if both parties intended the writing to state 1,000 units, a court might in a proper case reform the memorandum, which then would become enforceable to the extent of 1,000 units. See Section I of this chapter.

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The Statute of Frauds

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sale to others in the ordinary course of the seller’s business and the seller, before notice of repudiation is received and under circumstances which reasonably indicate that the goods are for the buyer, has made either a substantial beginning of their manufacture or commitments for their procurement. . . .”

c. Receipt of Confirmation (Subsection (2)) UCC Subsection 2-​201(2) adds another exception to the requirements of Section 2-​201, based on modern methods of contracting. This Subsection provides that “Between merchants if within a reasonable time a writing in confirmation of the contract and sufficient against the sender is received and the party receiving it has reason to know its contents, it satisfies the requirements of [Section 2-​ 201(1)] against such party unless written notice of objection to its contents is given within ten days after it is received” (emphasis added). UCC Section 2-​104(1) defines the term merchant to mean “a person who deals in goods of the kind or otherwise by his occupation holds himself out as having knowledge or skill peculiar to the practices or goods involved in the transaction or to whom such knowledge or skill may be attributed by his employment of an agent or broker or other intermediary who by his occupation holds himself out as having such knowledge or skill.” (Emphasis added.)

d. Admissions (Subsection 3(b)) Subsection 2-​201(3)(b) provides that “A contract which does not satisfy the requirements of [Section 2-​201(1)] but which is valid in other respects is enforceable . . . if the party against whom enforcement is sought admits in his pleading, testimony or otherwise in court that a contract for sale was made, but the contract is not enforceable under this provision beyond the quantity of goods admitted. . . .” Under the weight of authority the admission may be either voluntary or involuntary. Accordingly, under Subsection 3(b) a plaintiff can bring suit on an oral contract and then try to make the defendant admit, in discovery proceedings or on cross-​examination, that the oral contract was in fact made. If the defendant admits that the oral contract was made, the admission takes the contract out of the Statute. If the defendant falsely denies that the oral contract was made he is guilty of perjury. Where a complaint is based on an oral contract for the sale of goods, under the weight of authority the complaint ordinarily should not be dismissed on motion before the plaintiff has had the chance to depose the defendant, because the plaintiff should have an opportunity to elicit an admission that the contract was made.19 This is as it should be. The Statute of Frauds is designed to protect against the danger that a plaintiff may perjuriously establish a contract where there was no contract in fact. If the defendant admits the contract existed, the purpose of the Statute is satisfied. As stated in ALA, Inc. v. CCAIR, Inc.: In order for [the admission exception] to function, the plaintiff must have some opportunity to obtain an admission from the defendant. A Rule 12(b)(6) motion to dismiss, however, would derail the plaintiff ’s case pre-​pleading and allow the defendant to defeat a cause of action on an oral contract before the plaintiff has any opportunity to seek an admission that a contract existed. Allowing a defendant to dispose of a case on a Rule 12(b)(6) motion would eviscerate [the admissions

19.  See, e.g., ALA, Inc. v. CCAIR, Inc., 29 F.3d 855, 862–​63 (3d Cir. 1994); Theta Prods., Inc. v. Zippo Mfg. Co., 81 F. Supp. 2d 346, 350–​51 (D. R.I. 1999).

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exception] and potentially allow a defendant to avoid the obligations of an oral contract into which he or she actually entered.20

e. Two Problems of Interpretation Raised by UCC Section 2-​201 The following example illustrates two problems of interpretation raised by UCC Section 2-​201: Installment Shipments. Seller and Buyer enter into an oral contract whereby Seller is to deliver 12,000 widgets over a twelve-​month period in twelve shipments of 1,000 widgets each. The agreed price is $1 per widget. The first ten shipments are accepted and paid for. After the eleventh shipment has been accepted, but before it has been paid for, Buyer repudiates the contract, refusing to pay for the eleventh shipment and stating that he will not accept the final shipment for the twelfth month. Seller sues to recover $1,000 due for the eleventh shipment and damages of $400 for Buyer’s refusal to accept the final shipment. Buyer pleads UCC Section 2-​201 as a defense.

The case would be resolved as follows: The contract involves the sale of goods, and therefore comes within Section 2-​201. Since Buyer has already paid for the first ten shipments, those shipments are not in issue. Seller is entitled to the price of the eleventh shipment—​$1,000—​ because that shipment was made and accepted. However, Seller cannot recover $400 as damages for Buyer’s refusal to take the final delivery. Although $400 is less than the $500 amount in Section 2-​201, the $500 amount relates not to the extent of damages but to the total price set in the contract, which in this case was $12,000. CISG. Many international contracts for the sale of goods are governed by the CISG (Convention for the International Sale of Goods) rather than the UCC, and therefore are not subject to the Statute of Frauds even if one of the parties is domiciled in the United States: Article 11 of the CISG provides that “A contract of sale need not be concluded in or evidenced by writing and is not subject to any other requirement as to form. It may be proved by any means, including witnesses.”

20.  ALA, Inc., 29 F.2d at 862. In DF Activities Corp. v. Brown, 851 F.2d 920 (7th Cir. 1988), the court held that suit on an oral contract could be dismissed on summary judgment where the defendant, by sworn affidavit, denied that she ever agreed to sell the goods in question (a Frank Lloyd Wright chair) to the plaintiff: . . . When there is a bare motion to dismiss, or an answer, with no evidentiary materials, the possibility remains a live one that, if asked under oath whether a contract had been made, the defendant would admit it had been. The only way to test the proposition is for the plaintiff to take the defendant’s deposition, or, if there is no discovery, to call the defendant as an adverse witness at trial. But where as in this case the defendant swears in an affidavit that there was no contract, we see no point in keeping the lawsuit alive. Of course the defendant may blurt out an admission in a deposition, but this is hardly likely, especially since by doing so he may be admitting to having perjured himself in his affidavit. Stranger things have happened, but remote possibilities do not warrant subjecting the parties and the judiciary to proceedings almost certain to be futile.

Id. at 922.

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C.  OTHER UCC PROVISIONS THAT BEAR ON THE REQUIREMENT OF A WRITING The UCC has two other provisions that bear on the requirement of a writing. 1. Security interests in collateral. UCC Section 9-​203 provides that a security interest in most types of collateral is enforceable only if described in a written security agreement authenticated by the debtor or if the collateral is already in the creditor’s possession. 2. Purchase or sale of securities. UCC Section 8-​113 provides that “A contract or modification of a contract for the sale or purchase of a security is enforceable whether or not there is a writing signed or record authenticated by a party against whom enforcement is sought, even if the contract or modification is not capable of performance within one year of its making.”

D.  AGREEMENTS NOT TO BE PERFORMED WITHIN ONE YEAR FROM THE MAKING THEREOF Section 4(5) of the Statute of Frauds requires actions “upon any agreement that is not to be performed within the space of one year from the making thereof ” to be in a written record signed by the party to be charged under the contract. Most courts have held that the applicability of Section 4(5) depends not on what the parties thought would happen, or on how long the contract would probably take to perform, or on how long the contract actually took to perform, but on whether, when the oral contract was made, there was a possibility that by its terms it could have been performed within a year. If so, the contract is not within the Statute, and therefore is enforceable.21 However, if an oral contract by its terms could not possibly have been performed within one year it is within the Statute and therefore unenforceable against the party to be charged.22 What of a contract to employ A for ten years? Shall it be said that such a contract is not within the Statute because it would have been dissolved by the death of either party, under the principle of unexpected circumstances, and therefore might have been performed within a year? If this line of reasoning was accepted it would be hard to find any contract to which the one-​year provision would apply, because in the case of almost any contract it is possible to imagine some cataclysmic event that might occur during the first year and excuse performance. Accordingly, the courts have generally focused on whether performance can possibly occur within one year under the terms of the contract.23 On this basis an oral agreement to hire an octogenarian for thirteen months is within the Statute and therefore unenforceable unless in a writing or other record, but an oral agreement by A to hire B for life is not within the Statute because there is a possibility that the agreement can be performed within a year through the death of A before that 21.  See Restatement Second § 130. 22.  C.R. Klewin, Inc. v. Flagship Props., Inc., 600 A.2d 772, 777–​79 (Conn. 1991). 23.  See Restatement Second § 130.

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time.24 It is immaterial that in fact A lives, and works on the job, for another twenty years. If A is fired at that point he can sue B under the oral agreement made twenty years earlier. (However, in some states the legislature has provided that a contract that is not to be completed before the end of a lifetime is within the Statute. A few cases reach the same result.25) The one-​year provision has been heavily criticized. A good example is the opinion of Judge Peters in C.R. Klewin, supra: [As Farnsworth observed]: “[o]‌f all the provisions of the statute, [the one-​year provision] is the most difficult to rationalize. “If the one-​year provision is based on the tendency of memory to fail and of evidence to go stale with the passage of time, it is ill-​contrived because the one-​year period does not run from the making of the contract to the proof of the making, but from the making of the contract to the completion of performance. If an oral contract that cannot be performed within a year is broken the day after its making, the provision applies though the terms of the contract are fresh in the minds of the parties. But if an oral contract that can be performed within a year is broken and suit is not brought until nearly six years (the usual statute of limitations for contract actions) after the breach, the provision does not apply, even though the terms of the contract are no longer fresh in the minds of the parties. “If the one-​year provision is an attempt to separate significant contracts of long duration, for which writings should be required, from less significant contracts of short duration, for which writings are unnecessary, it is equally ill-​contrived because the one-​year period does not run from the commencement of performance to the completion of performance, but from the making of the contract to the completion of performance. If an oral contract to work for one day 13 months from now is broken, the provision applies, even though the duration of performance is only one day. But if an oral contract to work for a year beginning today is broken, the provision does not apply, even though the duration of performance is a full year.” 2 E. Farnsworth, Contracts (2d Ed.1990) Section 6.4, pp. 110-​11 . . . . In any case, the one-​year provision no longer seems to serve any purpose very well. . . . [F]‌or this reason, the courts have for many years looked on the provision with disfavor, and have sought constructions that limited its application. . . .26

E.  THE SURETYSHIP SECTION Section 4(2) of the Statute of Frauds concerns actions “whereby to charge the defendant upon any special promise to answer for the debt, default or miscarriages of another person.” Section 4(2) is known as the suretyship section. A surety is a person who is liable for a debt or other 24.  Suppose the stated term of a contract is more than a year but one or both parties are explicitly given the right to terminate the contract on three months’ notice. Is the contract within the Statute? The cases are divided. 25.  See, e.g., McInerney v. Charter Golf, Inc., 176 Ill 482, 680 N.E. 1347 (Ill. 1997) (holding, over a vigorous dissent, that a contract that is not to be completed before the end of a lifetime is within the Statute.) 26.  C.R. Klewin, Inc., 600 A.2d at 775–​76.

79

The Statute of Frauds

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obligation that another person, the principal, owes to a third person, the creditor, where the principal is primarily liable for the debt or other obligation. In such cases the principal and the surety owe the same debt or other obligation to the creditor, and if the principal defaults the creditor can sue either the principal or the surety. However, the principal’s obligation is primary, so that if the surety is required to pay the debt or perform the obligation he can sue the principal for indemnification. Suretyship is often used to afford security to a creditor. For example, Prince wishes to borrow from Moneypenny, but Prince’s credit is weak. To get the loan, Prince may not only promise to repay the loan herself but may also get Answer, whose credit is strong, to promise Moneypenny that he will repay the loan if Prince does not. Answer is then a surety for Prince’s debt. The suretyship section is subject to exceptions that are subtle and complex—​too subtle and too complex, because it is often difficult to determine whether a promise falls within the rule or an exception. The most important exception is called the main purpose rule. This rule applies when the main purpose of the surety is to serve a pecuniary interest of her own rather than the purpose of aiding the principal. If a suretyship contract falls within this exception the contract is not required to be in writing. According to Restatement Second Section 116, in applying the main purpose rule the question is whether the consideration given for the surety’s promise “is in fact or apparently desired by the [surety] mainly for his own economic advantage, rather than in order to benefit the third person.” However, Section 116 excepts from the exception, and thereby renders unenforceable, an oral promise—​typically made by a commercial guaranty company—​to answer for the obligation of another where the consideration given to the surety consists simply of a premium. The main purpose rule is applied chiefly to two types of cases: (1) Cases where the promisor is willing to become a surety in order to save her own property from the assertion of a lien that also secures the debtor’s obligation to the creditor. (2) Cases in which the surety has a pecuniary interest in the debtor’s affairs, for example because she is herself a creditor of the debtor, or because she is a shareholder in a debtor-​corporation, or because the debtor is under contract to construct a building for her, the completion of which she does not want impeded.

F.  PROMISES MADE BY EXECUTORS AND ADMINISTRATORS Section 4(1) of the Statute of Frauds concerns actions “to charge any executor or administrator upon any special promise to answer damages out of his own estate.” Section 4(1) aims at cases in which an executor or administrator of a decedent’s estate promises a creditor of the decedent that if the estate proves insufficient to discharge the debt owed by the decedent, the executor or administrator will personally answer for it. Although the Statute speaks in terms of any promise by an executor or administrator, in fact Section 4(1) covers only a promise by an executor or administrator to pay a debt contracted by the decedent. A promise by an executor or administrator to pay a fresh (post-​death) debt she contracted on the estate’s behalf is not deemed to be within the Statute, on the theory that under the principles of estate law an administrator or executor is liable on such an obligation primarily rather than secondarily as a surety.

798

Requirements of a Writing

798

Few cases arise under Section 4(1). In effect, the Section is a special case of suretyship, since a promise of an executor or administrator covered by Section 4(1) is a promise to answer for the debt of another—​the “other” in this case being the decedent and his estate.

G.  CONTRACTS UPON CONSIDERATION OF MARRIAGE Section 4(3) of the Statute of Frauds (the marriage section) concerns actions “to charge any person upon any agreement made upon consideration of marriage.” Ironically, the marriage section does not apply to a simple engagement by which two persons promise to marry each other. Such an agreement is said to be a contract “to marry,” not a contract “made upon consideration of marriage.”27 Even a promise between the parents of the prospective spouses may not be “made upon consideration of marriage” within the meaning of the Section 4(3), as the following example shows. Parents. Pater Primus, father of one prospective spouse, and Joan Secundus, mother of the other, exchange oral promises that if the marriage takes place they will each give $10,000 to the couple.

This agreement is not within Section 4(3) of the Statute because the consideration for the promise of each party is the promise of the other party, not the marriage. The occurrence of the marriage is merely the occasion for the parties’ contributions to the couple and a condition to their liability.28 The typical situation to which Section 4(3) does apply is that of a “marriage settlement,” in which a parent of a prospective spouse promises the prospective spouse (rather than a parent of the other spouse) to settle money or property on the couple upon their marriage. Similarly, if prospective spouses make an oral contract with each other concerning their anticipated marriage, and the contract involves pecuniary features, such as a promise by one prospective spouse to convey property to the other upon their marriage, Section 4(3) will apply. Since all of the terms of such a contract are intertwined, the entire contract, not merely the pecuniary features, will be unenforceable unless the contract is in a writing or other record.

V.   W H AT K I N D O F   W RI T I NG OR OT HER RE CO R D W I L L S AT I S F Y T HE  S TAT UT E? Sometimes a provision of a Statute of Frauds specifies the kind of writing that is needed to satisfy the provision. As to questions on this issue that are not resolved by the language of the relevant statutory provision, the principal points to note are the following: First. Unless the relevant state Statute of Frauds requires “the contract” to be in writing the Statute is satisfied by almost any kind of signed writing or other record that evidences

27.  See Restatement Second § 124. 28.  See id., illus. 5.

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The Statute of Frauds

799

the terms of the parties’ agreement. This result follows from the language of Section 4, which states, in effect, that there must be either a written contract or some memorandum or note of the contract. Second. The requirement of a “signed” writing does not mean that the document must be signed by the party in his own hand and with his full name. Any symbol used with an intent to authenticate a document will suffice. For example, an “O.K.” with initials is sufficient. Even a photocopied or computer-​printed name will count as a signature if it reflects an intent to authenticate a document. The UCC defines the term signed to include “any symbol executed or adopted by a party with present intention to authenticate a writing.” The Comment to UCC Section 1-​201 states: “. . . as the term ‘signed’ is used in the Uniform Commercial Code, a complete signature is not necessary. The symbol may be printed, stamped or written; it may be by initials or by thumbprint. It may be on any part of the document and in appropriate cases may be found in a billhead or letterhead. No catalog of possible situations can be complete and the court must use common sense and commercial experience in passing upon these matters. The question always is whether the symbol was executed or adopted by the party with present intention to adopt or authenticate the writing.”29 The approach of Restatement Second is somewhat broader than that of the UCC, in that it allows either actual or apparent intent to suffice.30 Farnsworth, in describing the Restatement approach, states that the “modern test is whether the other party reasonably believes that the asserted signer’s intention is to authenticate the writing as the asserted signer’s own.”31 In Donovan v. RRL Corp. the court held that “When an advertisement constitutes an offer, the printed name of the merchant is intended to authenticate the advertisement as that of the merchant. . . . In other words, where the advertisement reasonably justifies the recipient’s understanding that the communication was intended as an offer, the offeror’s intent to authenticate his or her name as a signature can be established from the face of the advertisement.”32 Third. If a writing or other record is to satisfy the Statute it must state the terms of the contract with reasonable adequacy. A writing or other record that failed to identify the parties, the subject-​matter, and the essential terms of the contract would normally not be sufficient. On the other hand, the courts do not demand perfection, and some degree of ambiguity or ellipsis is not fatal. Fourth. There are a variety of approaches to whether the consideration must be stated to make a writing effective. Some statutes provide that the consideration must be stated, while others provide that the consideration need not be stated. The latter approach presents the most difficulty. Does it mean, for example, that a written contract to sell land is effective although it makes no mention of the price or states the price incorrectly? The cases are divided, but some have gone so far as to accept this conclusion. Guarantees present a special problem because it is not uncommon for a written guarantee to omit the surety’s consideration—​which may be, for example, an extension of time granted to the debtor by the creditor. An early English case construing the suretyship Section (Section 4(2)) declared that a contract or memorandum that did not state the surety’s consideration was fatally 29.  U.C.C. § 1-​201 cmt. 37 (Am. Law Inst. & Unif. Law Comm’n 2011). 30.  Restatement Second § 134. 31.  E. Allan Farnsworth, Contracts § 6.8, at 390 (4th ed. 2004). 32.  Donovan v. RRL Corp., 27 P.3d 702, 713–​14 (Cal. 2001).

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Requirements of a Writing

defective. Some American courts have followed this decision; more have refused to. In 1856 the English law was changed by a statute that dispensed with the need for stating the surety’s consideration in a written guaranty.33 Fifth. Generally, the writing or other record need not be signed by both parties, but only by the “party to be charged.” This may result in a contract that is enforceable by one party but not the other. Sixth. Even where no single writing exists that is sufficient to satisfy the Statute, a memorandum may sometimes be obtained by piecing together several writings. If the writings are physically attached, or contain internal references to one another, there is no difficulty in piecing together the writings. More doubtful is the question whether piecing together is permissible where doing so rests entirely on oral evidence or general appearances. In Crabtree v. Elizabeth Arden Sales Corp.34 the court stated: Where each of the separate writings has been subscribed by the party to be charged, little if any difficulty is encountered. . . . Where, however, some writings have been signed, and others have not . . . there is basic disagreement as to what constitutes a sufficient connection permitting the unsigned papers to be considered as part of the statutory memorandum. The courts of some jurisdictions insist that there be a reference, of varying degrees of specificity, in the signed writing to that unsigned, and, if there is no such reference, they refuse to permit consideration of the latter in determining whether the memorandum satisfies the statute. . . . The other position which has gained increasing support over the years is that a sufficient connection between the papers is established simply by a reference in them to the same subject matter or transaction. . . . The view last expressed impresses us as the more sound . . . and we now definitively adopt it, permitting the signed and unsigned writings to be read together, provided that they clearly refer to the same subject matter or transaction. . . .

Seventh. A  memorandum may fail to satisfy the Statute of Frauds because it does not correctly state the agreement.35 (But note that UCC Section 2-​201(1) specifically provides otherwise in the case of a contract for the sale of goods. See Ninth, below.) This result is paradoxical. The Statute of Frauds finds its rationale in the untrustworthiness of oral agreements. Yet the writing or other record that the Statute requires may itself be impugned, and its effect destroyed, by orally showing that the writing or other record does not truly state the oral agreement. Eighth. A  principal will normally be bound by the signature of an authorized agent on the principal’s behalf even if the agent’s authority is not evidenced by a writing or other rec­ ord. However, some state statutes provide that if a contract signed by an agent is within the Statute of Frauds the agent’s authority must be evidenced in a writing or other record signed by the principal. The doctrine embodied in such legislation is sometimes called the “equal-​ dignity rule”—​meaning that the authority of an agent to enter into a contract on behalf of a principal must be evidenced by a formality equal to that required for the contract itself. The 33.  Mercantile Law Amendment Act 1856, 19 & 20 Vict., c. 97 (Eng.). 34.  110 N.E.2d 551, 553–​54 (N.Y. 1953). 35.  See Restatement Second § 131 cmt. g.

801

The Statute of Frauds

801

equal-​dignity rule is normally applicable only in states where it has been specifically adopted by statute. Ninth. As to contracts for the sale of goods, UCC Section 2-​201(1) changes this whole corner of the law in a fairly substantial way. It will be recalled that under Section 2-​201(1): Except as otherwise provided in this Section a contract for the sale of goods for the price of $500 or more is not enforceable by way of action or defense unless there is some writing sufficient to indicate that a contract for sale has been made between the parties and signed by the party against whom enforcement is sought or by his authorized agent or broker. A writing is not insufficient because it omits or incorrectly states a term agreed upon but the contract is not enforceable under this paragraph beyond the quantity of goods shown in such writing.36

According to the Official Comment to this Section: . . . The required writing need not contain all the material terms of the contract and such material terms as are stated need not be precisely stated. All that is required is that the writing afford a basis for believing that the offered oral evidence rests on a real transaction. It may be written in lead pencil on a scratch pad. It need not indicate which party is the buyer and which the seller. The only term which must appear is the quantity term which need not be accurately stated but recovery is limited to the amount stated. The price, time and place of payment or delivery, the general quality of the goods, or any particular warranties may all be omitted. . . .

There is some division of authority concerning whether a purchase order or a sales order will by itself satisfy UCC Section 2-​201. A naked purchase order or sales order signed by one party is unlikely to meet the test of that Section, because it does not provide evidence that a contract had been concluded.37 However, a purchase order or sales order that has more to it may satisfy Section 2-​201. For example, in Bazak International Corp. v.  Mast Industries, the New  York Court held that Section 2-​201 was satisfied by the purchase orders in that case, partly on the ground that the purchase orders had been sent by the seller from the premises of the buyer’s parent company to the buyer’s subsidiary. That fact, the court concluded, suggested that the purchase orders were not unsolicited, but instead reflected that an agreement had already been reached. Other courts have held that a purchase order suffices if it is signed by both parties, or can be matched with a document sent by the other party, or indicates that a down payment has been made.38 Furthermore, UCC Section 2-​201(2) provides that “Between merchants if within a reasonable time a writing”—​which could include a purchase order or sales order—​“in confirmation of the contract and sufficient against the sender is received and the party receiving it has reason to know its contents, it satisfies the requirements of [Section

36.  U.C.C. § 2-​201(1) (Am. Law Inst. & Unif. Law Comm’n 2002). 37.  Trilco Terminal v. Prebilt Corp., 400 A.2d 1237, 1240–​41 (N.J. Super. Ct. Law Div. 1979), aff ’d, 415 A.2d 356 (N.J. Super. Ct. App. Div. 1980). 38.  535 N.E.2d 633, 638–​39 (N.Y. 1989); see Lonnie Hayes & Sons Staves, Inc. v. Bourbon Cooperage Co., 777 S.W.2d 940, 942–​43 (Ky. Ct. App. 1989); Koenen v. Royal Buick Co., 783 P.2d 822, 826–​27 (Ariz. Ct. App. 1989).

802

802

Requirements of a Writing

2-​201(1)] against the recipient unless written notice of objection to its contents is given in a record within 10 days after it is received.”

V I.   THE E F F E C T O F   PA RT PER F OR M A NCE OF, O R R E L I A N C E UPON, A N  OR A L CO N T R A C T W I T H I N T HE  S TAT UT E A. INTRODUCTION This Section considers the following question: A has entered into an oral contract with B that is unenforceable under the Statute of Frauds. B breaks the contract after A has acted upon it. Should A  be given any recovery? Three situations may be distinguished:  (1) A  seeks restitutionary damages for a benefit that he conferred on B under the oral contract. (2) A seeks reliance damages for losses he incurred in reliance on the oral contract although B received no benefit as the result of A’s reliance. (3) A seeks expectation damages based on the value of the performance promised by B.

B. RESTITUTION It is well settled that normally a plaintiff may recover the value of any benefits he conferred on the defendant under a contract that is unenforceable against the defendant under the Statute of Frauds. A Mural. Under an oral contract with Marion Means, Steven Smock, an artist, agrees to paint a mural in Means’s home in exchange for a conveyance of Passacre. After full performance by Smock, Means refuses to convey Passacre.

Although this transaction is a contract for the sale of land within Section 4(4) of the Statute of Frauds, and therefore unenforceable against Means, Smock can recover the value of the mural. There are two explanations for reconciling this result with the Statute. One explanation is normative; the other is doctrinal. The normative explanation is that to allow a party to retain benefits that she has received under a contract that is unenforceable only because it is not in writing would be too unjust for the law to countenance. The doctrinal explanation is that the Statute of Frauds only bars actions to enforce a contract, and a suit in restitution is based not on contract law but on unjust enrichment and restitution, a separate body of law. Correspondingly, the measure of recovery in a suit in restitution is basically different from the normal measure of recovery in a suit on a contract. In a suit on a contract, the promisee’s recovery is normally measured by the value of the performance promised by the promisor. In A Mural this would be the market value of Passacre. In contrast, in a suit in restitution, the promisee’s recovery is measured by the value of his own performance as received by the promisor. In A Mural this would be the market value of the mural.

803

The Statute of Frauds

803

C. RELIANCE Suppose a plaintiff seeks recovery, under a contract that is unenforceable by virtue of the Statute of Frauds, for losses that he incurred in acting under the contract, which did not result in a benefit to the defendant. The issue here is not as clear-​cut as in the benefit-​conferred case. Normatively, allowing a defendant to retain a benefit conferred upon her under a contract that is unenforceable by virtue of the Statute of Frauds would be more shocking to the sense of justice than a rule that a defendant need not reimburse the plaintiff for losses that did not result in a benefit to the defendant. (This is not to say that a rule of the second kind would be just, but only that the injustice would be less intense in the reliance case than in the restitution case.) Doctrinally, unlike an action to recover the value of a benefit conferred, which is brought under the law of unjust enrichment and restitution, an action to recover reliance damages is brought under contract law. Such an action therefore runs more squarely afoul of the Statute of Frauds where the contract is within the Statute. At least until recently the prevailing view has been that it would be contrary to the Statute of Frauds to allow a recovery for losses through reliance on a contract that is unenforceable under the Statute if those losses did not benefit the defendant. Today that view is gradually changing. Two of the leading cases are Monarco v. Lo Greco and Alaska Airlines v. Stephenson.39 In Monarco v. Lo Greco Christie Lo Greco’s mother and stepfather orally promised Christie that if he would stay on the family farm and help in its management, they would leave him the bulk of their property. Christie did as they asked, and the family farm prospered. However, the farm was left to the stepfather’s grandson. Despite Section 4(4) of the Statute of Frauds (the land section), the court held for Christie on the basis of his reliance. The opinion qualified the judicially crafted reliance exception to the Statute by stating that reliance was a ground for overcoming the Statute only “where either an unconscionable injury or unjust enrichment would result from refusal to enforce the contract.”40 In Alaska Airlines v.  Stephenson Alaska Airlines orally promised to give an airline pilot a two-​year written employment contract as soon as the airline obtained a required certificate to fly between Seattle and Alaska. In reliance on this promise the pilot let his right to return to his previous employer expire. The airline broke its promise. Despite Section 4(5) of the Statute of Frauds (the one-​year provision) the court held for the pilot on the ground that his reliance overcame the Statute.41 Restatement Second Section 139 gives full recognition to the reliance principle in the Statute of Frauds area: Section 139. Enforcement by Virtue of Action in Reliance (1) A  promise which the promisor should reasonably expect to induce action or forbearance on the part of the promisee or a third person and which does induce the action or

39.  Monarco v.  Lo Greco, 220  P.2d 737 (Cal. 1950); Alaska Airlines v.  Stephenson, 217 F.2d 295 (9th Cir. 1954). 40.  Monarco, 220 P.2d at 741. 41.  Alaska Airlines, 217 F.2d at 281. See also, e.g., Alaska Democratic Party v. Rice, 934 P.2d 1313, 1316–​17 (Alaska 1997).

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804

Requirements of a Writing forbearance is enforceable notwithstanding the Statute of Frauds if injustice can be avoided only by enforcement of the promise. The remedy granted for breach is to be limited as justice requires. (2) In determining whether injustice can be avoided only by enforcement of the promise, the following circumstances are significant: (a)  the availability and adequacy of other remedies, particularly cancellation and restitution; (b) the definite and substantial character of the action or forbearance in relation to the remedy sought; (c) the extent to which the action or forbearance corroborates evidence of the making and terms of the promise, or the making and terms are otherwise established by clear and convincing evidence; (d)  the reasonableness of the action or forbearance; (e)  the extent to which the action or forbearance was foreseeable by the promisor. . . . Comment . . . d.  Partial enforcement; particular remedies. The same factors which bear on whether any relief should be granted also bear on the character and extent of the remedy. In particular, the remedy of restitution is not ordinarily affected by the Statute of Frauds . . . ; where restitution is an adequate remedy, other remedies are not made available by the rule stated in this Section. Again, when specific enforcement is available . . . an ordinary action for damages is commonly less satisfactory, and justice then does not require enforcement in such an action. . . . In some cases it may be appropriate to measure relief by the extent of the promisee’s reliance rather than by the terms of the promise. See § 90. . . .

Restatement Second Section 139 has undoubtedly reinforced the trend to judicially adopt a reliance exception to the Statute of Frauds. However, not all courts adopt this exception.42 Furthermore, some courts that adopt the reliance exception continue to qualify the exception in the same manner as did Monarco. A special problem is presented where a party invokes the reliance exception in the case of a contract for the sale of goods. The UCC Statute of Frauds provision, Section 2-​201, includes a number of exceptions. Reliance is not one of these exceptions. Some cases take the position that the exceptions included in Section 2-​201 should be deemed to be exclusive of any others, including reliance, partly to promote uniformity in the application of the Code.43 Other cases take the position that the reliance exception applies to cases that fall under Section 2-​201 because UCC Section 1-​103 provides that “Unless displaced by the particular provisions of this Act, the principles of law and equity, including . . . the law relative to . . . estoppel . . . or other validating or invalidating cause shall supplement its provisions.”44

42.  See, e.g., Stearns v. Emery-​Waterhouse Co., 596 A.2d 72, 74–​75 (Me. 1991). 43.  See, e.g., Renfroe v. Ladd, 701 S.W.2d 148, 149–​50 (Ky. Ct. App. 1985); Lige Dickson Co. v. Union Oil Co., 635 P.2d 103, 106–​07 (Wash. 1981). 44.  See, e.g., Allen M. Campbell Co. v. Virginia Metal Indus., 708 F.2d 930, 932–​34 (4th Cir. 1983); Ralston Purina Co. v. McCollum, 611 S.W.2d 201, 203 (Ark. Ct. App. 1981).

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The Statute of Frauds

805

D.  EXPECTATION DAMAGES From the standpoint of a plaintiff who has acted under a contract that is unenforceable against the defendant under the Statute of Frauds, the state of the law summarized in the last two sections is unsatisfactory in two respects: (1) Despite some straining in that direction the law does not always reimburse the plaintiff ’s losses in acting under the contract. (2) Where the plaintiff has performed his side of the contract it would often be to his advantage if his measure of recovery was the value of the performance promised by the defendant rather than the value of his own performance. If the plaintiff seeks expectation damages to realize the advantage of a profitable bargain, his objective seems to be contrary to the Statute of Frauds. On the other hand, a plaintiff ’s right to restitution is clearly recognized by the cases, and the plaintiff has legitimate grounds for complaint if this right is impaired in practice by the imposition of an uncertain measure of recovery. This objection has particular application where the defendant has promised to pay a flat sum of money for the performance and the benefit conferred on the defendant by the plaintiff ’s performance does not have a definite market value. As an original question, it would seem sensible to avoid the hazards and doubts involved in measuring the value of the plaintiff ’s performance in such cases by taking, as the value of that performance, the amount the defendant promised to pay for it. Against this reasoning stands the plain language of the Statute of Frauds. Nevertheless, over the centuries the courts have read exceptions into certain provisions of the Statute under which the plaintiff can bring suit for expectation damages, even though the contract is otherwise within the Statute, where the contract has been fully or even partly performed on one side. These part-​performance exceptions vary from Section to Section of the Statute. the suretyship section . 

Generally, a part-​performance exception is not read into the suretyship section. For example, if Seller delivers goods to Buyer in reliance on Surety’s oral promise to answer for Buyer’s obligation to pay the price, Surety does not thereby become bound. the marriage section . 

It is generally assumed that an oral contract upon consideration of marriage is not taken out of the Statute of Frauds simply because the marriage has taken place in reliance on the promise. (There are, however, cases enforcing the oral agreement where a serious change of position involving acts in addition to marriage has occurred.) the land section . 

In the case of contracts for the sale of an interest in land (land contracts), a part-​performance exception—​perhaps more accurately, a part-​performance-​and-​reliance exception—​has become institutionalized and has been built into an imposing body of case law. Traditionally, the cases in this area make explicit two different considerations for enforcing certain land contracts that would fall within the Statute of Frauds except for the fact that they have been partly performed: (1) The equity in favor of a party who has acted under the oral contract and who will suffer hardship if the contract is not enforced. (2) The evidentiary value of acts of reliance or part performance in pointing to the existence of a contract. Because these considerations may appear in varying degrees there are strict and liberal applications of the part-​performance exception in the land contract context. Furthermore, some decisions place

806

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Requirements of a Writing

greater weight on the evidentiary significance of part performance whereas others place greater weight on the element of hardship. In considering the part-​performance exception for land contracts it is necessary to distinguish between acts under the contract by the vendor and acts under the contract by the purchaser. A vendor is entitled to recover the purchase price under an oral contract for the sale of land as soon as he has actually conveyed the land to the purchaser.45 Thus the vendor can obtain the price promised by the purchaser—​and with it, the benefit of the vendor’s bargain—​instead of being thrown back upon either an action in restitution for the reasonable value of the land conveyed or a suit in specific restitution to compel a reconveyance of the land. Where it is the purchaser who acts under a contract that is otherwise within the Statute the law is more complicated. A good summary of the traditional rule in this area was set out in Restatement First Section 197. That Section provided that an oral agreement for the sale of an interest in land becomes specifically enforceable if “the purchaser with the assent of the vendor (a) makes valuable improvements on the land, or (b) takes possession thereof or retains a possession thereof existing at the time of the bargain, and also pays a portion or all of the purchase price.” As indicated by Restatement First Section 197, under the traditional rule payment of all or part of the purchase price, without more, does not itself make the contract enforceable, although there are some cases to the contrary. The theory is that such a payment does not identify the land sold. (However, the payment itself can be recovered in a suit for restitution.) Similarly, under the traditional rule the purchaser’s act of taking possession, without more, does not make the contract enforceable by the purchaser. The theory is that although taking possession may have evidentiary value as indicating some kind of agreement and identifying its object, taking possession is just as consistent with a lease as with a purchase and may not necessarily involve a serious change of position by the purchaser. These limitations are by no means universally respected by the courts. In addition to some cases indicating that taking possession is sufficient even without payment of the purchase price many cases hold that the rendition of services by the purchaser over a long period will suffice to take the contract out of the Statute. This holding is typically found in situations involving contracts of the “care-​for-​me-​for-​the-​rest-​of-​my-​life-​and-​you-​can-​have-​the-​farm-​when-​I-​am-​gone” type. Concerning the traditional rule that certain acts by the purchaser under a land contract may make the contract specifically enforceable, the following points should be noted. * This rule was developed by courts of equity, and therefore it is generally assumed only to give the purchaser a right to specific performance, not to give the purchaser a right to recover damages measured by the value of the land.46 In contrast, the vendor’s right to the price after conveying the land is a right to sue at law. * Generally it is the purchaser who, having made improvements or otherwise acted under the contract, brings suit for specific performance against the vendor. However, there are cases holding that acts under the contract by the purchaser that create a right to specific performance in him will also create a right to specific performance in the vendor. Here it is not the hardship to the vendor that makes the oral contract enforceable, but either the evidentiary value of the purchaser’s acts or a notion that if it is fair for the purchaser to enforce the contract, equality of treatment should allow the vendor to sue as well. 45.  See Restatement Second § 125(3). 46.  See Restatement Second § 129, cmt c.

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* In a few jurisdictions the courts have stated that they do not recognize the rule that part performance of an oral contract for the sale of an interest in land will make the contract specifically enforceable. * There is a general tendency to very liberally enforce an oral contract that settles a disputed boundary. Where parties are in dispute or doubt about the boundary between their lands, and orally agree to settle the issue by running a fence or other marker along a designated line, generally the agreement becomes enforceable as soon as any action is taken under it.47 Restatement Second Section 129 completely reconceptualizes and reformulates the part-​ performance exception for land contracts by making the exception center on reliance. That Section provides: A contract for the transfer of an interest in land may be specifically enforced notwithstanding failure to comply with the Statute of Frauds if it is established that the party seeking enforcement, in reasonable reliance on the contract and on the continuing assent of the party against whom enforcement is sought, has so changed his position that injustice can be avoided only by specific enforcement.

Whether the law in this area will shift to the rule stated in Restatement Second Section 129 remains to be seen. The One-​Year Provision. Under Restatement Second Section 130 and many cases, as soon as one side of a contract has been fully performed, the promise of the other party becomes binding even if that promise cannot be performed within one year. Putting this rule together with the basic rule for interpreting the one-​year provision, it may be said that an oral contract is either not within or is taken out of the one-​year provision if the whole contract could have been performed within one year although neither party has as yet fully performed, or if one party has already fully performed, no matter how long it took for that performance to take place.48 Other cases, however, are less favorable to removing an oral contract from the one-​year provision as a result of part performance. According to some cases, if the defendant’s performance will require more than a year the fact that the plaintiff has fully performed is immaterial and the plaintiff ’s only relief is in restitution. Still other cases say that full performance on one side will take the contract out of the Statute only if that performance itself takes place within the first year.

V I I .   O R A L R ES CI S S I ON The problem of the validity of an oral rescission arises chiefly in connection with the following situation: Under the Statute of Frauds the original contract had to be and was in a writing or other record. Subsequently, however, the contract was orally rescinded by mutual agreement. As a general proposition, rescission in such cases is effective, even if not in writing, on the theory that the rescission does not call for the performance of any duties, and therefore does not fall 47.  See Restatement Second § 128(1). 48.  See Restatement Second § 130.

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within any of the classes covered by the Statute.49 However, there are two qualifications on this general proposition: 1. Sale of land. Where the rescinded contract was for the sale of land and was fully executed, the rescission itself effectively calls for a conveyance—​albeit a reconveyance—​ and therefore falls within the Statute. Suppose the original contract was executory at the time the contract of rescission was entered into? Even here there are cases saying that the rescission is ineffective unless it is in a writing or other record. The theory of these cases is that a contract to sell land creates a present property interest in the purchaser, so that the rescission of such a contract also involves the reconveyance of an interest in land. However, according to Restatement Second Section 148, comment c, “[t]‌he prevailing rule”—​which is adopted by Restatement Second—​“is that an executory land contract may be rescinded orally like other contracts within the Statute. . . .” 2. Sale of goods. Where the original contract was for the sale of goods and ownership had already passed to the buyer, a “rescission” is really a resale of the goods, and comes within UCC Section 2-​201 if the amount involved is $500 or more.50

V I I I .   O R A L MO DI F I CAT I ONS Generally speaking, a modification of a contract falls within the Statute of Frauds if but only if the new agreement that results from putting together the original agreement and the modification is within the Statute. However, the situation regarding modifications of contracts for the sale of goods is more complex. UCC Section 2-​209(3) provides that: The requirements of Section 2-​201 must be satisfied if [a contract for the sale of goods] as modified is within its provisions.

Comment 3 adds: . . . . The Statute of Frauds provisions of this Article are expressly applied to modifications by Subsection (3). Under those provisions the “delivery and acceptance” test is limited to the goods which have been accepted, that is, to the past. “Modification” for the future cannot therefore be conjured up by oral testimony if the price involved is $500.00 or more since such modification must be shown at least by an authenticated memo. And since a memo is limited in its effect to the quantity of goods set forth in it there is safeguard against oral evidence.

The Comment strongly suggests that any modification of a contract for the sale of goods must be in writing. This position was taken in Zemco Manufacturing. Inc. v. Navistar International Transportation Corp.,51 decided by the Seventh Circuit under Indiana law. In 1983 the parties 49.  See Restatement Second § 148 and cmt. a. 50.  See Restatement Second § 148, cmt. b and illus. 2. 51.  186 F.3d 815 (7th Cir. 1999).

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entered into a written contract for the sale of parts. Originally, the contract was to last one year, but it was extended until 1987 by written agreements. After 1987, the parties orally agreed to extend the contract. Navistar argued that the oral contract extensions were unenforceable under the Statute of Frauds even though Section 2-​201 (the UCC Statute of Frauds) is triggered only by the price, not by the duration, of the contract. The Seventh Circuit agreed: We begin our analysis of this question with [UCC § 2-​209(3)], which generally applies to contract modifications. It states that “[t]‌he requirements of the statute of frauds . . . must be satisfied if the contract as modified is within its provisions.” . . . The interpretation of this provision . . . has generated controversy among courts and commentators. One view is that all contract modifications must be in writing; another view is that only modifications of terms that are required to be in writing under UCC § 2-​201 must be in writing. Under the second view, the time extension would not need to be in writing because the length of a contract is not a type of term that needs to be in writing. Indiana courts have not interpreted the meaning of [UCC § 2-​209(3)]. A substantial number of the courts in other jurisdictions that have considered identical UCC provisions have held that every contract modification must be in writing. . . . Although these courts have provided little analysis, they essentially interpret § 2-​209(3) to mean that, if the post-​modification contract fits within the terms of § 2-​201 (i.e., it is a sale of goods for more than $500), then any modification of it must be in writing. . . . At least one court has held that the writing requirement for modifications applies only to either a change in consideration, or a change in a term that the UCC statute of frauds requires to be in writing. See Costco Wholesale Corp. v. World Wide Licensing Corp., 78 Wash. App. 637, 898 P.2d 347, 351 & n.5 (1995). This view also appears to be favored among commentators. The general theory behind this approach is that it would be anomalous, if not inconsistent, to require that a modification be in writing if the same term in the original contract could be proven by parol evidence. Moreover, proponents of this view argue, § 2-​209(3) explicitly invokes only the writing requirements contained in § 2-​201—​nothing less and nothing more. . . . We need not decide in the abstract the correct interpretation of § 2-​209(3). Because the jurisdiction of the district court was based on the diversity of citizenship of the parties, it was obligated to apply the law of Indiana. . . . Although the Indiana courts have not spoken directly on the matter, we believe . . . that Indiana would follow the majority of jurisdictions and hold that the extension of the contract needed to be in writing. . . . [because there] is no suggestion in this record that Indiana would not follow the majority rule or that its courts would not consider important the goal of uniformity in the interpretation of the Commercial Code . . . and the influential [Official Comment] suggests strongly that Indiana would require compliance with the statute of frauds in this case.52

In contrast, White and Summers comment that: Assuming that a party can establish a modifying agreement, must one show that it was reduced to writing? Section 2-​209(3) states that “[t]‌he requirements of the statute of frauds section of this Article (2-​201) must be satisfied if the contract as modified is within its provisions.” The impact of this provision is not clear. We see at least the following possible interpretations: (1) that if the 52.  Id. at 819–​20.

810

810

Requirements of a Writing original contract was within 2-​201, any modification thereof must also be in writing; (2) that a modification must be in writing if the term it adds brings the entire deal within 2-​201 for the first time, as where the price is modified from $400 to $500; (3) that a modification must be in writing if it falls in 2-​201 on its own; (4) that the modification must be in writing if it changes the quantity term of an original agreement that fell within 2-​201; and (5) some combination of the foregoing. Given the purposes of the basic statute of frauds section 2-​201, we believe interpretations (2), (3), and (4) are each justified, subject, of course, to the exceptions in 2-​201 itself and to any general supplemental principles of estoppel.53

I X .   I N T E R A C T I ON OF T HE STAT U T E O F F R A UDS WI T H T HE PAR O L E V I D E N C E R UL E A ND T HE R E M E D Y O F R E FOR M AT I ON The interaction of the Statute of Frauds with the parol evidence rule and with the remedy of reformation is a subject richly productive of confusion. The following points should be noted: First. The parol evidence rule does not invalidate a later oral modification of a written agreement, but the Statute of Frauds may. Second. The Statute of Frauds requires a writing or other record, and where applicable prevents the use of an oral agreement as the basis for suit. The parol evidence rule may exclude written as well as oral agreements. Third. Unless the Statute of Frauds requires “the contract” to be in writing, it may often be satisfied by piecing together a series of informal letters. Such a series of letters would not ordinarily be construed as an integration of the contract, and therefore would also not prevent the introduction of parol evidence. Fourth. In litigation involving a contract embodied in a writing or other record one party may object that the contract is incomplete. The other party may then offer parol evidence to fill the gap. The proffer of such evidence can raise two questions: (1) Is the testimony offered admissible under the parol evidence rule? (2) Is the gap so serious that the writing fails to satisfy the Statute of Frauds? These are different questions, the answers to which depend on distinct considerations. Take the following hypothetical: Omitted Description. Seller and Buyer sign a written contract covering the sale of certain land for $10,000. The contract is complete in every respect except that it does not identify or describe the land, but merely says, “This contract covers the land that we have this day orally agreed shall be conveyed.” Buyer refuses to buy the land, and Seller sues Buyer for breach of contract. Buyer pleads the Statute of Frauds. Seller relies on the written contract as satisfying the Statute, while Buyer contends that the writing is insufficient because it does not describe the land sold.

53. James J. White & Robert S. Summers, Uniform Commercial Code 78 (6th ed. 2010).

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The Statute of Frauds

811

Seller answers by saying, “The parol evidence rule does not prevent introducing oral evidence showing what the land is. Therefore, I can supplement the written contract by parol evidence identifying the land intended to be conveyed. Hence the writing satisfies the Statute.”

Seller is right about the parol evidence rule, but wrong about the Statute of Frauds. Fifth. How does the remedy of reformation fit with these rules? In considering this question it would be well to start with a case where the Statute of Frauds is plainly not involved. C contracts to build a house for O in nine months for a price of $100,000. A  written contract is drawn up and signed, which contains all the requisite terms except that as a result of a typist’s error the price is stated as $10,000 instead of the agreed figure of $100,000. Here, on clear and convincing proof that both parties understood the price to be $100,000, the court would order reformation. Would it make any difference if the contract had been one that was required by the Statute to be in writing? There is something disturbing about the idea of a court’s rewriting a contract to make it conform to an oral agreement of a type that the Statute of Frauds declares to be legally unenforceable. However, the basic purpose of the Statute of Frauds is to obtain the security of a writing or other record for certain transactions. In the hypothetical case the parties sought that security for themselves in a written contract signed by both of them. A court would not hesitate to rewrite that contract to make it conform to an intention plainly shared by both parties. It should not make any difference if the contract was such that if it had been wholly oral it would have been unenforceable. If the Statute is thought, as it often is, to be grounded in large measure on a distrust of juries, no jury is involved in the remedy of reformation, which in any event is granted only on the basis of clear and convincing evidence. Today it is generally accepted that the circumstance that a contract falls within the Statute of Frauds does not of itself bar the possibility of reformation. There are, however, substantial traces of discomfort in some cases concerning reformation of contracts that fall within the Statute. For example, reformation of a wholly executory agreement may be refused. Reformation may also be denied where it concerns the central term of a contract that falls within the Statute of Frauds—​for example, where a written contract for the sale of land inadvertently omits any hint of what land is to be conveyed.

X .   P L E A D I N G A ND PR OCEDUR A L P R O B L E M S I N  CONNECT I ON W I T H   T H E S TAT UT E In most jurisdictions a defendant’s failure to plead the Statute of Frauds will be treated as waiving that defense. Furthermore, in many or most jurisdictions a defendant who wants to invoke the Statute must raise the Statute as a specially pleaded affirmative defense, and cannot simply rely on pleading a general denial of the complaint. A companion rule in most jurisdictions is that the Statute of Frauds cannot be raised for the first time on appeal.

812

813

fifty-s ​ even

No-​Oral-​Modification Clauses Often a writ ten c ontract in clu des a provi si on that the

contract cannot be modified except by a writing—​a sort of private Statute of Frauds. Such provisions are sometimes referred to as n.o.m. (no oral modification) provisions. The general rule at common law was that an oral modification of a written contract that includes an n.o.m. provision was enforceable notwithstanding the provision. The theory was that: (1) Parties can, by later contracts, change their earlier contracts. (2) An oral modification is a later contract. (3) An implied provision of the later contract is to abrogate the n.o.m. provision of the earlier contract. As to contracts for the sale of goods, UCC Section 2-​209 makes two critical changes in the common law rules concerning modifications. From the perspective of enforceability, these two changes go in opposite directions. In one direction, Section 2-​209(1) provides that a modification needs no consideration to be enforceable, so that the legal-​duty rule does not apply. In the other direction, Section 2-​209(2) provides that if a contract for the sale of goods includes an n.o.m. clause then modifications of the contract must be in writing. The force of Section 2-​209(2) is moderated by Section 2-​209(4), which provides that “Although an attempt at modification does not satisfy [Section 2-​209(2)] it can operate as a waiver.” The inference is that when a modification “operate[s]‌as a waiver” it will be legally effective. However, Section 2-​209(4) is limited by Section 2-​209(5), which provides that “[a] party who has made a waiver affecting an executory [unperformed] portion of the contract may retract the waiver by reasonable notification received by the other party that strict performance will be required of any term waived, unless the retraction would be unjust in view of a material change of position in reliance on the waiver.” There is emergent in this area another doctrine of part performance, under which an oral modification of a contract for the sale of goods becomes effective if action has been taken under it.1 As just noted, UCC Section 2-​209(4) provides that an attempt at modification that does not satisfy Section 2-​209(3) can operate as a waiver, and Section 2-​209(5) provides that such a waiver cannot be retracted if retraction would be unjust in view of a material change of position in reliance on the waiver. There is some division of opinion whether a waiver is effective if not

1.  See Restatement (Second) of Contracts § 150 (Am. Law Inst. 1982).

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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accompanied by reliance, but the better view is that reliance is not required to make a waiver effective under the UCC. In BMC Industries, Inc. v. Barth Industries, Inc.,2 the court said: As an initial matter, we must determine whether, under the UCC, waiver must be accompanied by detrimental reliance. . . . [C]‌ourts disagree on whether the UCC retains this requirement. We conclude, however, that the UCC does not require consideration or detrimental reliance for waiver of a contract term. Our conclusion follows from the plain language of subsections [2-​209(4) and (5)]. While subsection (4) states that an attempted modification that fails may still constitute a waiver, subsection (5)  provides that the waiver may be retracted unless the non-​waiving party relies on the waiver. Consequently, the statute recognizes that waivers may exist in the absence of detrimental reliance—​these are the retractable waivers referred to in subsection (5). Only this interpretation renders meaning to subsection (5), because reading subsection (4)  to require detrimental reliance for all waivers means that waivers would never be retractable. See Wisconsin Knife Works v. National Metal Crafters, 781 F.2d 1280, 1291 (7th Cir.1986) (Easterbrook, J., dissenting) (noting that reading a detrimental reliance requirement into the UCC would eliminate the distinction between subsections (4) and (5)). Subsection (5) would therefore be meaningless. . . . . Although [some] courts have held that waiver requires reliance under the UCC, those courts have ignored the UCC’s plain language. The leading case espousing this view of waiver is Wisconsin Knife Works v. National Metal Crafters, 781 F.2d 1280 (7th Cir.1986) . . . in which a panel of the Seventh Circuit addressed a contract that included a term prohibiting oral modifications, and considered whether an attempted oral modification could instead constitute a waiver. Writing for the majority, Judge Posner concluded that the UCC’s subsection (2), which gives effect to “no oral modification” provisions, would become superfluous if contract terms could be waived without detrimental reliance. Judge Posner reasoned that if attempted oral modifications that were unenforceable because of subsection (2) were nevertheless enforced as waivers under subsection (4), then subsection (2) is “very nearly a dead letter.” Id. at 1286. According to Judge Posner, there must be some difference between modification and waiver in order for both subsections (2) and (4) to have meaning. This difference is waiver’s detrimental reliance requirement.

Judge Posner, however, ignores a fundamental difference between modifications and waivers: while a party that has agreed to a contract modification cannot cancel the modification without giving consideration for the cancellation, a party may unilaterally retract its waiver of a contract term provided it gives reasonable notice. The fact that waivers may unilaterally be retracted provides the difference between subsections (2) and (4) that allows both to have meaning. We therefore conclude that waiver under the UCC does not require detrimental reliance.3

2.  160 F.3d. 1322 (11th Cir.1998). 3.  Id. at 1333–​34.

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Table of Cases

A Abex Corp. v.  Controlled Sys., Inc., Nos. 92–​1368, 92–​1423, 92–​1550, 1993 WL 4836 (4th Cir. 1993) . . . 339n14 Abney v. Baptist Med. Ctrs., 597 So. 2d 682 (Ala. 1992) . . . 433n20 Academy Chi. Publishers v. Cheever, 578 N.E.2d 981 (Ill. 1991) . . . 498–​499, 501 Aceros Prefabricados, S.A. v. TradeArbed, Inc., 282 F.3d 92 (2d Cir. 2002) . . . 444 Action Eng’g v. Martin Marietta Aluminum, 670 F.2d 456 (3d Cir. 1982) . . . 726n28 Acton v. Fullmer, 323 B.R. 287 (Bank. Ct. D. Nev. 2005) . . . 43n37 Adams v. Lindsell, (1818) 106 Eng. Rep. 250; 1 B. & Ald. 681 . . . 450 Adras v. Harlow & Jones Gmbh, [1988] 42(1) PD 221 (Isr.) . . . 352n49 Advanced, Inc. v. Wilks, 711 P.2d 524 (Alaska 1985) . . . 212 Aetna Cas. & Sur. Co. v. Murphy, 538 A.2d 219 (Conn. 1988) . . . 720 Akers v. J. B. Sedberry, Inc., 286 S.W.2d 617 (Tenn. Ct. App. 1955) . . . 459n6 ALA, Inc. v. CCAIR, Inc., 29 F.3d 855 (3d Cir. 1994) . . . 793 Alaska Airlines v. Stephenson, 217 F.2d 295 (9th Cir. 1954) . . . 803 Alaska Democratic Party v. Rice, 934 P.2d 1313 (Alaska 1997) . . . 803n41 Alaska N. Dev., Inc. v. Alyeska Pipeline Serv. Co., 666 P.2d 33 (Alaska 1983) . . . 542 Albre Marble & Tile v. John Bowen Co., 155 N.E.2d 437 (Mass. 1959) . . . 640 Alden v. Presley, 637 S.W.2d 862 (Tenn. 1982) . . . 128n99 Alexander H. Revell & Co. v. C.H. Morgan Grocery Co., 214 Ill. App. 526 (App. Ct. 1919) . . . 775n138 Algernon Blair, Inc.; United States v., 479 F.2d 638 (4th Cir. 1973) . . . 326 Allegheny Coll. v. National Chautauqua Cty. Bank, 246 N.Y. 369, 159 N.E. 173 (1927) . . . 116n52 Allegheny Energy, Inc. v. DQE, Inc., 171 F.3d 153 (3d Cir. 1999) . . . 305 Allen M. Campbell Co. v. Virginia Metal Indus., 708 F.2d 930 (4th Cir. 1983) . . . 804n44 Allied Canners & Packers, Inc. v. Victor Packing Co., 209 Cal. Rptr. 60 (Ct. App. 1984) . . . 198, 199 Aluminum Co. of Am. (ALCOA) v. Essex Group, 499 F. Supp. 53 (W.D. Pa. 1980) . . . 649 Alvord v. Banfield, 166 P. 549 (Or. 1917) . . . 286n9 American Fin. Corp. v. Computer Sci. Corp., 558 F. Supp. 1182 (D. Del. 1983) . . . 753n62 American Oil Co. v. Estate of Wigley, 169 So. 2d 454 (Miss. 1964) . . . 476n59 Ammons v. Wilson & Co., 170 So. 227 (Miss. 1936) . . . 138n20 AM PAT/​Midwest, Inc. v. Illinois Tool Works, Inc., 896 F.2d 1035 (7th Cir. 1990) . . . 147 Anchorage Yacht Haven, Inc. v. Robertson, 264 So. 2d 57 (Fla. 4th DCA 1972) . . . 338n9

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Table of Cases

Angel v. Murray, 322 A.2d 630 (R.I. 1974) . . . 39n21, 43n32, 43n37 Anglia Television Ltd. v. Reed, [1972] 1 QB 60 (C.A.) (Eng.) . . . 231 Arcadian Phosphates, Inc. v. Arcadian Corp., 884 F.2d 69 (2d Cir. 1989) . . . 516n66 Arnold v. Lyman, 17 Mass. (17 Tyng) 400 (1821) . . . 743n15, 744n27 Arnold Palmer Gold Co. v. Fuqua Indus., Inc., 541 F.2d 584 (6th Cir. 1976) . . . 513n54 Arok Constr. Co. v. Indian Constr. Servs., 848 P.2d 870 (Ariz. Ct. App. 1993) . . . 500–​501 Arrowsmith v. Mercantile-​Safe Deposit & Tr. Co., 545 A.2d 674 (Md. 1988) . . . 117n53 Ashland Mgmt. Inc. v. Janien, 624 N.E.2d 1007 (N.Y. 1993) . . . 232 Asmus v. Pacific Bell, 999 P.2d 71 (Cal. 2000) . . . 435 Automated Donut Sys. v. Consolidated Rail Corp., 424 N.E.2d 265 (Mass. App. Ct. 1981) . . . 155n22 Automatic Laundry Serv., Inc. v. Demas, 141 A.2d 497 (Md. 1958) . . . 349n41 Avery v. Fredericksen & Westbrook, 154 P.2d 41 (Cal. Ct. App. 1944) . . . 208n17 Axford v. Price, 61 S.E.2d 637 (W. Va. 1993) . . . 339n14 B Balaban-​Gordon Co. v. Brighton Sewer Dist. No. 2, 342 N.Y.S.2d 435 (1973) . . . 559n6 Baltimore & Ohio R.R. Co. v. Boyd, 10 Atl. 315 (1887) . . . 338n9 Baltimore Humane Impartial Soc’y v. Pierce, 60 A. 277 (Md. 1905) . . . 69n2 Bank of Am. Canada v. Mutual Trust Co., [2002] 2 S.C.R. 601 (Can.) . . . 352n49 Barbarossa & Sons, Inc. v. Iten Chevrolet, Inc., 265 N.W.2d 655 (Minn. 1978) . . . 634 Barclay’s Bus. Credit, Inc. v. Inter Urban Broad. of Cincinnati, Inc., No. 90 Civ. 2272, 1991 WL 258751 (S.D.N.Y. Nov. 27, 1991) . . . 631n15 Bar-​Del, Inc. v. Oz, Inc., 850 S.W.2d 855 (Ky. Ct. App. 1993) . . . 586, 645n63 Barker v. Bucklin, 2 Denio 45 (N.Y. Sup. Ct. 1846) . . . 743n13 Barry v. Davies, [2000] 1 WLR 1962 (C.A.) (Eng.) . . . 465n25 Barwil ASCA v. M/​V SAVA, 44 F. Supp. 2d 484 (E.D.N.Y. 1999) . . . 256n4 Bastian v. Gafford, 563 P.2d 48 (Idaho 1977) . . . 494 Bazak Int’l Corp. v. Mast Indus., 535 N.E.2d 633 (N.Y. 1989) . . . 801 Beall v. Beall, 434 A.2d 1015 (Md. 1981) . . . 476n59 Beardsley; People v., 113 N.W. 1128 (Mich. 1907) . . . 134, 135 Beefy Trail, Inc. v. Beefy King Int’l, Inc., 267 So. 2d 853 (Fla. Dist. Ct. App. 1972) . . . 230, 324n12 Bell v. Lever Bros., Ltd., [1932] AC 161 (Eng.) . . . 583n11 Bellak v. United Home Life Ins. Co., 211 F.2d 280 (6th Cir. 1954) . . . 139n21 Berg v. Hudesman, 801 P.2d 222 (Wash. 1990) . . . 377 Berke Moore Co. v Phoenix Bridge Co., 98 A.2d 150 (N.H. 1953) . . . 401 Bethlahmy v. Bechtel, 415 P.2d 698 (Idaho 1966) . . . 615n71 Bethlehem Steel Co.; United States v., 205 U.S. 105 (1907) . . . 288n20 Biddel v. Brizzolara, 30 P. 609 (Cal. 1883) . . . 775n139 Biggins v. Shore, 565 A.2d 737 (Pa. 1989) . . . 777n144 Bishop v. Eaton, 37 N.E. 665 (Mass. 1894) . . . 140n24, 439n38 Black & White Cabs of St. Louis, Inc. v. Smith, 370 S.W.2d 669 (Mo. Ct. App. 1963) . . . 754n64 Black Gold Coal Corp. v. Shawville Coal Co., 730 F.2d 941 (3d Cir. 1984) . . . 256n2 The Blackwall, 77 U.S. (10 Wall.) 1 (1869) . . . 76n20 Blake v.  Attorney Gen., [1998] Ch 439 (Eng.), on appeal, [2001] 1 AC 268 (HL) . . . 350, 351–​352,  354n53 BMC Indus., Inc. v. Barth Indus., Inc., 160 F.3d. 1322 (11th Cir. 1998) . . . 814 Board of Control v. Burgess, 206 N.W.2d 256 (Mich. 1973) . . . 112n44 Bohanan v. Pope, 42 Me. 93 (1856) . . . 743n15, 745n27 Bomberger v. McKelvey, 220 P.2d 729 (Cal. 1950) . . . 309n34 Boston Plate & Window Glass Co. v. John Bowen Co., 141 N.E.2d 715 (Mass. 1957) . . . 640 Bourdieu v. Seaboard Standard Oil Corp., 119 P.2d 973 (Cal. 1941) . . . 338n9

817

Table of Cases

817

Bourne v. Mason, 86 Eng. Rep. 5; 1 Ventris 5 (1723) . . . 742n10 Braunstein; United States v., 75 F. Supp. 137 (S.D.N.Y. 1947) . . . 569n26 Brawn v. Lyford, 69 A. 544 (Me. 1907) . . . 118n58 Brewer v. Custom Builders Corp., 356 N.E.2d 565 (Ill. App. 1976) . . . 213n36 Brewer v. Dyer, 61 Mass. (7 Cush.) 337 (1851) . . . 743n15, 744n27 Bridgman v. Curry, 398 N.W.2d 167 (Iowa 1986) . . . 777n144, 778n149 Brinkibon Ltd. v. Stahag Stahl und Stahiwarenhandels GmbH, [1983] AC 34 (H.L.) . . . 456n75 British Columbia & Vancouver’s Island Spar, Lumber & Saw-​Mill Co. v. Nettleship, [1868] 3 LR-​CP.499 (Eng.) . . . 241n11 British Trade Ass’n v. Gilbert, [1951] 2 All ER 641 (Ch.) (Eng.) . . . 353 Britton v. Turner, 6 N.H. 481 (1834) . . . 328 Broadway Maint. Corp. v. Rutgers, 447 A.2d 906 (N.J. 1982) . . . 767n111 Brooks v. White, 43 Mass. (2 Met.) 283 (1841) . . . 43n31 Brown v. Kern, 57 P. 798 (Wash. 1899) . . . 43n31 Brown v. KMR Servs. Ltd. [1995] 4 All ER 598 . . . 247n28 Buchanan v. Tilden, 52 N.E. 724 (N.Y. 1899) . . . 748 Buchman Plumbing Co. v. Regents of the Univ. of Minn., 215 N.W.2d 479 (Minn. 1974) . . . 752n57, 767n110 Bucquet v. Livingston, 129 Cal. Rptr. 514 (Ct. App. 1976) . . . 763n89 Budget Mktg., Inc. v. Centronics Corp., 927 F.2d 421 (8th Cir. 1991) . . . 517 Buono Sales, Inc. v. Chrysler Motors Corp., 449 F.2d 715 (3d Cir. 1971) . . . 255n2 Burger King Corp. v. Madison, 710 F.2d 1480 (11th Cir. 1983) . . . 339 Burton v. Coombs, 557 P.2d 148 (Utah 1976) . . . 477n62 Bush v. Bush, 177 So. 2d 568 (Ala. 1965) . . . 128n99 Bush v. Canfield, 2 Conn. 485 (1818) . . . 324–​325 Butterfield v. Hartshorn, 7 N.H. 345 (1834) . . . 743n15 Buxbaum v. G.H.P. Cigar Co., 206 N.W. 59 (Wis. 1925) . . . 349n41, 350n42 B.V. Bureau Wijsmuller v. United States, 487 F. Supp. 156 (S.D.N.Y. 1979) . . . 76n21, 78n24 C Caldwell v. Cline, 156 S.E. 55 (W. Va. 1930) . . . 454n73 Caldwell v. E.F. Spears & Sons, 216 S.W. 83 (Ky. 1919) . . . 459n8 California Gasoline Retailers v. Regal Petroleum Corp., 330 P.2d 778 (Cal. 1958) . . . 486n5 Camden Trust Co. v.  Haldeman, 33 A.2d 611 (N.J. Ch. 1943), aff ’d, 40 A.2d 601 (N.J. E.&A. 1945) . . . 776n143 Campbell Soup Co. v. Wentz, 172 F.2d 80 (3d Cir. 1948) . . . 69n2, 94n67 Carr v. Mahaska Cnty. Bankers Ass’n, 269 N.W. 494 (Iowa 1936) . . . 473n49 Carson Pirie Scott & Co. v. Parrett, 178 N.E. 498 (Ill. 1931) . . . 754n66 Central Bank v. Hume, 128 U.S. 195 (1888) . . . 776n140 Central Me. Gen. Hosp. v. Carter, 132 A. 417 (Me. 1926) . . . 116n52 Certified Question, In re, 443 N.W.2d 112 (Mich. 1989) . . . 433n19 Cetkovic v. Boch, Inc., 2003 Mass. App. Div. 1 (Mass. Dist. Ct. App. Div.) . . . 223, 225n14 Chaffin v. Ramsey, 555 P.2d 459 (Or. 1976) . . . 283n2 Chambers v. Ogle, 174 S.W. 532 (Ark. 1915) . . . 422n19 Champagne Chrysler-​Plymouth, Inc. v. Giles, 388 So. 2d 1343 (Fla. Dist. Ct. App. 1980) . . . 437n35, 486n4 Chang v. First Colonial Sav. Bank, 410 S.E.2d 928 (Va. 1991) . . . 423n25 Channel Home Ctrs. v. Grossman, 795 F.2d 291 (3d Cir. 1986) . . . 505–​507 Chaplin v. Hicks, [1911] 2 KB 786 (Eng.) . . . 489–​491 Chazy Hardware, Inc.; People v., 675 N.Y.S. 2d 770 (N.Y. Sup. Ct. 1998) . . . 79n27 Chenard v. Marcel Motors, 387 A.2d 596 (Me. 1978) . . . 486n4 Cheshire Oil Co. v. Springfield Realty Corp., 385 A.2d 835 (N.H. 1978) . . . 74n14

81

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Table of Cases

Chestnut Hill Dev. Corp. v. Otis Elevator Co., 653 F. Supp. 927 (D. Mass. 1987) . . . 768n117, 770n128 Chicago, Milwaukee, & St. Paul Ry. Co. v. Clark, 178 U.S. 353 (1900) . . . 43n31 Chiriboga v. International Bank for Reconstr. & Dev., 616 F. Supp. 963 (D.D.C. 1985) . . . 775n138 Christianson v. Chicago, St. P., M. & O. Ry., 69 N.W. 640 (Minn. 1896) . . . 244n21 Cincinnati Siemens-​Lungren Gas Illuminating Co. v.  Western Siemen-​Lungren Co., 152 U.S. 200 (1894) . . . 349n41 Cities Serv. Oil Co. v. National Shawmut Bank, 172 N.E.2d 104 (Mass. 1961) . . . 452n64 City of. See name of city City Stores Co. v.  Ammerman, 266 F.  Supp.  766 (D.D.C. 1967), aff ’d mem., 394 F.2d 950 (D.C. Cir. 1968) . . . 314n55 Clark v. State, 80 So. 2d 308 (Ala. Ct. App. 1954) . . . 486n5 Clayton v. Clark, 21 So. 565 (Miss. 1897) . . . 43n33 COAC, Inc. v. Kennedy Eng’rs, 136 Cal. Rptr. 890 (Ct. App. 1977) . . . 768n114 Coady v. Cross Country Bank, Inc., 729 N.W.2d 732 (Wis. App. 2007) . . . 92n61 Cobaugh v. Klick-​Lewis Inc., 561 A.2d 1248 (Pa. Super. Ct. 1989) . . . 437, 486 Cochran v. Taylor, 7 N.E.2d 89 (N.Y. 1937) . . . 110n40 Cohen v. Sabin, 307 A.2d 845 (Pa. 1973) . . . 43n32 Coker Int’l v. Burlington Indus., 747 F. Supp. 1168 (D.S.C. 1990), aff ’d, No. 90-​2494, 1991 WL 97487 (4th Cir. June 11, 1991) . . . 636n32 Colby v. Street, 178 N.W. 599 (Minn. 1920) . . . 347n32 Cole v. Arizona Edison Co., 86 P.2d 946 (Ariz. 1939) . . . 771n131 Cole-​Mcintyre-​Norfleet Co. v. Holloway, 214 S.W. 817 (Tenn. 1919) . . . 138n20 Collatz v. Fox Wis. Amusement Corp., 300 N.W. 162 (Wis. 1941) . . . 491n20 Colonial at Lynnfield, Inc. v. Sloan, 870 F.2d 761 (1st Cir. 1989) . . . 288n22 Columbia Hyundai, Inc. v. Carll Hyundai, Inc., 484 S.E.2d 468 (S.C. 1997) . . . 442n44 Colvin v. Baskett, 407 S.W.2d 19 (Tex. Civ. App. 1966) . . . 573 Congregation B’Nai Sholom v. Martin, 173 N.W.2d 504 (Mich. 1969) . . . 116n50, 116n52 Congregation Kadimah Toras-​Moshe v. DeLeo, 540 N.E.2d 691 (Mass. 1989) . . . 116n51 Conklin v. Hurley, 428 So. 2d 654 (Fla. 1983) . . . 615n68 Contemporary Mission, Inc. v. Famous Music Corp., 557 F.2d 918 (2d Cir. 1977) . . . 236 Coppola Enters. v. Alfone, 531 So. 2d 334 (Fla. 1988) . . . 339n13, 347–​348 Cosden Oil v. Karl O. Helm Aktiengesellschaft, 736 F.2d 1064 (5th Cir. 1984) . . . 681 Costco Wholesale Corp. v. World Wide Licensing Corp., 78 Wash. App. 637, 898 P.2d 347 (1995) . . . 809 Couch’s Estate, In re, 103 N.W.2d 274 (1960) . . . 116n52 County of. See name of county Coyer v. Watt, 720 F.2d 626 (10th Cir. 1983) . . . 43n37 C.R. Klewin, Inc. v. Flagship Props., Inc., 600 A.2d 772 (Conn. 1991) . . . 795n22, 796n26 Crabtree v. Elizabeth Arden Sales Corp., 110 N.E.2d 551 (N.Y. 1953) . . . 800 Craft v. Elder & Johnston Co., 38 N.E.2d 416 (Ohio Ct. App. 1941) . . . 422n22 Cretex Cos. v. Construction Leaders, Inc., 342 N.W.2d 135 (Minn. 1984) . . . 753n60, 764n95, 766n108 Crocker v. Higgins, 7 Conn. 342 (1829) . . . 743n15 Cross v. People, 32 P. 821 (Colo. 1893) . . . 486n5 Crow v. Rogers, (K.B. 1723) 93 Eng. Rep. 719; 1 Strange 592 . . . 742n10 CSU Holdings v. Xerox Corp., 162 F.R.D. 355 (D. Kan. 1995) . . . 275 Culton v. Gilchris, 61 N.W. 384 (Iowa 1894) . . . 480 Cumbest v. Harris, 363 So. 2d 294 (Miss. 1978) . . . 309n34 Curley v. Allstate Ins. Co. 289 F. Supp. 2d 614 (E.D. Pa. 2003) . . . 339n15 Czarnikow-​Rionda Co. v. Federal Sugar Ref. Co., 173 N.E. 913 (N.Y. 1930) . . . 242n14

819

Table of Cases

819

D Dadourian Exp. Co. v. United States, 291 F.2d 178 (2d Cir. 1961) . . . 403n18 Daitom, Inc. v. Pennwalt Corp. 741 F.2d 1569 (10th Cir. 1984) . . . 445n51 Danann Realty Corp. v. Harris, 157 N.E.2d 597 (1959) . . . 545 Danby v. Osteopathic Hosp. Ass’n, 104 A.2d 903 (Del. 1954) . . . 116n51, 116n52 Daniel-​Morris Co. v. Glen Falls Indem. Co., 126 N.E.2d 750 (N.Y. 1955) . . . 765n100 Daniels v. Newton, 114 Mass. 530 (1876) . . . 674 Davies v. Langin, 21 Cal. Rptr. 682 (Ct. App. 1962) . . . 139n23, 458n5, 460n10 Dawkins v. Sappington, 26 Ind. 199 (1866) . . . 439n36 Day v. Caton, 119 Mass. 513 (1876) . . . 137 De Cicco v. Schweizer, 117 N.E. 807 (N.Y. 1917) . . . 129, 436n29 Defeyter v. Riley, 671 P.2d 995 (Colo. Ct. App. 1983) . . . 347n32 Delaware & Hudson Canal Co. v. Westchester Cnty. Bank, 4 Denio 97 (N.Y. Sup. Ct. 1847)  .  .  .  743n13 De Maris v. Asti, 426 So. 2d 1153 (Fla. Dist. Ct. App. 1983) . . . 762n87 Demasse v. ITT Corp., 984 P.2d 1138 (Ariz. 1999) . . . 434 DeMoss v. Conart Motor Sales, Inc., 72 N.E.2d 158 (Ohio Ct. C.P. 1947), aff ’d, 78 N.E.2d 675 (Ohio 1948) . . . 309n34 Denburg v. Parker Chapin Flattau & Klimpl, 624 N.E.2d 995 (N.Y. 1993) . . . 44n39 De Pauw Univ. v. Ankeny, 166 P. 1148 (Wash. 1917) . . . 116n51 Dethmers Mfg. Co. v. Automatic Equip. Mfg. Co., 73 F. Supp. 2d 997 (N.D. Iowa 1999) . . . 339n15 Devecmon v. Shaw, 14 A. 464 (1888) . . . 118n58, 119n60, 126n91, 128, 129n104 Devlin v. Smith, 89 N.Y. 470 (1882) . . . 14n13 Dewien v. Estate of Dewien, 174 N.E.2d 875 (Ill. App. Ct. 1961) . . . 128n99 DF Activities Corp. v. Brown, 851 F.2d 920 (7th Cir. 1988) . . . 794n20 Dial; United States v., 757 F.2d 163 (7th Cir. 1985) . . . 616 Diamond Fruit Growers, Inc. v. Krack Corp., 794 F.2d 1440 (9th Cir. 1986) . . . 447n53 Dick v. United States, 82 F. Supp. 326 (Ct. Cl. 1949) . . . 454n70 Dickinson v. Dodds, [1876] 2 Ch D 463 (Ct. App.) (Eng.) . . . 130n108, 460n11, 470–​471 Dickson v. Delhi Seed Co., 760 S.W.2d 382 (Ark. Ct. App. 1988) . . . 224n13 Dingley v. Oler, 117 U.S. 490 (1886) . . . 675n6 Diversified Energy, Inc. v. Tennessee Valley Auth., 339 F.3d 437 (6th Cir. 2003) . . . 199 Donalson v. Coca-​Cola Co., 298 S.E.2d 25 (Ga. Ct. App. 1982) . . . 753n61 The Don Carlos, 47 F. 746 (N.D. Cal. 1891) . . . 75n19 Donoghue v. Stevenson, [1932] AC 562 (HL) . . . 12–​13 Donovan v. RRL Corp., 27 P.3d 702 (Cal. 2001) . . . 423n25, 559n7, 572, 574, 575n48, 799 Dorton v. Collins & Aikman Corp., 453 F.2d 1161 (6th Cir. 1972) . . . 446n52 Dougherty v. Salt, 125 N.E. 94 (N.Y. 1919) . . . 97, 99 Dover Pool & Racquet Club v. Brooking, 322 N.E.2d 168 (Mass. 1975) . . . 586, 645n63 Doyle v. South Pittsburgh Water Co., 199 A.2d 875 (Pa. 1964) . . . 771n131 Dravo Corp. v. Robert B. Kerris, Inc., 655 F.2d 503 (3d Cir. 1981) . . . 754n67 Drennan v. Star Paving Co., 333 P.2d 757 (Cal. 1958) . . . 465n26 Dreyfus & Co. v. Roberts, 87 S.W. 641 (Ark. 1905) . . . 43n33 Driscoll v. Columbia Realty-​Woodland Park Co., 590 P.2d 73 (Colo. Ct. App. 1978) . . . 769n118 Duncan v. Black, 324 S.W.2d 483 (Mo. Ct. App. 1959) . . . 44n38 Durnherr v. Rau, 32 N.E. 49 (N.Y. 1892) . . . 747n41 Dutton v. Poole, (1677) 83 Eng. Rep. 523; 2 Lev. 210 . . . 742, 746 Duval & Co. v. Malcom, 214 S.E.2d 356 (Ga. 1975) . . . 302n19, 478n64 Dyer v. National By-​Prods., Inc., 380 N.W.2d 732 (Iowa 1986) . . . 44n39

820

820

Table of Cases

E Eagle v. Smith, 9 Del. 293 (1871) . . . 439n36 Earl E. Roher Transfer & Storage Co. v. Hutchinson Water Co., 322 P.2d 810 (Kan. 1958) . . . 771n131 EarthInfo, Inc. v. Hydrosphere Res. Consultants, Inc., 900 P. 2d 113 (Colo. 1995) . . . 345, 362 Eastern Air Lines, Inc. v. Gulf Oil Corp., 415 F. Supp. 429 (S.D. Fla. 1975) . . . 308, 648n70 Eastern Air Lines, Inc. v. McDonnell Douglas Corp., 532 F.2d 957 (5th Cir. 1976) . . . 631n15 Eastern S.S. Lines, Inc. v. United States, 112 F. Supp. 167 (Ct. Cl. 1953) . . . 207, 213, 303, 304 E.B. Roberts Constr. Co. v. Concrete Contractors, Inc., 704 P.2d 859 (Colo. 1985) . . . 754n64 ECDC Envtl., L.C. v. N.Y. Marine & Gen. Ins. Co., 96 Civ. 6033, 1999 U.S. Dist. LEXIS 9836 (S.D.N.Y. June 29, 1999) . . . 256n4 Edenfield v. Woodlawn Manor, Inc., 462 S.W.2d 237 (Tenn. Ct. App. 1970) . . . 214n36 Educational Beneficial, Inc. v. Reynolds, 324 N.Y.S.2d 813 (Civ. Ct. 1971) . . . 218n1 Ellwood v. Monk, 5 Wend. 235 (N.Y. Sup. Ct. 1830) . . . 743n13 Elsinore Union Elementary Sch. Dist. v. Kastorff, 353 P.2d 713 (Cal. 1960) . . . 559n6 Embry v. Hargadine, McKittrick Dry Goods Co., 105 S.W. 777 (Mo. Ct. App. 1907) . . . 399–​400 English v. Fischer, 660 S.W.2d 521 (Tex. 1983) . . . 707n5 Entores Ld. v. Miles Far E. Corp., [1955] 2 Q.B. 327 . . . 455n75 Equitable Trust Co. v. Western Pac. Ry., 244 Fed. 485 (S.D.N.Y. 1917), remanded for correction & aff 'd, 250 Fed. 327 (2d Cir. 1918) . . . 674 Estate of. See name of party Everett, City of v. Estate of Sumstad, 631 P.2d 366 (Wash. 1981) . . . 589 F Faith Lutheran Ret. Home v. Veis, 473 P.2d 503 (1970) . . . 97n1 Falcone; United States v., 257 F.3d 226 (2d Cir. 2001) . . . 615n72 Falconer v. Mazess, 168 A.2d 558 (Pa. 1961) . . . 454n72 Falzarano v. United States, 607 F.2d 506 (1st Cir. 1979) . . . 773n137 Famous Knitwear Corp. v. Drug Fair, Inc., 493 F.2d 251 (4th Cir. 1974) . . . 191n4 Farley v. Cleveland, 4 Cow. 432 (N.Y. Sup. Ct. 1825), aff ’d without opinion, 9 Cow. 639 (N.Y. Sup. Ct. 1827) . . . 742 Farrington v. Freeman, 99 N.W.2d 388 (Iowa 1959) . . . 355n55 Federal Mogul Corp. v. Universal Constr. Co., 376 So. 2d 716 (Ala. Civ. App.) . . . 761n82, 769n118 Feinberg v. Pfeiffer Co., 322 S.W. 2d 163 (Mo. App. 1959) . . . 127n92, 128n99 Felton v. Dickinson, 10 Mass. (10 Tyng) 287 (1813) . . . 743n15 Fera v. Village Plaza, Inc., 242 N.W.2d 372 (Mich. 1976) . . . 234 Fernandez v. Fahs, 144 F. Supp. 630 (S.D. Fla. 1956) . . . 437n35, 486n4 Fidelity & Deposit Co. v. Rainer, 125 So. 55 (Ala. 1929) . . . 754n66, 766n107 Filley v. Illinois Life Ins. Co., 137 P. 793 (Kan. 1914) . . . 776n140 First Nat’l Bank v. Logan Mfg. Co., 577 N.E.2d 949 (Ind. 1991) . . . 126, 128 Fiser v. Dell Computer Corp., 188 P.3d 1215 (N.M. 2008) . . . 92n61 Fisher v. Bell, [1961] 1 QB 394 (Eng.) . . . 420 Florida ex rel. Westinghouse Elec. Supply Co. v.  Wesley Constr. Co., 316 F.  Supp.  490 (S.D. Fla. 1970) (mem.), aff ’d mem., 453 F.2d 1366 (5th Cir. 1972) . . . 764n94 Floyd v. Christian Church Widows & Orphans Home, 176 S.W.2d 125 (Ky. 1943) . . . 116n51 Foakes v. Beer, [1884] 9 App. Cas. 605 (H.L.) (Eng.) . . . 130n106 Forbes v.  Board of Missions of Methodist Episcopal Church, S., 110  P.2d 3 (Cal. 1941) . . . 139n23, 458, 460n10 Forman v. Benson, 446 N.E.2d 535 (Ill. App. Ct. 1983) . . . 726 Fortune v. National Cash Register Co., 364 N.E.2d 1251 (Mass. 1977) . . . 431n12, 708n8

821

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821

Freedman v. Rector, 230 P.2d 629 (Cal. 1951) . . . 288n21 Freitag v. Bill Swad Datsun, 443 N.E.2d 988 (Ohio 1981) . . . 224n12 Freund v. Washington Square Press, Inc., 314 N.E.2d 419 (N.Y. 1975) . . . 227, 229, 231, 232, 237 Friends of Lubavitch/​L andow Yeshiva v.  Northern Tr. Bank, 685 So. 2d 951 (Fla. App.  1996) . . . 116n51 Frigaliment Imp. Co. v. B.N.S. Int’l Sales Co., 190 F. Supp. 116 (S.D.N.Y. 1960) . . . 403n18 Frigidaire Sales Corp. v. Maguire Homes, Inc., 186 F. Supp. 767 (D. Mass. 1959) . . . 761n82 Frye v. Hubbell, 68 A. 325 (N.H. 1907) . . . 43n33 F.S. Credit Corp. v. Shear Elevator, Inc., 377 N.W.2d 227 (Iowa 1985) . . . 43n37 Funkhouser v. J.B. Preston Co., 290 U.S. 163 (1933) . . . 255n2 G Gabapentin Patent Litig., In re, 312 F. Supp. 2d 653 (D.N.J. 2004) . . . 275 Gandy v. Gandy, (1885) 30 Ch D 57 (C.A.) (Eng.) . . . 746n35 Garcia v. Borelli, 180 Cal. Rptr. 768 (Ct. App. 1982) . . . 763n89 Garden State Plaza Corp. v. S.S. Kresge Co., 189 A.2d 448 (N.J. Super. Ct. App. Div. 1963) . . . 377 Gardner Zemke Co. v. Dunham Bush, Inc., 850 P.2d 319 (N.M. 1993) . . . 440n40, 445n51 Garnsey v. Rodgers, 47 N.Y. 233 (1872) . . . 744n24 Gassner v. Lockett, 101 So. 2d 33 (Fla. 1958) . . . 339n12 G.C. Casebolt Co. v. United States, 421 F.2d 710 (Ct. Cl. 1970) . . . 454n71 General Time Corp. v. Eye Encounter, Inc., 274 S.E.2d 391 (N.C. 1981) . . . 455n75 Gerhardt v. Continental Ins. Cos., 48 N.J. 291, 225 A.2d 328 (1966) . . . 525 Gifford v. Commissioner of Pub. Health, 105 N.E.2d 476 (Mass. 1952) . . . 638–​639 Gilbert v. Sanderson, 9 N.W. 293 (Iowa 1881) . . . 775n139 Gillman v. Chase Manhattan Bank, 534 N.E.2d 824 (N.Y. 1988) . . . 89n48 Giovanola v. Fort Lee Bldg. & Loan Ass’n, 196 A. 357 (N.J. Ch. 1938) . . . 470n37 Giuseppi v. Walling, 144 F.2d 608 (2d Cir. 1944) . . . 384n26 Glendale Fed. Bank, ESB v. United States, 43 Fed. Cl. 390 (1999) . . . 339n15 The Glengyle, [1898] A.C. 519 (H.L.) (Eng.) . . . 78n24 Globe Ref. Co. v. Landa Cotton Oil Co., 190 U.S. 540 (1903) . . . 241n11 G. Loewus & Co. v. Vischia, 65 A.2d 604 (N.J. 1949) . . . 33n7 Glover v. District of Columbia, 77 A.2d 788 (D.C. 1951) . . . 439n36 Glover v. Metropolitan Life Ins. Co., 664 F.2d 1101 (8th Cir. 1981) . . . 568n25 Gorham v. Peerless Life Ins. Co., 118 N.W.2d 306 (Mich. 1962) . . . 139n21 Gory Associated Indus. Inc. v. Jupiter Roofing & Sheet Metal, Inc., 358 So. 2d 93 (Fla. Dist. Ct. App. 1978) . . . 214n36 Grayddon v. Knight, 292 P. 2d 632 (Cal. 1956) . . . 126n89 Great Am. Ins. Co. v. C.G. Tate Constr. Co., 279 S.E.2d 769 (N.C. 1981) . . . 721 Greenberg v. Mallick Mgmt., Inc., 527 N.E.2d 943 (Ill. App. Ct. 1988) . . . 43n37 Greer Props., Inc. v. LaSalle Nat’l Bank, 874 F.2d 457 (7th Cir. 1989) . . . 60, 708 Greguhn v. Mutual of Omaha Ins. Co., 461 P.2d 285 (Utah 1969) . . . 676 Griffith v. Brymer, [1903] 19 TLR 434 (KB) (Eng.) . . . 580, 582–​583 Grinnell Co. v. Voorhees, 1 F.2d 693 (3d Cir. 1924) . . . 153, 205 Gross v. Diehl Specialties, Int’l, Inc., 776 S.W.2d 879 (Mo. Ct. App. 1989) . . . 130n107 Grouse v. Group Health Plan, Inc., 306 N.W.2d 114 (Minn. 1981) . . . 432n14 Grove v. Charbonneau Buick-​Pontiac, Inc. 240 N.W.2d 853 (N.D. 1976) . . . 437n35, 486n4 Grummel v. Hollenstein, 367 P.2d 960 (Ariz. 1962) . . . 346n30 Gurfein v. Werbelovsky, 118 A. 32 (Conn. 1922) . . . 48, 419 Guy v. Liederbach, 459 A.2d 744 (Pa. 1983) . . . 762nn84–​86, 763n88, 763nn91–​92 G.W.S. Serv. Stations, Inc. v. Amoco Oil Co., 346 N.Y.S.2d 132 (N.Y. Sup. Ct. 1973)  . . . 308n34

82

822

Table of Cases

H Hadley v. Baxendale, (1854) 156 Eng. Rep. 145, 9 Ex. 341 . . . 55, 65, 144–​145, 222, 239–​254, 260, 265, 275, 276, 290, 297, 302, 306, 651 Hale v. Groce, 744 P.2d 1289 (Or. 1987) . . . 763n88 Hall v. Marston, 17 Mass. (17 Tyng) 575 (1822) . . . 743n15 Hall v. Nassau Consumers’ Ice Co., 183 N.E. 903 (N.Y. 1933) . . . 491n20 Hall v. United States, 19 Cl. Ct. 558 (1990) . . . 574 Hampton & Sons, Ltd. v. George, [1939] 3 All ER 627 (KB) (Eng.) . . . 490n13 Hanberry Corp. v. State Bldg. Comm’n, 390 So. 2d 277 (Miss. 1980) . . . 767n110 Hancock Bank & Trust Co. v. Shell Oil Co., 309 N.E.2d 482 (Mass. 1974) . . . 48n44 Hansen v. Andersen, 71 N.W.2d 921 (Iowa 1955) . . . 208n21 Harper v. Graham, 20 Ohio 105 (1851) . . . 43n31 Harper v. Herman, 499 N.W.2d 472 (Minn. 1993) . . . 135 Harris v. Board of Water & Sewer Comm’rs, 320 So. 2d 624 (Ala. 1975) . . . 771n131 Harris v. Time, Inc., 237 Cal. Rptr. 584 (Ct. App. 1987) . . . 48, 439n38 H.A. Steen Indus., Inc. v. Richer Commc’ns, 314 A.2d 319 (Pa. 1973) . . . 154n18 Hawkins v. McGee, 146 A. 641 (N.H. 1929) . . . 180–​182, 183n6, 186–​188, 207, 655n95 Hawrysh v. St. John’s Sportsmen’s Club, [1964] 46 D.L.R. 45 (Manitoba Q.B.) (Can.) . . . 490n13 Hayes v. Durham Life Ins. Co., 96 S.E.2d 109 (Va. 1957) . . . 139n21 Hayes v. Plantations Steel Co., 438 A.2d 1091 (R.I. 1982) . . . 128n99 H.B. Deal & Co. v. Head, 251 S.W.2d 1017 (Ark. 1952) . . . 773n137 Healy v. Fallon, 37 A. 495 (Conn. 1897) . . . 355n55 Hector Martinez & Co. v. Southern Pac. Transp. Co., 606 F.2d 106 (5th Cir. 1979) . . . 243 Hegeberg v. New England Fish Co., 110 P.2d 182 (Wash. 1941) . . . 720, 723n17 Heideck v. Kent Gen. Hosp., 446 A.2d 1095 (Del. 1982) . . . 432n16 Helle v. Landmark, Inc., 472 N.E.2d 765 (Ohio Ct. App. 1984) . . . 49 Hendrickson v. International Harvester, 135 A. 702 (Vt. 1927) . . . 138n20 Herman v. Schlesinger, 90 N.W. 460 (Wis. 1902) . . . 43n31 Hewson Constr., Inc. v. Reintree Corp., 685 P.2d 1062 (Wash. 1984) . . . 766n108 Heyer v. Flaig, 449 P.2d 161 (Cal. 1970) . . . 762nn85–​86, 763n90 Hickox v. Bell, 552 N.E.2d 1133 (Ill. App. Ct. 1990) . . . 777n144 Higgins, Inc. v. The Tri-​State, 99 F. Supp. 694 (S.D. Fla. 1951) . . . 75n19 Hill v. Gateway 2000, 106 F. 3d 1147 (7th Cir. 1997) . . . 529n29 Hill v. Jones, 725 P.2d 1115 (Ariz. Ct. App. 1986) . . . 614 Hinkley v. Wynkoop, 137 N.E. 154 (Ill. 1922) . . . 81n30 Hochster v. De La Tour, (1853) 118 Eng. Rep. 922; El. & Bl. 678 . . . 673 Hoffman v. Red Owl Stores, Inc., 133 N.W.2d 267 (Wis. 1965) . . . 330n32, 516n66 Hoffman v. United States, 340 F.2d 645 (Cl. Ct. 1964) . . . 768n113 Hoggard v. Dickerson, 165 S.W. 1135 (Mo. Ct. App. 1914) . . . 473n49 Holbrook v. Pitt, 643 F.2d 1261 (7th Cir. 1981) . . . 772n132, 773n137 Holiday Inns of Am., Inc. v. Knight, 450 P.2d 42 (Cal. 1969) . . . 718, 720 Holley v. St. Paul Fire & Marine Ins. Co., 396 So. 2d 75 (Ala. 1981) . . . 754n68 Home Gas Co. v. Magnolia Petroleum Co., 287 P. 1033 (Okla. 1930) . . . 478n68 Honey v. George Hyman Constr. Co., 63 F.R.D. 443 (D.D.C. 1974) . . . 761n82 Horning Co. v. Falconer Glass Indus., Inc., 730 F. Supp. 962 (S.D. Ind. 1990) . . . 444n49 Hotchkiss v. National City Bank, 200 F. 287 (S.D.N.Y. 1911), aff ’d, 201 F. 664 (2d Cir. 1912), aff ’d, 231 U.S. 50 (1913) . . . 26n2, 397 Howe v Teefy (1927) 27 SR (NSW) 301 (Austl.) . . . 490n13 H. Parsons (Livestock) Ltd. v. Uttley Ingham & Co., [1978] QB 791 (Eng.) . . . 243n19, 246 H.P. Droher & Sons v. Toushin, 85 N.W.2d 273 (Minn. 1957) . . . 210 H.R. Moch Co. v. Rensselaer Water Co., 159 N.E. 896 (N.Y. 1928) . . . 771

823

Table of Cases

823

Hrushka v. Department of Pub. Works & Highways, 381 A.2d 326 (N.H. 1977) . . . 761n82 Hume v. United States, 132 U.S. 406 (1889) . . . 81n30 Hunt Foods & Indus., Inc. v. Doliner, 270 N.Y.S.2d 937 (App. Div. 1966) . . . 541 Huntington Coach Corp. v. Board of Educ., 372 N.Y.S.2d 717 (App. Div. 1975), aff 'd, 357 N.E.2d 1017 (1976) . . . 289n22 Hurst v. W.J. Lake, 16 P.2d 627 (Or. 1932) . . . 379 Hutchison v. Tompkins, 259 So. 2d 129 (Fla. 1972) . . . 287–​288, 289n23 H-​W-​H Cattle Co. v. Schroeder, 767 F.2d 437 (8th Cir. 1985) . . . 197, 199 Hylte Bruks Aktiebolag v. Babcock & Wilcox Co., 399 F.2d 289 (2d Cir. 1968) . . . 753n62 Hyman v. Cohen, 73 So. 2d 393 (Fla. 1954) . . . 287–​289 I I. & I. Holding Corp. v. Gainsburg, 12 N.E.2d 532 (1938) . . . 116n52 Independent Mech. Contractors, Inc. v. Gordon T. Burke & Sons, 635 A.2d 487 (N.H. 1993) . . . 235 India.com, Inc. v. Dallal, 412 F.3d 315 (2d Cir. 2005) . . . 761n82 Indiana Tri-​City Plaza Bowl, Inc. v. Estate of Glueck, 422 N.E.2d 670 (Ind. Ct. App. 1981) . . . 726n28 The “Industry,” (1835) 166 Eng. Rep. 381; 3 Hag. Adm. 203 . . . 76n21 In re. See name of party Interform Co. v. Mitchell Constr. Co., 575 F.2d 1270 (9th Cir. 1978) . . . 536 International Filter v.  Conroe Gin, Ice & Light Co., 277 S.W. 631 (Tex. Comm’n App.  1925) . . . 447–​448 Intersource, Inc. v. Kidder Peabody & Co., 1992 WL 369918 (S.D.N.Y. Nov. 20, 1992) . . . 604n26 Iodice v. Bradco Cleaners, 1993 Mass. App. Div. 54 (1993) . . . 631n15 Iowa Elec. Light & Power Co. v. Atlas Corp., 467 F. Supp. 129 (N.D. Iowa 1978), rev’d, 603 F.2d 1301 (8th Cir. 1979) . . . 648n70 Itek Corp. v. Chicago Aerial Indus., Inc., 248 A.2d 625 (Del. 1968) . . . 504–​505, 507 ITM, Inc.; State v., 275 N.Y.S.2d 303 (Sup. Ct. 1966) . . . 88n46, 90n54 Izadi v. Machado (Gus) Ford, Inc., 550 So. 2d 1135 (Fla. Dist. Ct. App. 1989) . . . 423n25 J Jacob & Youngs, Inc. v. Kent, 129 N.E. 889 (N.Y. 1921) . . . 208, 211, 215, 304, 323, 355, 693, 698 Jacobs Assocs. v. Argonaut Ins. Co., 580 P.2d 529 (Or. 1978) . . . 765n100, 766n107 James v. Morgan, (1793) 83 Eng. Rep. 323, 1 Lev. 111 . . . 81n30 James v. Pawsey, 328 P.2d 1023 (Cal. App. Ct. 1958) . . . 777n147 James D. Shea Co. v. Perini Corp., 321 N.E.2d 831 (Mass. App. Ct. 1975) . . . 764n94 Janke Const. Co. v. Vulcan Materials Co., 527 F.2d 772 (7th Cir. 1976) . . . 126n89 Javins v. First Nat’l Realty Corp., 428 F.2d 1071 (D.C. Cir. 1970) . . . 615n68 The Jessomene, 47 F. 903 (N.D. Cal. 1891) . . . 75n19 Jewish Fed’n v. Barondess, 560 A.2d 1353 (N.J. Super. Ct. Law. Div. 1989) . . . 116n50 J.F., Inc. v. S.M. Wilson & Co., 504 N.E.2d 1266 (Ill. App. Ct. 1987) . . . 767n110 J.J. & L. Inv. Co. v. Minaga, 487 P.2d 561 (Colo. App. 1971) . . . 218n1 J. Louis Crum Corp. v. Alfred Lindgren, Inc., 564 S.W.2d 544 (Mo. Ct. App. 1978) . . . 754n64 Johnson v. Davis, 480 So. 2d 625 (Fla. 1985) . . . 615n68 Johnson v. Moreau, 82 N.E.2d 802 (Mass. 1948) . . . 476n59 Johnson v. National Beef Packing Co., 551 P.2d 779 (Kan. 1976) . . . 432n16 Johnson v. Scottish Union Ins. Co., 22 S.W.2d 362 (Tenn. 1929) . . . 143n36 Jom Inc. v. Adell Plastics, Inc., 193 F.3d 47 (1st Cir. 1999) . . . 447n53 Jones v. Star Credit Corp., 298 N.Y.S.2d 264 (Sup. Ct. 1969) . . . 90 Jordan v. Duff & Phelps, Inc., 815 F.2d 429 (7th Cir. 1987) . . . 708n8 Juliano v. Gaston, 455 A.2d 523 (N.J. Super. Ct. App. Div. 1982) . . . 769n118

824

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Table of Cases

K Kaiser Aluminum & Chem. Corp. v. Ingersoll-​Rand Co., 519 F. Supp. 60 (S.D. Ga. 1981) . . . 769 Kaiser Trading Co. v. Associated Metals & Minerals Corp., 321 F. Supp. 923 (N.D. Cal. 1970) . . . 308 Kanavos v. Hancock Bank & Trust Co., 479 N.E.2d 168 (Mass. 1985) . . . 678 Kann v. Wausau Abrasives Co., 129 A. 374 (N.H. 1925) . . . 308n34 Kansas City, Mo. v. Kansas City, Kan., 393 F. Supp. 1 (W.D. Mo. 1975) . . . 650n79 Kansas City, Mexico & Orient Ry. Co. v. Bell, 197 S.W. 322 (Tex. Civ. App. 1917) . . . 491n20 Kansas Mun. Gas Agency v. Vesta Energy Co., 843 F. Supp. 1401 (D. Kan. 1994) . . . 515 Kanzmeir v. McCoppin, 398 N.W.2d 826 (Iowa 1987) . . . 224n12 Karo v. San Diego Symphony Orchestra Ass’n, 762 F.2d 819 (9th Cir. 1985) . . . 777n144 Kearns v. Andree, 139 A. 695 (Conn. 1928) . . . 330 Kearsarge Computers, Inc. v. Acme Staple Co. 366 A.2d 467 (1976) . . . 154n18 Keel v. Titan Constr. Corp., 639 P.2d 1228 (Okla. 1981) . . . 753n61 Keithley v. Civil Serv. Bd., 89 Cal. Rptr. 809 (1970) . . . 84n43 Kellogg v. Richards, 14 Wend. 116 (N.Y. Sup. Ct. 1835) . . . 43n31 Kelly Health Care, Inc. v. Prudential Ins. Co. of Am., 309 S.E.2d 305 (Va. 1983) . . . 753n61 Kemble v. Farren, (1829) 19 Eng. Rep. 1234, 6 Bing. 141 . . . 285, 286 Kemp v. Gannett, 365 N.E.2d 1112 (Ill. App. 1977) . . . 346n30 Kenford Co. v. Erie Cnty., 493 N.E.2d 234 (N.Y. 1986) . . . 227, 228n9, 229, 231, 232, 237 Kerr S.S. Co. v. Radio Corp. of Am., 157 N.E. 140 (N.Y. 1927) . . . 249n34 Keystone Diesel Engine Co. v. Irwin, 191 A.2d 376 (Pa. 1963), overruled (Pa. 1977) . . . 242n14 KGM Harvesting Co. v. Fresh Network, 42 Cal. Rptr. 2d 286 (Ct. App. 1995) . . . 197, 199 Khabbaz v. Swartz, 319 N.W.2d 279 (Iowa 1982) . . . 753n61 Killpack v. National Old Line Life Ins. Co., 229 F.2d 851 (10th Cir. 1956) . . . 139n21 Kimes v. United States, 207 F.2d 60 (2d Cir. 1953) . . . 76n21 King v. Travelers Ins. Co., 513 So. 2d 1023 (Ala. 1987) . . . 479n70, 480 King v. Trustees of Bos. Univ., 647 N.E.2d 1196 (Mass. 1995) . . . 116n51 Kinsman Transit Co., Petition of, 338 F.2d 708 (2d Cir. 1964), cert. denied, 380 U.S. 944 (1965) . . . 244 Kirksey v. Kirksey, 8 Ala. 131 (1845) . . . 117, 122–​123 Kisiel v. Holz, 725 N.W.2d 67 (Mich. App. 2006) . . . 768n115 Klockner v. Green, 254 A.2d 782 (N.J. 1969) . . . 129n104, 436 Knapp v.  McFarland, 344 F.  Supp.  601 (S.D.N.Y. 1971), modified & remanded, 457 F.2d 881 (2d Cir. 1972) . . . 482n85 Knight v. Seattle First Nat’l Bank, 589 P.2d 1279 (Wash. Ct. App. 1979) . . . 470n37 Koch v. Consolidated Edison Co., 468 N.E.2d 1 (N.Y. 1984) . . . 771n131 Koch v. Construction Tech., Inc., 924 S.W.2d 68 (Tenn. 1996) . . . 724 Koehring Co. v. Glowacki, 253 N.W.2d 64 (Wis. 1977) . . . 442 Koenen v. Royal Buick Co., 783 P.2d 822 (Ariz. Ct. App. 1989) . . . 801n38 Koufos v. C. Czarnikow Ltd., [1969] 1 AC 350 (HL)387 . . . 242, 243 Krell v. Henry, [1903] 2 KB 740 . . . 627–​628, 630, 642–​643, 646, 660, 737 Kryer v. Driscoll, 159 N.W.2d 680 (Wis. 1968) . . . 694 Kugler v. Romain, 279 A.2d 640 (N.J. 1971) . . . 90 Kukuska v. Home Mut. Hail-​Tornado Ins. Co., 235 N.W. 403 (Wis. 1931) . . . 139n21 Kurio v. United States, 429 F. Supp. 42 (S.D. Tex. 1970) . . . 139n23, 460n10 Kutzin v. Pirnie, 591 A.2d 932 (N.J. 1991) . . . 329n28 L Laclede Gas Co. v. Amoco Oil Co., 522 F.2d 33 (8th Cir. 1975) . . . 34, 308 Laidlaw v. Organ, 15 U.S. (2 Wheat.) 178 (1817) . . . 599–​601, 608n44, 613n60 Lake Bluff Orphanage v. Magill’s Ex’rs, 204 S.W.2d 224 (Ky. 1947) . . . 116n51

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825

Lake Placid Club Attached Lodges v.  Elizabethtown Builders, Inc., 521 N.Y.S.2d 165 (App. Div. 1987) . . . 769 Lake River Corp. v. Carborundum Co., 769 F.2d 1284 (7th Cir. 1985) . . . 283n3, 285, 286 L.Albert & Son v. Armstrong Rubber Co., 178 F.2d 182 (2d Cir. 1949) . . . 230n17, 324n12 The Lamington, 86 F. 675 (2d Cir. 1898) . . . 78n24 Las Vegas Hacienda v. Gibson, 359 P.2d 85 (Nev. 1961) . . . 437n35, 486n4 Laurel Race Course, Inc. v. Regal Const. Co., 333 A.2d 319 (Md. 1975) . . . 137n18 Laurin v. DeCarolis Constr. Co., 363 N.E.2d 675 (Mass. 1977) . . . 348 Lawrence v. Fox, 20 N.Y. 268 (1859) . . . 743–​747, 749, 755, 760 Lawson v. Martin Timber Co., 115 So. 2d 821 (La. 1959) . . . 391, 399 Lazenby Garages Ltd. v. Wright, [1976] 1 W.L.R. 459 (Ct. App.) (U.K.) . . . 190 LeDuc v. Liquid Air Corp., 826 P.2d 664 (Wash. 1992) . . . 433n19, 434n22 Lee Oldsmobile, Inc. v. Kaiden, 363 A.2d 270 (Md. 1976) . . . 287 Lefkowitz v. Great Minneapolis Surplus Store, Inc., 86 N.W.2d 689 (Minn. 1957) . . . 422–​423 Lenawee Cnty. Bd. of Health v.  Messerly, 331 N.W.2d 203 (Mich. 1982) . . . 580, 582, 589n28, 592, 595n2, 645 Leo Found., Inc. v. Kiernan, 240 A.2d 218 (Conn. Cir. Ct. 1967) . . . 218n1 Lewis v. Globe Constr. Co., 630 P.2d 179 (Kan. Ct. App. 1981) . . . 761n82 Lewis River Golf, Inc. v. O.M. Scott & Sons, 845 P.2d 987 (Wash. 1993) . . . 237n41 Lexington Prods. Ltd. v. B.D. Commc’ns, Inc., 677 F.2d 251 (2d Cir. 1982) . . . 237n40 Lifeguard Indus., Inc., In re, 42 B.R. 734 (Bankr. S.D. Ohio 1983) . . . 224n11 Lige Dickson Co. v. Union Oil Co., 635 P.2d 103 (Wash. 1981) . . . 804n43 Lindner v. Mid-​Continent Petroleum Corp., 252 S.W.2d 631 (Ark. 1952) . . . 35, 47–​48 Little v. Banks, 85 N.Y. 258 (1881) . . . 747n41 Little v. Union Tr. Co. of Md., 412 A.2d 1251 (Md. 1980) . . . 753n60 LLMD v. Marine Midland Realty Credit Corp., 789 F. Supp. 657 (E.D. Pa. 1992) . . . 507n30 Lloyds Bank Ltd. v. Bundy, [1975] Q.B. 326 (Eng.) . . . 82n34 L.N. Jackson & Co. v. Royal Norwegian Gov’t, 177 F.2d 694 (2d Cir. 1949) . . . 650n78 Lobosco v. New York Tel. Co./​NYNEX, 751 N.E. 2d 462 (N.Y. 2001) . . . 433n20 Locator of Missing Heirs, Inc. v. Kmart Corp., 33 F. Supp. 2d 229 (W.D.N.Y. 1999) . . . 604n26 Locke v. United States, 283 F.2d 521 (Cl. Ct. 1960) . . . 235 Loeb v. Wilson, 61 Cal. Rptr. 377 (Ct. App. 1967) . . . 69n3 Logan v. Glass, 7 A.2d 116 (Pa. Super. Ct. 1939), aff ’d, 14 A.2d 306 (1940) . . . 776n142 London Bucket Co. v. Stewart, 237 S.W.2d 509 (Ky. 1951) . . . 313–​314 Long v. Chronicle Publ’g Co., 228 P. 873 (Cal. Dist. Ct. App. 1924) . . . 472–​474 Lonnie Hayes & Sons Staves, Inc. v. Bourbon Cooperage Co., 777 S.W.2d 940 (Ky. Ct. App. 1989)  .  .  .  801n38 Loop v. Litchfield, 42 N.Y. 351 (1870) . . . 14n14 Lorillard v. Clyde, 25 N.E. 917 (N.Y. 1890) . . . 747n41 Losee v. Clute, 51 N.Y. 494 (1873) . . . 14n14 Louise Caroline Nursing Home, Inc. v. Dix Constr. Corp., 285 N.E.2d 904 (Mass. 1972) . . . 207 Lowden v. T-​Mobile USA, Inc., 512 F.3d 1213 (9th Cir. 2008) . . . 92n60 Lowey v. Watt, 684 F.2d 957 (D.C. Cir. 1982) . . . 43n37 Lucas v. Hamm, 364 P.2d 685 (Cal. 1961), cert. denied, 368 U.S. 987 (1962) . . . 762n84, 762n86, 763n89 Luck v. Southern Pac. Transp. Co., 267 Cal. Rptr. 618 (Ct. App. 1990) . . . 432n14 Luna v. Household Fin. Corp. III, 236 F. Supp. 2d 1166 (W.D. Wash 2002) . . . 92n61 Lusk Corp. v. Burgess, 332 P.2d 493 (Ariz. 1958) . . . 544 M MacPherson v. Buick Motor Co., 111 N.E. 1050 (N.Y. 1916) . . . 13–​14 Macrae v. Clarke, [1866] 1 LR-​CP 403 (Eng.) . . . 490n13 Macrose Indus., In re, 186 B.R. 789 (E.D.N.Y. 1995) . . . 586, 645n63

826

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Mactier’s Adm’rs v. Frith, 6 Wend. 103 (N.Y. 1830) . . . 458 Madeirense Do Brasil, S.A. v. Stulman-​Emrick Lumber Co., 147 F.2d 399 (2d Cir. 1945) . . . 631n16 Magnolia Petroleum Co. v. National Oil Trans. Co., 281 F. 336 (S.D. Tex. 1922) . . . 75n19 M. Ahern Co. v. John Bowen Co., 133 N.E.2d 484 (Mass. 1956) . . . 639, 661 M’Alister (or Donoghue) v. Stevenson, [1932] AC 562 (HL) . . . 12–​13 M. & R. Contractors & Builders v. Michael, 138 A.2d 350 (Md. 1958) . . . 154 Maneri v. Amodeo, 238 N.Y.S.2d 302 (Sup. Ct. 1963) . . . 762n87 Mange v. Unicorn Press, Inc., 129 F. Supp. 727 (S.D.N.Y. 1955) . . . 491n20 Mann v. Ben Tire Distribs., Ltd. 411 N.E.2d 1235 (Ill. App. Ct. 1980) . . . 431n9 Manor Junior Coll. v. Kaller’s Inc., 507 A.2d 1245 (Pa. Super. Ct. 1986) . . . 768n115 Manouchehri v. Heim, 941 P.2d 978 (N.M. Ct. App. 1997) . . . 207 Marcus & Co. v. K.L.G. Baking Co., 3 A.2d 627 (N.J. 1939) . . . 242n14 Market St. Assocs. Ltd. P’ship v. Frey, 941 F.2d 588 (7th Cir. 1991) . . . 141, 145, 147, 405n25, 566n20, 710–​711 Marquet v. Aetna Life Ins. Co., 159 S.W. 733 (Tenn. 1913) . . . 776n140 Martella v. Woods, 715 F.2d 410 (8th Cir. 1983) . . . 224n12 Martinez v. Socoma Cos., 521 P.2d 841 (Cal. 1974) . . . 772, 773–​774 Martyn v. Hind, (1776) 98 Eng. Rep. 1174; 2 Cowp. 437 . . . 742 Maryland Cas. Co. v. Johnson, 15 F.2d 253 (W.D. Mich. 1926) . . . 753n60, 764n95 Maryland Nat’l Bank v. United Jewish Appeal Fed’n, 407 A.2d 1130 (Md. 1979) . . . 116n51 Masterson v. Sine, 436 P.2d 561 (Cal. 1968) . . . 539 Matternes v. City of Winston-​Salem, 209 S.E.2d 481 (N.C. 1974) . . . 760n81 Maxon Corp. v. Tyler Pipe Indus., Inc., 497 N.E.2d 570 (Ind. Ct. App. 1986) . . . 444n49 Maxwell v. Fidelity Fin. Servs. Inc., 907 P.2d 51 (Ariz. 1995) . . . 90–​91, 95 McCartney v. Badovinac, 160 P. 190 (Colo. 1916) . . . 725 McCarty v. Blevins, 13 Tenn. (5 Yer.) 195 (1833) . . . 743n15 McClelland v. Climax Hosiery Mills, 169 N.E. 605 (N.Y. 1930) . . . 149n1, 154n19 McClure v. Raben, 33 N.E. 275 (Ind. 1893) . . . 69n2 MCC-​Marble Ceramic Ctr., Inc. v. Ceramica Nuova d’Agostino, S.p.A, 144 F.3d 1384 (11th Cir. 1998) . . . 402n14 McCrann v. U.S. Lines, Inc., 803 F.2d 771 (2d Cir. 1986) . . . 256n4 McCutchan v. Iowa State Bank, 5 N.W.2d 813 (Iowa 1942) . . . 470n37 McDonald v. Mobil Coal Producing, Inc., 820 P.2d 986 (Wyo. 1991) . . . 434n22 McInerney v. Charter Golf, Inc., 176 Ill. 482, 680 N.E. 1347 (Ill. 1997) . . . 432n14, 796n25 McKee v. AT&T Corp., 191 P.3d 845 (Wash. 2008) . . . 91 McKinnon v. Benedict, 157 N.W.2d 665 (Wis. 1968) . . . 69n3 McMillain Lumber Co. v. First Nat’l Bank, 110 So. 602 (Ala. 1926) . . . 242n14 McMullen v. Wel-​Mil Corp., 209 S.E.2d 507 (N.C. 1974) . . . 154n18 McRae v. Commonwealth Disposals Comm’n, (1951) 84 CLR 377 (Austl.) . . . 591 Mears v. Nationwide Mut. Ins. Co., 91 F.3d 1118 (8th Cir. 1996) . . . 229 Meltzer v. Old Furnace Dev. Corp., 254 N.Y.S.2d 246 (1964) . . . 286n9 Mercer v. Lemmens, 40 Cal. Rptr. 803 (Ct. App. 1964) . . . 347n31 Merritt Hill Vineyards, Inc. v. Windy Heights Vineyard, Inc., 460 N.E.2d 1077 (N.Y. 1984) . . . 716n2 Mersereau v. Simon, 8 N.Y.S.2d 534 (App. Div. 1938) . . . 69n2 Methodist Mission Home v. N.A.B., 451 S.W.2d 539 (Tex. Civ. App. 1970) . . . 84n43 Metropolitan Life Ins. Co. v. Solomon, 996 F. Supp. 1473 (M.D. Fla. 1998) . . . 560n9 Midland Hotel Corp. v. Reuben H. Donnelley Corp., 515 N.E.2d 61 (Ill. 1987) . . . 243n17 Midwest Concrete Prods. Co. v. La Salle Nat’l Bank, 418 N.E.2d 988 (Ill. App. Ct. 1981) . . . 770n127 Migerobe, Inc. v. Certina USA, Inc., 924 F.2d 1330 (5th Cir. 1991) . . . 237n42 Miles v. Kavanaugh, 350 So. 2d 1090 (Fla. Dist. Ct. App. 1977) . . . 243n17 Miller v. Allstate Ins. Co., 573 So. 2d 24 (Fla. Dist. Ct. App. 1990) . . . 229n12, 490n14 Miller Constr. Co. v. Stresstek, 697 P.2d 1201 (Idaho Ct. App. 1985) . . . 510n41

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827

Mills v. Wyman, 20 Mass. (3 Pick.) 207 (1825) . . . 115n49 Mineral Park Land v. Howard, 156 P. 458 (Cal. 1916) . . . 650n75 Minerals & Chem. Phillip Corp. v. Millwhite Co., 414 F.2d 428 (5th Cir. 1969) . . . 137n19 Minor v. Minor, 7 Cal. Rptr. 455 (Dist. Ct. App. 1960) . . . 676n7 Misahara Constr. Co. v. Transit-​Mixed Concrete Corp., 310 N.E.2d 363 (Mass. 1974) . . . 650 Missouri Pub. Serv. Co. v. Peabody Coal Co., 583 S.W.2d 721 (Mo. Ct. App. 1979) . . . 660 Mr. Eddie v. Ginsberg, 430 S.W.2d 5 (Tex. Civ. App. 1968) . . . 155 Mitchell v. Lath, 160 N.E. 646 (N.Y. 1928) . . . 535, 539 Mitchell v. Marklund, 47 Cal. Rptr. 756 (Dist. Ct. App. 1965) . . . 776n143 Mitsubishi Goshi Kaisha v. J. Aron & Co., 16 F.2d 185 (2d Cir. N.Y. 1926) . . . 699n7 Mobil Oil Corp. v. Attorney Gen., 280 N.E.2d 406 (Mass. 1972) . . . 486n5 Molaison, Succession of, 34 So. 2d 897 (La. 1948) . . . 81n30 Monarco v. Lo Greco, 220 P.2d 737 (Cal. 1950) . . . 803, 804 More Game Birds in Am., Inc. v. Boettger, 14 A.2d 778 (N.J. 1940) . . . 116n50 Morgan v. Reaser, 204 N.W.2d 98 (S.D. 1973) (per curiam) . . . 81, 82 Morin Bldg. Prods. Co. v. Baystone Constr., Inc., 717 F.2d 413 (7th Cir. 1983) . . . 708n7, 726 Morrison v. Thoelke, 155 So. 2d 889 (Fla. 1963) . . . 454n70 Morrison Flying Serv. v. Deming Nat’l Bank, 404 F.2d 856 (10th Cir. 1968) . . . 43n32 Mount Sinai Hosp. v. Jordan, 290 So. 2d 484 (Fla. 1974) . . . 116n51 Moyer v. Little Falls, 510 N.Y.S.2d 813 (Sup. Ct. 1986) . . . 651 M.T. Reed Constr. Co. v. Virginia Metal Prods. Corp., 213 F.2d 337 (5th Cir. 1954) . . . 767n110 Mueller v. McGill, 870 S.W.2d 673 (Tex. App. 1994) . . . 224n13 Murphy v. Lifschitz, 49 N.Y.S.2d 439 (1944), aff ’d mem., 63 N.E.2d 26 (N.Y. 1945) . . . 347n30 N Nanakuli Paving & Rock Co. v. Shell Oil Co., 664 F.2d 772 (9th Cir. 1981) . . . 708, 709 National Cash Register Co. v. Unarco Indus., Inc., 490 F.2d 285 (7th Cir. 1974) . . . 769n119 National Sur. Co. v. Brown-​Graves Co., 7 F.2d 91 (6th Cir. 1925) . . . 753n60, 764n95 Nebraska Seed Co. v. Harsh, 152 N.W.310 (1915) . . . 421n15 Neiss v. Ehlers, 899 P.2d 700 (Or. Ct. App. 1995) . . . 330n32 Neri v. Retail Marine Corp., 285 N.E.2d 311 (N.Y. 1972) . . . 190, 192 Nester v. Michigan Land & Iron Co., 66 Mich. 568, 33 N.W. 919 (Mich. 1887) . . . 588n26 New Hampshire Ins. Co. v. Madera, 192 Cal. Rptr. 548 (Ct. App. 1983) . . . 771n131 New Headley Tobacco Warehouse Co. v. Gentry’s Ex’r, 212 S.W.2d 325 (Ky. 1948) . . . 476n59 Newman v. Cary, 466 So. 2d 774 (La. Ct. App. 1985) . . . 347n31 Newman & Snell’s State Bank v. Hunter, 220 N.W. 665 (Mich. 1928) . . . 82n36 Newmeyer v. Newmeyer, 140 A.2d 892 (Md. 1958) . . . 123n75 New Orleans, City of v. Firemen’s Charitable Ass’n, 9 So. 486 (La. 1891) . . . 354n53 Nicholas E. Vernicos Shipping Co. v. United States, 349 F.2d 465 (2d Cir. 1965) . . . 78n24 Nicosia v. Wakefern Food Corp., 643 A.2d 554 (N.J. 1994) . . . 434n22 Nobs Chem., U.S.A., Inc. v. Koppers Co., 616 F.2d 212 (5th Cir. 1980) . . . 198, 199 Norcon Power Partners v. Niagra Mohawk Power Co., 705 N.E.2d 656 (N.Y. 1988) . . . 685–​686 Normile v.  Miller, 306 S.E.2d 147 (N.C. Ct. App.  1983), aff ’d as modified, 326 S.E.2d 11 (N.C. 1985) . . . 470n37 Norrington v. Wright, 115 U.S. 188 (1885) . . . 699n6 Norse Petroleum A/​S v. LVO Int’l, Inc., 389 A.2d 771 (Del. Super. Ct. 1978) . . . 455n75 North Carolina State Ports Auth. v. L.A. Fry Roofing Co., 240 S.E.2d 345 (N.C. 1978) . . . 769n120 Northern Del. Indus. Dev. Corp. v. E.W. Bliss Co., 245 A.2d 431 (Del. Ch. 1968) . . . 313n50 North German Lloyd v. Guaranty Trust Co., 244 U.S. 12 (1917) . . . 650n78 Northwest Fixture Co. v. Kilbourne & Clark Co., 128 F. 256 (9th Cir. 1904) . . . 288n22 Norwalk Door Closer Co. v. Eagle Lock & Screw Co., 220 A.2d 263 (Conn. 1966) . . . 289n22

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Table of Cases

O Ocean Tramp Tankers Corp. v. V/​O Sovfracht [The Eugenia], [1964] 2 QB 226 (Eng.) . . . 660 Odorizzi v. Bloomfield Sch. Dist., 54 Cal. Rptr. 533 (1966) . . . 83 Ogden, Town of v. Earl R. Howarth & Sons, Inc., 294 N.Y.S.2d 430 (Sup. Ct. 1968) . . . 771n131 Ogle v. Fuiten, 445 N.E.2d 1344 (Ill. App. Ct. 1983) . . . 763n89 O’Hagan; United States v., 521 U.S. 642 (1997) . . . 562n14, 615n72 Okemah Constr., Inc., v. Barkley-​Farmer, Inc., 583 S.W.2d 458 (Tex. Civ. App. 1979) . . . 130n107 Oliver v. Henley, 21 S.W.2d 576 (Tex. Civ. App. 1929) . . . 423n25 Oliver B. Cannon & Son, Inc. v. Dorr-​Oliver, Inc., 336 A.2d 211 (Del. 1975) . . . 768n116 Oloffson v. Coomer, 296 N.E.2d 871 (Ill. App. Ct. 1973) . . . 680 Olwell v. Nye & Nissen Co., 173 P.2d 652 (Wash. 1946) . . . 338n8 Oppenheimer & Co. v.  Oppenheim, Appel, Dixon & Co., 660 N.E.2d 415 (N.Y. 1995) . . . 716, 720nn9–​10 Oral-​X Corp. v. Farnam Cos., 931 F.2d 667 (10th Cir. 1991) . . . 237n41 Osborne; State v., 607 P.2d 369 (Alaska 1980) . . . 753n60 Oscar Barnett Foundry Co. v. Crowe, 86 A. 915 (N.J. 1912) . . . 349n41 Oscar Schlegel Mfg. Co. v. Peter Cooper’s Glue Factory, 132 N.E. 148 (N.Y. 1921) . . . 33n6 Osteen v. Johnson, 473 P.2d 184 (Colo. App. 1970) . . . 321, 323, 325 Oswald v. Allen, 417 F.2d 43 (2d Cir. 1969) . . . 403 P Pacific Gas & Electric Co. v. G.W. Thomas Drayage & Rigging Co., 442 P.2d 641 (Cal. 1968) . . . 376 Palo Alto Town & Country Vill. v. BBTC Co., 521 P.2d 1097 (Cal. 1974) . . . 452n65 Panhandle Eastern Pipe Line Co. v. Smith, 637 P.2d 1020 (Wyo. 1981) . . . 480 Parker v. Twentieth Century-​Fox Film Corp., 474 P.2d 689 (Cal. 1970) . . . 151 Patton v. Mid-​Continent Sys., Inc., 841 F.2d 742 (7th Cir. 1988) . . . 256, 578n1 Peerless case. See Raffles v. Wichelhaus Peevyhouse v. Garland Coal & Mining Co., 382 P.2d 109 (Okla. 1962) . . . 209, 214 Pembroke v. Caudill, 37 So. 2d 538 (Fla. 1948) . . . 287 Pennsylvania R.R. Co. v. City of Louisville, 126 S.W.2d 840 (Ky. 1939) . . . 314 People v. See name of opposing party People ex rel. See name of related party People’s Bank & Trust Co. v. Weidinger, 64 A. 179 (N.J. 1906) . . . 775n139 Perma Research & Dev. Co. v. Singer, 542 F.2d 111 (2d Cir. 1976) . . . 228n8 Perry v. Housing Auth., 664 F.2d 1210 (4th Cir. 1981) . . . 773n137 Pessin v. Fox Head Waukeshaw Corp., 282 N.W. 582 (Wis. 1938) . . . 33n5 Petermann v. International Bhd. of Teamsters, Local 396, 344 P.2d 25 (Cal. Ct. App. 1959) . . . 432n13 Peters Grazing Assoc. v. Legerski, 544 P.2d 449 (Wyo. 1976) . . . 779n152 Petition of. See name of opposing party Petropoulos v. Lubienski, 152 A.2d 801 (Md. 1959) . . . 202n2 P.H.C.C.C., Inc. v. Johnston, 340 N.W.2d 774 (Iowa 1983) . . . 117n53 Phillips v. Moor, 71 Me. 78 (1880) . . . 139, 460 Phillips v. Pantages Theatre Co., 300 P. 1048 (Wash. 1931) . . . 491n20 Phillpotts v. Evans, (1839) 151 Eng. Rep. 200; 5 M. & W. 475 . . . 674n4 Pierce Assocs., Inc. v. Nemours Found., 865 F.2d 530 (3d Cir.) . . . 768n115 Pigott v. Thompson, (1802) 127 Eng. Rep. 80; 3 Bos. & Pul. 147 . . . 742 Pine River State Bank v. Mettille, 333 N.W.2d 622 (Minn. 1983) . . . 432 Pitcher v. United Oil & Gas Syndicate, Inc., 139 So. 760 (La. 1932) . . . 411n13 Pitts v. McGraw-​Edison Co., 329 F.2d 412 (6th Cir. 1964) . . . 128n99 Poel v. Brunswick-​Balke-​Collender Co., 110 N.E. 619 (N.Y. 1919) . . . 440n40

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829

Pond v. New Rochelle Water Co., 76 N.E. 211 (N.Y. 1906) . . . 747n41 The Port Caledonia & The Anna, [1903] P. 184 (Eng.) . . . 75n19 Post v. Jones, 60 U.S. (19 How.) 150 (1857) . . . 75 Potter v. Carolina Water Co., 116 S.E.2d 374 (N.C. 1960) . . . 771n131 Preston v. Connecticut Mut. Life Ins. Co., 51 A. 838 (Md. 1902) . . . 776n140 Price v. Easton, (1833) 110 Eng. Rep. 518; 4 B. & AD. 433 . . . 746n35 Printing Ctr. of Tex., Inc. v. Supermind Publ’g Co., 669 S.W.2d 779 (Tex. App. 1984) . . . 700 ProCD, Inc. v. Zeidenberg, 86 F.3d 1447 (3d. Cir. 1996) . . . 529n29 Propane Indus., Inc. v. General Motors Corp., 429 F. Supp. 214 (W.D. Mo. 1977) . . . 130n109 Prutch v. Ford Motor Co., 618 P.2d 657 (Colo. 1980) . . . 243n17 Puro v. Puro, 393 N.Y.S.2d 633 (Sup. Ct. 1976) . . . 777n147 Q Quality Excelsior Coal Co. v. Reeves, 177 S.W.2d 728 (Ark. 1944) . . . 338n9 R Rabago-​Alvarez v. Dart Indus., Inc., 127 Cal. Rptr. 222 (Ct. App. 1976) . . . 432n14 Racine & Laramie Ltd. v. California Dep’t of Parks & Recreation, 14 Cal. Rptr. 2d 335 (Ct. App. 1992) . . . 516 Radford v. de Froberville, [1977] 1 WLR 1262 (Ch) (U.K.) . . . 213 Raffles v. Wichelhaus, (1864) 159 Eng. Rep. 375; 2 H. & C. 906 . . . 403–​404 Ralston Purina Co. v. McCollum, 611 S.W.2d 201 (Ark. Ct. App. 1981) . . . 804n44 Record Club of Am., Inc. v. United Artists Records Inc., 890 F.2d 1264 (2d Cir. 1989) . . . 678n16 R.E. Crummer & Co. v. Nuveen, 147 F.2d 3 (7th Cir. 1945) . . . 458n3 Rector v. Teed, 24 N.E. 1014 (N.Y. 1890) . . . 747n41 R.E. Davis Chem. Corp. v. Diasonics, Inc., 826 F.2d 678 (7th Cir. 1987) . . . 191 Reed v. King, 193 Cal. Rptr. 130 (Ct. App. 1983) . . . 615 Reed v. Wadsworth, 553 P.2d 1024 (Wyo. 1976) . . . 346n30 Rego v. Decker, 482 P.2d 834 (Alaska 1971) . . . 500, 501 Reidy v. Macauley, 290 S.E.2d 746 (N.C. Ct. App. 1982) . . . 755n68 Reilly v. Richards, 632 N.E.2d 507 (Ohio 1994) . . . 586, 645n63 Renfroe v. Ladd, 701 S.W.2d 148 (Ky. Ct. App. 1985) . . . 804n43 Resnik, People ex rel. v. Curtis & Davis, Architects & Planners, Inc., 400 N.E.2d 918 (Ill. 1980) . . . 768n116 Rhodes v. Rhodes, 266 S.W.2d 790 (Ky. 1953) . . . 777n147 Richey v. Richey, 179 N.W. 830 (Iowa 1920) . . . 69n2 Ricketts v. Scothorn, 77 N.W. 365 (Neb. 1898) . . . 126n90, 127n93 Ridgway v. Wharton, (1857) 10 Eng. Rep. 1287; 6 H.L.C. 238 . . . 503 Rigney v. New York Cent. & H.R.R. Co., 111 N.E. 226 (N.Y. 1916) . . . 747n41 R.I. Lampus Co. v. Neville Cement Prods. Corp., 378 A.2d 288 (Pa. 1977) . . . 242n14, 243n17 Rite Fabrics, Inc. v. Stafford-​Higgins Co., 366 F. Supp. 1 (S.D.N.Y. 1973). . . . 482n84 R.J. Berke & Co. v. J.P. Griffin, Inc., 367 A.2d 583 (N.H. 1976) . . . 695n18 R.K. Cooper Builders Inc. v. Free-​Lock Ceilings, Inc., 219 So. 2d 87 (Fla. Dist. Ct. App. 1969) . . . 223 Rockingham Cnty. v. Luten Bridge Co., 35 F.2d 301 (4th Cir. 1929) . . . 149–​150, 300–​301, 678 Rombola v. Cosindas, 220 N.E.2d 919 (Mass. 1966) . . . 236 Rood v. General Dynamics Corp., 507 N.W.2d 591 (Mich. 1993) . . . 433 Rossi v. Douglas, 100 A.2d 3 (1953) . . . 524n11 Rouse v. United States, 215 F.2d 872 (D.C. Cir. 1954) . . . 775n138, 779 Rowe v. Town of Peabody, 93 N.E. 604 (Mass. 1911) . . . 635n30 Royal-​Globe Ins. Co. v. Craven, 585 N.E.2d 315 (Mass. 1992) . . . 722 Ruxley Elecs. & Constr. Ltd v. Forsyth, [1996] 1 A.C. 344 (HL) . . . 210, 213n36

830

830

Table of Cases

S Sabo v. Delman, 143 N.E.2d 906 (N.Y. 1957) . . . 544, 545 Sabo v. Fasano, 201 Cal. Rptr. 270 (Ct. App. 1984) . . . 139n23, 458n5, 460n10 Salmon v. Chute, (1994) 4 NTLR 149 (Austl.) . . . 133n1 Salsbury v. Northwestern Bell Tel. Co., 221 N.W.2d 609 (Iowa 1974) . . . 116n50 Salvage Chief—​S.T. Ellin, 1969 Am. Mar. Cas. 1739 (S.D. Cal. 1966) . . . 77n24 Samson & Samson Ltd. v. Proctor, [1975] 1 NZLR 655 (HC) . . . 355 Sam Wong & Son v. New York Mercantile Exch., 735 F.2d 653 (2d Cir. 1984) . . . 707 Sanchez v. Life Care Ctrs. of Am., Inc., 855 P.2d 1256 (Wyo. 1993) . . . 433 Sanders v. FedEx Ground Package Sys., Inc., 188 P.3d 1200 (N.M. 2008) . . . 709 Sanders v. Parry, [1967] 2 All E.R. 803 . . . 490n13 San Francisco, City & Cnty. of v. Western Air Lines, Inc., 22 Cal. Rptr. 216 (Ct. App. 1962)  .  .  .  772–​773n137 Sardo v. Fidelity & Deposit Co., 134 A. 774 (N.J. 1926) . . . 524n11 Schermerhorn v. Vanderheyden, 1 Johns. 139 (N.Y. Sup. Ct. 1806) . . . 742n11 Schilling v. Kidd Garrett Ltd, [1977] 1 NZLR 243 CA (N.Z.) . . . 490n13 Schlegel v. Moorhead, 553 P.2d 1009, (Mont. 1976) . . . 69n3 Schliep v. Commercial Cas. Ins. Co., 254 N.W. 618 (Minn. 1934) . . . 139n21 Schmidt v. Louisville & N.R. Co., 41 S.W. 1015 (Ky. 1897) . . . 314 Schneider v. TRW, Inc., 938 F2d 986 (9th Cir. 1991) . . . 431n9 Schreiner v. Weil Furniture Co., 68 So. 2d 149 (La. Ct. App. 1953) . . . 437n35, 486n4 Schwartz v. Michigan Sugar Co., 308 N.W.2d 459 (Mich. Ct. App. 1981) . . . 432n12 Schwartzreich v. Bauman-​Basch, Inc., 131 N.E. 887 (N.Y. 1921) . . . 43n32 Scott-​Burr Stores Corp. v Wilcox, 194 F.2d 989 (5th Cir. 1952) . . . 452n64 Scott v. Lane, 409 So. 2d 791 (Ala. 1982) . . . 432n14 Scott v. Moragues Lumber Co., 80 So. 394 (Ala. 1918) . . . 715 Sears Roebuck & Co.; United States v., 778 F.2d 810 (D.C. Cir. 1985) . . . 43n37 Seaside Cmty. Dev. Corp. v. Edwards, 573 So. 2d 142 (Fla. Ct. App. 1991) . . . 347n32 Seaver v. Ransom, 120 N.E. 639 (N.Y. 1918) . . . 748–​749, 759–​760, 778–​779 SEC v. See name of opposing party Security Fund Servs., Inc. v. American Nat’l Bank & Trust Co., 542 F. Supp. 323 (N.D. Ill. 1982) . . . 753n62 Security Mut. Cas. Co. v. Pacura, 402 So. 2d 1266 (Fla. Dist. Ct. App. 1981) . . . 753n61 Security Stove & Mfg. Co. v. American Rys. Express Co., 51 S.W.2d 572 (Mo. Ct. App. 1932) . . . 230, 237, 342n19, 349n40 Seggebrush v. Stosar, 33 N.E.2d 159 (Ill. 1941) . . . 710 Seibel v. Layne & Bowler, Inc., 641 P.2d 668 (Or. Ct. App. 1982) . . . 543 Seizure of $82,000 More or Less, In re, 119 F. Supp. 2d 1013 (W.D. Mo. 2000) . . . 591–​593, 645 Semelhago v. Paramadevan, [1996] 2 S.C.R. 415 . . . 310 Sengal v. IGT, 2 P.3d 258 (Nev. 2000) . . . 575n49 Shea-​S & M Ball v. Massman-​Kiewit-​Early, 606 F.2d 1245 (D.C. Cir. 1979) . . . 315n59, 767n112, 768n113 Shell v. Schmidt, 272 P.2d 82 (Cal. Dist. Ct. App. 1954) . . . 772n132, 773n137 Sherwood v. Walker, 33 N.W. 919 (Mich. 1887) . . . 588–​589, 592, 594 Shubert Theatrical Co. v. Rath, 271 F. 827 (2d Cir. 1921) . . . 452n65 Shuey v. United States, 92 U.S. 73 (1875) . . . 472, 473–​747 Siegel v. Spear & Co., 138 N.E. 414 (N.Y. 1923) . . . 119n59 Silverman v. Alday, 38 S.E.2d 419 (Ga. 1946) . . . 311n43 Simmons v. United States, 308 F.2d 160 (4th Cir. 1962) . . . 437, 485, 487 Sioux Falls Adjustment Co. v. Penn Soo Oil Co., 220 N.W. 146 (S.D. 1928) . . . 138n20 The Sirius, 57 F. 851 (9th Cir. 1893) . . . 75n19 S.J. Groves & Sons Co. v. Warner Co., 576 F.2d 524 (3d Cir. 1978) . . . 315n59 Slovek v. Board of Cnty. Comm’rs, 697 P.2d 781 (Colo. Ct. App. 1984) . . . 338n9 Smith v. Hughes, (1871) 6 LRQB 597 (Eng.) . . . 400, 597 Smyth v. City of New York, 96 N.E. 409 (N.Y. 1911) . . . 747n41

831

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831

Snepp v. United States, 444 U.S. 507 (1980) . . . 350–​353, 361 Snyder v. Herbert Greenbaum & Assocs., Inc., 380 A.2d 618 (Md. Ct. Spec. App. 1977) . . . 191n4 Snyder Plumbing & Heating Corp. v. Purcell, 195 N.Y.S.2d 780 (App. Div. 1960) . . . 752n57, 753n61 Socony-​Vacuum Oil Co. v. Continental Cas. Co., 219 F.2d 645 (2d Cir. 1955) . . . 765n100, 766n107 Soldano v. O’Daniels, 190 Cal. Rptr. 310 (Ct. App. 1983) . . . 134, 135 Southern Ill. Riverboat Casino Cruises, Inc. v. Triangle Insulation & Sheet Metal Co., 302 F.3d 667 (7th Cir. 2002) . . . 444 Southwest Eng’g Co. v. United States, 341 F.2d 998 (8th Cir. 1965) . . . 288n20, 442n42 Spates v. Spates, 296 A.2d 581 (Md. 1972) . . . 776n143 Speckel v. Perkins, 364 N.W.2d 890 (Minn. Ct. App. 1985) . . . 569 Springstead v. Nees, 109 N.Y.S. 148 (App. Div. 1908) . . . 44n38, 502n13 State v. See name of opposing party Statler v. George A. Ray Mfg. Co., 88 N.E. 1063 (N.Y. 1909) . . . 14n13 Stearns v. Emery-​Waterhouse Co., 596 A.2d 72 (Me. 1991) . . . 804n42 Steele v. Steele, 23 A. 959 (1892) . . . 118n58 Stepps Invs., Ltd. v. Security Capital Corp., (1976) 73 D.L.R.3d 351 (Can.) . . . 574n47 Step-​Saver Data Sys., Inc. v. Wyse Tech., 939 F.2d 91 (3d Cir. 1991) . . . 446n52 Steuart v. McChesney, 444 A.2d 659 (Pa. 1982) . . . 381–​383 Stevens v. Bouchard, 532 A.2d 1028 (Me. 1987) . . . 615n71 Stevenson, Jaques, & Co. v. McLean, [1880] 5 QBD 346 (Eng.) . . . 478n68 Stewart v. Basey, 245 S.W.2d 484 (Tex. 1952) . . . 286n9 Stowe v. Smith, 441 A.2d 81 (Conn. 1981) . . . 763n88 S.T.S. Transp. Serv., Inc. v. Volvo White Truck Corp., 766 F.2d 1089 (7th Cir. 1985) . . . 405, 558 Succession of. See name of party Sullivan v. O’Connor, 296 N.E. 2d 183 (Mass. 1976) . . . 180, 186n10 Sumerel v. Pinder, 83 So. 2d 692 (Fla. 1955) . . . 439n37 Swift & Co. v. Smigel, 279 A.2d 895 (N.J. Super. Ct. App. Div. 1971), aff ’d, 289 A.2d 793 (N.J. 1972) . . . 475 Swift Canada Co. v. Banet, 224 F.2d 36 (3d Cir. 1955) . . . 636n32 Syndoulos Lutheran Church v. A.R.C. Indus., 662 P.2d 109 (Alaska 1983) . . . 768n116, 769 T Tameny v. Atlantic Richfield Co., 610 P.2d 1330 (Cal. 1980) . . . 432n13 Taylor v. Caldwell, (1863) 122 Eng. Rep. 309; 3 B&S 826 . . . 641, 737 Taylor v. Johnston, 539 P.2d 425 (Cal. 1975) . . . 677n14 Taylor v. Kelly, 56 N.C. 240 (1857) . . . 347n32 Taylor v. Meirick, 712 F.2d 1112 (7th Cir. 1983) . . . 344 T.C. May Co. v. Menzies Shoe Co., 113 S.E. 593 (N.C. 1922) . . . 138n20 Teachers Ins. & Annuity Ass’n v. Butler, 626 F. Supp. 1229 (S.D.N.Y. 1986) . . . 513–​514 Teachers Ins. & Annuity Ass’n v. Tribune Co., 670 F. Supp. 491 (S.D.N.Y. 1987) . . . 507–​513 The Telemachus, [1957] p. 47 (Eng.) . . . 76n21 Tetenman v. Epstein, 226 P. 966 (Cal. Dist. Ct. App. 1924) . . . 591n34 Texas Co. v. Central Fuel Oil Co., 194 F. 1 (8th Cir. 1912) . . . 308n34 Texas Gulf Sulphur Co., SEC v., 401 F.2d 833 (2d Cir. 1968) (en banc) . . . 596n3, 618 Textron, Inc. v. Froelich, 302 A.2d 426 (Pa. Super. Ct. 1973) . . . 459 Thacker v. Tyree, 297 S.E.2d 885 (W. Va. 1982) . . . 615n71 Thatcher v. Kramer, 180 N.E. 434 (Ill. 1932) . . . 81n30 Theta Prods., Inc. v. Zippo Mfg. Co., 81 F. Supp. 2d 346 (D.R.I. 1999) . . . 793n19 Thomas v. Winchester, 6 N.Y. 397 (1852) . . . 14n13 Thompson v. McAllen Federated Woman’s Bldg. Corp., 273 S.W.2d 105 (Tex. Civ. App. 1954) . . . 116n52 Thompson v. St. Regis Paper Co., 685 P.2d 1081 (Wash. 1984) . . . 433n19 Thornborow v. Whitacre, (1790) 92 Eng. Rep. 270; 2 Ld. Raym. 1164 . . . 81n30 Thorne v. Deas, 4 Johns. 84 (N.Y. Sup. Ct. 1809) . . . 118n58

832

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Table of Cases

Thorstenson v. Mobridge Iron Works Co., 208 N.W.2d 715 (S.D. 1973) . . . 224n13 Thos. J. Dyer Co. v. Bishop Int’l Eng’g Co., 303 F.2d 655 (6th Cir. 1962) . . . 725 Timko v. Useful Homes Corp., 168 A. 824 (N.J. Ch. 1933) . . . 347n32, 348n35 Timko, In re Estate of v. Oral Roberts Evangelistic Ass’n, 215 N.W.2d 750 (Mich. Ct. App. 1974) . . . 116n51 Ting v. AT&T, 319 F.3d 1126 (9th Cir. 2003) . . . 92n61 Tito v. Waddell (No.2), [1977] 1 Ch. 106, 332 (Ch.) (U.K.) . . . 213n36 Todd v. Weber, 95 N.Y. 181 (1884) . . . 747n41 Toker v. Westerman, 274 A.2d 78 (N.J. Union Cty. D. Ct. 1970) . . . 90 Tongish v. Thomas, 829 P.2d 916 (Kan. Ct. App. 1992) . . . 196–​197, 199 Topps Co., v. Cadbury Stani S.A.I.C., 380 F. Supp. 2d 250 (S.D.N.Y. 2005) . . . 339n15 Toussaint v. Blue Cross & Blue Shield, 292 N.W.2d 880 (Mich. 1980) . . . 433 Tower Inv’rs v. 111 E. Chestnut Consultants, Inc., 864 N.E.2d 927 (Ill. App. Ct. 2007) . . . 44n39 Town of. See name of town Transatlantic Fin. Corp. v. United States, 363 F.2d 312 (D.C. Cir. 1966) . . . 632, 634, 650, 657 Trans World Metals, Inc. v. Southwire Co., 769 F.2d 902 (2d Cir. 1985) . . . 199n32 Travelers Indem. Co. v. Maho Mach. Tool Corp., 952 F.2d 26 (2d Cir. 1991) . . . 315n59 Triangle Waist Co. v. Todd, 119 N.E. 85 (N.Y. 1918) . . . 346n30 Trident Ctr. v. Connecticut Gen. Life Ins. Co., 847 F.2d 564 (9th Cir. 1998) . . . 383n24 Trilco Terminal v. Prebilt Corp., 400 A.2d 1237 (N.J. Super. Ct. Law Div. 1979), aff ’d, 415 A.2d 356 (N.J. Super. Ct. App. Div. 1980) . . . 801n37 Trinidad Bean & Elevator Co. v. Frosh, 494 N.W.2d 347 (Neb. Ct. App. 1992) . . . 681 Turner Entm’t Co. v. Degeto Film GmbH, 25 F.3d 1512 (11th Cir. 1994) . . . 661n121 T.W. Oil Inc. v. Consolidated Edison Co., 443 N.E.2d 932 (N.Y. 1982) . . . 692, 701 Tweddle v. Atkinson, (1861) 121 Eng. Rep. 762; 1 B. & S. 393 . . . 746 Two Wheel Corp.; People v., 512 N.Y.S.2d 439 (N.Y. App. Div. 1987), aff ’d, 525 N.E.2d 692 (N.Y. 1988) . . . 79n27 U Union Carbide Corp. v. Consumers Power Co., 636 F. Supp. 1498 (E.D. Mich. 1986) . . . 199n32 Union Carbide Corp. v. Oscar Mayer Foods Corp., 947 F.2d 1333 (7th Cir. 1991) . . . 444n48 Unita Oil Ref. Co. v. Ledford, 244 P.2d 881 (Colo. 1952) . . . 349n41, 350n42 United States v. See name of opposing party United States Naval Inst. Press v. Charter Commc’ns, Inc., 936 F.2d 692 (2d Cir. 1991) . . . 339–​341 University of Colo. Found., Inc. v. American Cyanamid Co., 342 F.3d 1298 (Fed. Cir. 2003) . . . 358n61 University of V. I. v. Petersen-​Springer, 232 F. Supp. 2d 462 (D.V.I. 2002) . . . 43n37 Unlimited Equip. Lines, Inc. v. The Graphic Arts Ctr., Inc., 889 S.W.2d 926 (Mo. Ct. App. 1994) . . . 199n32 V Valashinas v. Koniuto, 124 N.E.2d 300 (N.Y. 1954) . . . 480 Vanadium Corp. v. Fidelity & Deposit Co., 159 F.2d 105 (2d Cir. 1947) . . . 145–​146 Van Gulic v. Resource Dev. Council for Alaska, 695 P.2d 1071 (Alaska 1985) . . . 491 Vantage Point, Inc. v. Parker Bros., Inc., 529 F. Supp. 1204 (E.D.N.Y. 1981) . . . 473n49 Vasquez-​Lopez, v. Beneficial Or., Inc., 152 P.3d 940 (Or. App. 2007) . . . 92n61 Venture Assocs. Corp. v. Zenith Data Syst. Corp., 96 F.3d 275 (7th Cir. 1996) . . . 515 Vermont Elec. Supply Co. v. Andrus, 373 A.2d 531 (Vt. 1977) . . . 349n41 Vernon, City of v. Los Angeles, 290 P.2d 841 (Cal. 1955) . . . 650, 661 Verstandig v. Schlaffer, 70 N.E.2d 15 (N.Y. 1946) (per curiam) . . . 81n28 Vickery v. Ritchie, 88 N.E. 835 (Mass. 1909) . . . 331

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833

Victoria Laundry (Windsor) Ltd. v. Newman Indus. Ltd., [1949] 2 K.B. 528 (C.A.) (Eng.) . . . 242n14, 245–​246, 246n25 Vincent v. Superior Oil Co., 178 F. Supp. 276 (W.D. La. 1959) . . . 81n30 Vincent v. Woodland Oil Co., 30 A. 991 (Pa. 1895) . . . 459n6 Vincenzi v. Cerro, 442 A.2d 1352 (Conn. 1982) . . . 699 Vines v. Orchard Hills, Inc., 435 A.2d 1022 (Conn. 1980) . . . 289n22, 698 Visintine & Co. v. New York, Chi. & St. Louis R.R. Co., 160 N.E.2d 311 (Ohio 1959) . . . 768n114 Vitex Mfg. Corp., Ltd. v. Caribtex Corp., 377 F.2d 795 (3d Cir. 1967) . . . 204 Vito v. Pokoik, 150 A.D.2d 331 (1989) . . . 130n107 Vogel v. Reed Supply Co., 177 S.E.2d 273 (N.C. 1970) . . . 752n57, 768n115 Vrooman v. Turner, 69 N.Y. 280 (1877) . . . 746, 748 W Wachtel v. National Alfalfa Journal Co., 176 N.W. 801 (Iowa 1920) . . . 491n20 Wagenvoord Broad. Co. v.  Canal Automatic Transmission Serv., Inc., 176 So. 2d 188 (La. Ct. App. 1965) . . . 459n6 Wagner v. Sperry Univac, Div. of Sperry Rand Corp., 458 F. Supp. 505 (E.D. Pa. 1978), aff ’d, 624 F.2d 1092 (3d Cir. 1980) . . . 432n14 Walgreen Co. v. Sara Creek Prop. Co., 966 F.2d 273 (7th Cir. 1992) . . . 54–​55, 295n2 Walker & Co v. Harrison, 81 N.W.2d 352 (Mich. 1957) . . . 695 Walsh v. Mutual Life Ins. Co., 31 N.E. 228 (N.Y. 1892) . . . 776n140 Warden v. Jones, (1857) 2 De G. & J. 76 . . . 789n15 Watkins v. Paul, 511 P.2d 781 (Idaho 1973) . . . 311 Watters v. Lincoln, 135 N.W. 712 (S.D. 1912) . . . 470n37 W.E. Rippon & Son v. United States, 348 F.2d 627 (2d Cir. 1965) . . . 78n24 Weathersby v. Gore, 556 F.2d 1247 (5th Cir. 1977) . . . 300n12, 301, 303, 307 Weaver v. American Oil Co., 276 N.E.2d 144 (Ind. 1971) . . . 81 Webb v. McGowin, 168 So. 196 (Ala. Ct. App. 1935), cert. denied, 169 So. 199 (Ala. 1936) . . . 113–​114 Webb v. Saunders, 181 P.2d 43 (Cal. 1947) . . . 84n43 Weeks Marine, Inc. v. John P. Picone, Inc., 97 Civ. 9560, 1998 U.S. Dist. LEXIS 15053 (S.D.N.Y. Sept. 23, 1998) . . . 256n4 Wegematic Corp.; United States v., 360 F.2d 674 (2d Cir. 1966) . . . 633 Weintraub v. Krobatsch, 317 A.2d 68 (N.J. 1974) . . . 615 Wells v. Davis, 14 S.W. 237 (Tex. 1890) . . . 123n75 West-​Fair Elec. v. Aetna Cas. & Sur. Co., 661 N.E.2d 967 (N.Y. 1995) . . . 725n23 West Haven Sound Dev. Corp. v. West Haven, 514 A.2d 734 (Conn. 1986) . . . 154 Westside Galvanizing Serv. Inc. v. Georgia-​Pacific Corp., 921 F.2d 735 (8th Cir. 1990) . . . 126n87 Wheat v. Rice, 97 N.Y. 296 (1884) . . . 747 White & Carter (Councils) Ltd. v. McGregor, [1962] A.C. 413 (HL) 427 . . . 301n16 Whitney v. Alltel Commc’ns, Inc., 173 S.W.3d 300 (Mo. App. 2005) . . . 92n61 Whittaker v. Care-​More, Inc., 621 S.W.2d 395 (Tenn. Ct. App. 1981) . . . 432n12 Wickham & Burton Coal Co. v. Farmers’ Lumber Coal Co., 179 N.W. 417 (Iowa 1920) . . . 130n109 Wigginton v. Dell, Inc., 890 N.E.2d 541 (Ill. App. 3d 2008) . . . 92n61 Williams v. Walker-​Thomas Furniture Co., 198 A.2d 914 (D.C. 1964) . . . 524n12 Williams v. Walker-​Thomas Furniture Co., 350 F.2d 445 (D.C. Cir. 1965) . . . 70n7, 89n48, 94–​95, 524 Wired Music, Inc. v. Clark, 168 N.E. 2d 736 (Ill. App. Ct. 1960) . . . 205 Wisconsin Knife Works v. National Metal Crafters, 781 F.2d 1280 (7th Cir. 1986) . . . 814 WM. R. Clarke Corp. v. Safeco Ins. Co., 938 P.2d 372 (Cal. 1997) . . . 725n23 Woburn Nat’l Bank v. Woods, 89 A. 491 (N.H. 1914) . . . 397 Wolosoff v. Gadsden Land & Bldg. Corp., 18 So. 2d 568 (Ala. 1944) . . . 778n150

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Wood v. Lucy, Lady Duff-​Gordon, 118 N.E. 214 (N.Y. 1917) . . . 36, 236 Woodmere Acad. v. Steinberg, 363 N.E.2d 1169 (N.Y. 1977) . . . 117n53 Woods v. Morgan City Lions Club, 588 So. 2d 1196 (La. Ct. App. 1991) . . . 473n49 Wroth v. Tyler, [1974] Ch 30 (Eng.) . . . 246 Wullschleger & Co. v. Jenny Fashions, Inc., 618 F. Supp. 373 (S.D.N.Y. 1985) . . . 243n17 Y Yania v. Bigan, 155 A.2d 343 (Pa. 1959) . . . 134, 135 Yellow-​Stone Kit v. State, 7 So. 338 (Ala. 1890) . . . 486n5 Y.J.D. Rest. Supply Co. v. Dib, 413 N.Y.S.2d 835 (N.Y. Sup. Ct. 1979) . . . 349n41 Young v. Overbaugh, 39 N.E. 712 (N.Y. 1895) . . . 123n75 The Young Am., 20 F. 926 (D.N.J. 1884) . . . 75n19 Z Zemco Mfg. Inc. v. Navistar Int’l Transp. Corp., 186 F.3d 815 (7th Cir. 1999) . . . 808 Zigas v. Superior Court, 174 Cal. Rptr. 806 (Ct. App. 1981) . . . 772, 774 Zim Israel Navigation Co. v. 3-​D Imps. Inc., 29 F. Supp. 2d 186 (S.D.N.Y 1998) . . . 256n4

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FEDERAL LAWS AND REGULATIONS U.S. Code 11 U.S.C. §541(a) . . . 770n124 12 U.S.C. §1713(b) . . . 772n136 15 U.S.C. §§77a–​77aa . . . 614n62 §1635 . . . 83n41 §1635(a)–​(g) . . . 83n41 §§7001–​7006 . . . 785n5 §7002 . . . 785n6 §7006(9) . . . 449n56 §7021 . . . 785n5 §7031 . . . 785n5 18 U.S.C. §1514A . . . 431n11 21 U.S.C. §§301–​399 . . . 614n63 29 U.S.C. §160(c) . . . 313n48 §626(a)(1) . . . 431n10 §626(b) . . . 313n49 42 U.S.C. §2000e-​2(a)(1) . . . 431n10 §2000e-​5(g)(1) . . . 313n49 §12112 . . . 431n10 §12117 . . . 313n49 46 U.S.C. §2304 . . . 148n54 Code of Federal Regulations 16 C.F.R. §429.1 . . . 83n40, 162n21 17 C.F.R. §240.10b-​5 . . . 562n14

STATE LAWS California Civil Code §§1102–​1102.18 . . . 614n66 §1521 . . . 43n34 §1524 . . . 43n34 §1697 . . . 43n34 Georgia Code §9-​11-​70 . . . 311n43 Illinois Comp. Stat. §205/​2 . . . 256n3 Louisiana Civil Code art. 1997 . . . 252 Michigan Comp. Laws §566.1 . . . 43n34 §600.6013(8) . . . 256n4 New York Gen. Bus. Law §396-​r . . . 78–​79 New York Gen. Oblig. §5-​702 . . . 82n33 §5-​1103 . . . 43n34 §5-​1109 . . . 464 New York Penal Law §155.05 . . . 563n15, 563n16 Pennsylvania Cons. Stat. §3924 . . . 563 Texas Prop. Code §5.008(b) . . . 614n66 Virginia Code §55-​519 . . . 614n66 UNIFORM LAWS Uniform Commercial Code art. 1 . . . 4

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

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§1-​103 . . . 804 §1-​106 . . . 196, 198 §1-​106(1) . . . 196, 198 §1-​201 . . . 709 §1-​201, cmt. 1 . . . 387n40 §1-​201, cmt. 37 . . . 799 §1-​201(3) . . . 367 §1-​201(12) . . . 367, 629n12 §1-​201(20) . . . 700, 707n4 §1-​302(a) . . . 387 §1-​302(b) . . . 387n41 §1-​303(a) . . . 369n4 §1-​303(d) . . . 369–​370 §1-​304 . . . 700, 707, 709 §1-​305(a) . . . 193 art. 2 . . . 4, 310, 444, 680 §2-​104(1) . . . 793 §2-​201 . . . 784, 791, 792, 794, 801, 804, 808, 809, 810 §2-​201, cmt. 2 . . . 387n40 §2-​201(1) . . . 792, 793, 800, 801, 802 §2-​201(2) . . . 793, 801 §2-​201(3)(a) . . . 792 §2-​201(3)(b) . . . 793 §2-​201(3)(c) . . . 792 §2-​202 . . . 387, 536–​537, 541, 543 §2-​202, cmt. 3 . . . 536, 539 §2-​202(2) . . . 541 §2-​202(b) . . . 542 §2-​203(1) . . . 155 §2-​204 . . . 502 §2-​204(2) . . . 502 §2-​205 . . . 387, 464, 465–​466 §2-​206 . . . 787 §2-​206(1)(b) . . . 428n2 §2-​206(2) . . . 439n39 §2-​207 . . . 139, 441–​442, 443, 444, 446, 482, 525, 528 §2-​207, cmt. 2 . . . 444 §2-​207, cmt. 4 . . . 443 §2-​207, cmt. 5 . . . 444 §2-​207, cmt. 6 . . . 445, 528 §2-​207(1) . . . 442, 443, 445, 446, 447, 482 §2-​207(2) . . . 443, 445 §2-​207(2)(a)–​(c) . . . 444, 445 §2-​207(2)(b) . . . 443, 445 §2-​207(2)(c) . . . 445 §2-​207(3) . . . 442, 446–​447, 528 §2-​209 . . . 43, 813 §2-​209, cmt. 1 . . . 43 §2-​209, cmt. 3 . . . 808 §2-​209(1) . . . 813 §2-​209(2) . . . 813, 814

§2-​209(3) . . . 808–​809, 813 §2-​209(4) . . . 813–​814 §2-​209(5) . . . 813–​814 §2-​302 . . . 69, 91 §2-​302, cmt. 1 . . . 543 §2-​305 . . . 502, 518 §2-​306(1) . . . 33n8 §2-​306(2) . . . 36n15 §2-​308 . . . 502 §2-​309 . . . 502 §2-​310 . . . 502 §2-​311 . . . 539 §2-​311(3) . . . 145n42 §§2-​314 to 2-​316 . . . 614, 614n64 §2-​316 . . . 543 §2-​328(2)–​(3) . . . 465n23 §2-​328(3) . . . 465n24 §2-​504 . . . 539 §2-​507 . . . 669n1 §2-​508 . . . 692, 701 §2-​508, cmt. . . . 684–​685 §2-​508(1) . . . 701 §2-​508(2) . . . 692, 693, 701 §2-​511 . . . 669n1 §2-​601 . . . 700, 701, 702 §2-​608 . . . 700 §2-​609 . . . 184n8, 680, 683, 685, 686 §2-​609, cmt. 1 . . . 59n18, 264n12, 674n3, 680, 683–​684 §2-​609(1) . . . 685 §2-​610 . . . 680 §2-​610, cmt. 1 . . . 678 §2-​610(a) . . . 681 §2-​611 . . . 677n12 §2-​612 . . . 700, 702 §2-​615 . . . 648 §2-​615, cmt. 6 . . . 661 §2-​615, cmt. 8 . . . 632n18, 634 §2-​703 . . . 310n36 §2-​704 . . . 680 §2-​706 . . . 189 §2-​708 . . . 261n7 §2-​708(1) . . . 189, 191, 196, 680 §2-​708(2) . . . 154n18, 189, 191, 191n4 §2-​708(a) . . . 199 §2-​709 . . . 310 §2-​710 . . . 261n6 §2-​711 . . . 310n36 §2-​712 . . . 221n1, 224 §2-​712(1) . . . 221n1, 515 §2-​712(2) . . . 221n1 §2-​713 . . . 193, 680 §2-​713, cmt. . . . 193

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§2-​713(1) . . . 196, 680–​681 §2-​714(2) . . . 192, 206 §2-​715 . . . 150n5, 193 §2-​718 . . . 190, 444 §2-​718(1) . . . 329n27 §2-​718(2) . . . 328, 329n26 §2-​718(3) . . . 329n26 §2-​719 . . . 91, 250, 444 §2-​719(1)(a) . . . 250n35 §2-​719(3) . . . 251 §2-​723(1) . . . 680 §8-​113 . . . 795 §9-​203 . . . 795 Uniform Computer Information Transactions Act §15 . . . 456n75 Uniform Consumer Credit Code §3.502 . . . 83n39 §5.108 . . . 69n4,  95–​96 §5.108(4) . . . 96 Uniform Consumer Sales Practices Act §4 . . . 69n4 Uniform Electronic Transactions Act . . . 784, 786 §2(8) . . . 785 §2(13) . . . 449n56, 785 §7 . . . 785 §15 . . . 456n75 Uniform Residential Landlord and Tenant Act §1.303(a)(1) . . . 69n4 §2.104 . . . 615n68 FOREIGN STATUTES English Act for the Prevention of Frauds and Perjuries (1677) . . . 783 English Law Reform (Enforcement of Contracts) Act (1954) . . . 787n8 English Mercantile Law Amendment Act (1856) . . . 787n8 English Statute of Frauds . . . 4, 783–​784, 786–​ 789, 800 French Civil Code art. 953 . . . 100n10 art. 955 . . . 100n10 art. 960 . . . 100n10 art. 1150 . . . 252 German Civil Code §138(2) . . . 72, 75, 81, 94 §519 . . . 100n9 §528 . . . 100n10 §530(1) . . . 100n8, 100n10 German Code of Obligations art. 21(1) . . . 72n12, 94n64

RESTATEMENTS Restatement (Third) of Agency §8.05 . . . 337 Restatement (First) of Contracts §42 . . . 470–​471 §45 . . . 467–​468 §74 . . . 44n39 §75 . . . 119n62 §76 . . . 44 §76(b) . . . 44n38 §84 . . . 111 §90 . . . 117, 119, 120, 121, 122, 124–​129 §133 . . . 749–​750, 752n55 §135 . . . 750 §136 . . . 750 §142 . . . 776 §143 . . . 776 §197 . . . 806 §228 . . . 534 §235 . . . 390 §236 . . . 390 §237 . . . 534 §240 . . . 537, 538 §240(1)(b) . . . 540 §246 . . . 390–​391 §326 . . . 363 §339 . . . 283 §346 . . . 209n23 §346(1)(a)(i) . . . 208 §503 . . . 567 Restatement (Second) of Contracts §1 . . . 33n4, 103n20, 430 §15 . . . 81 §15(1) . . . 80 §15(2) . . . 81n28 §20(1) . . . 402 §22(1) . . . 502 §24 . . . 418n2, 419, 420n10 §26 . . . 421, 422 §27 . . . 503n15, 510n41 §30(2) . . . 428n4 §32 . . . 428 §38, cmt. a . . . 477n61 §39 . . . 478 §39(1) . . . 477n63 §40 . . . 452–​453 §41, cmt. . . . 458 §41(1) . . . 457n1 §43 . . . 471n42 §45 . . . 440, 467, 468, 472 §46 . . . 473n50 §48 . . . 475 §50 . . . 430n7

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§53 . . . 438 §54 . . . 140n24, 439n38 §56 . . . 447, 449 §59 . . . 440n40, 441n41, 479n73 §59, cmt. . . . 482 §59, cmt. b . . . 480n75 §61 . . . 430n7 §62 . . . 469 §63 . . . 452, 453n68, 454 §64 . . . 455 §67 . . . 450 §70 . . . 139n23, 460n10 §71 . . . 47, 464 §71, cmt. b . . . 47n41 §71(1) . . . 29, 32n3 §73 . . . 120n68 §73, cmt. a . . . 38n18 §74 . . . 44 §74, cmt. b . . . 45n39 §77 . . . 45–​46, 47 §79 . . . 432 §86 . . . 113n45, 114 §86(2) . . . 115 §87 . . . 47 §87(1)(a) . . . 47, 464n22 §87(2) . . . 465, 472 §89 . . . 43 §89(a) . . . 43n36 §90 . . . 124–​125, 128, 777n146 §90(1) . . . 122, 125, 128–​129 §90(2) . . . 116, 129 §96 . . . 110n41 §116 . . . 797 §124 . . . 798n27, 798n28 §125 . . . 791n17 §125, cmt. a . . . 791n17 §125, cmt. c . . . 791n17 §125(3) . . . 806n45 §127 . . . 786n7 §128(1) . . . 807n47 §129 . . . 807 §129, cmt. c . . . 806n46 §130 . . . 795n21, 795n23, 807 §131, cmt. g . . . 800n35 §133 . . . 790n16 §139 . . . 330n33, 803 §141(2) . . . 789 §143 . . . 799n30 §144 . . . 789n12 §145 . . . 789n13 §148 . . . 808 §150 . . . 813n1 §152 . . . 636n33

§152, cmt. b . . . 588n23 §153 . . . 567n22, 568, 571, 573, 574 §154 . . . 571, 587, 590 §154, cmt. c . . . 585, 588 §157 . . . 637 §161 . . . 615, 616 §175 . . . 38n19, 39n20, 74n14 §177 . . . 83 §177(1) . . . 83 §201 . . . 401 §201(1) . . . 17 §201(2) . . . 17 §201(2)(a) . . . 404 §201(2)(b) . . . 398, 399 §202, cmt. c . . . 370 §202(4) . . . 369 §204, cmt. d . . . 757 §205 . . . 143, 707 §207 . . . 757 §208 . . . 69n5, 719 §209 . . . 535 §209, cmt. . . . 535 §209(3) . . . 536 §210 . . . 542 §210, cmt. b . . . 536 §211 . . . 524 §212 . . . 373 §213 . . . 535 §214 . . . 540n16 §214, cmt. b . . . 378n10 §214(d) . . . 544n24 §215 . . . 540 §216 . . . 538 §216, cmt. e . . . 543 §217 . . . 546, 547 §219 . . . 368 §220 . . . 368, 378n12 §221 . . . 368, 378 §221(1) . . . 369 §222 . . . 378 §223(1) . . . 369 §227 . . . 723 §228 . . . 726, 727 §229 . . . 719, 720, 722 §230 . . . 722 §234, cmt. a . . . 670n2 §234(1) . . . 669 §234(2) . . . 670 §235(2) . . . 175 §237 . . . 702 §237, cmt. d . . . 717 §241 . . . 688, 698 §241(b) . . . 694

839

Table of Statutes, Regulations, and Restatements

§241(e) . . . 698–​699 §242 . . . 688–​689 §247 . . . 688 §251 . . . 184n8, 685 §253 . . . 675, 676, 677 §253(1) . . . 675 §256 . . . 677 §261 . . . 636, 637, 638, 644, 650 §265 . . . 635 §266(1) . . . 637n37 §271 . . . 722 §272(2) . . . 661 §302 . . . 751n54, 754n67, 755, 758 §302, cmt. d . . . 759 §302(1) . . . 755 §302(1)(a) . . . 755 §302(1)(b) . . . 754, 755 §309(1)–​(2) . . . 775n138 §309(3) . . . 779 §311 . . . 776–​777, 778n151 §311, cmt. h . . . 778n151 §313 . . . 771n131 §313(2) . . . 770 §318(2) . . . 315n57 §322 . . . 693 §344 . . . 335–​336, 337, 363 §344(c) . . . 345 §346, cmt. h . . . 201 §346(2) . . . 202 §346(3) . . . 490 §347, cmt. c . . . 155n22 §348(3) . . . 491 §350 . . . 150, 155 §350(1) . . . 149 §351 . . . 240n8, 651 §351, cmt. f . . . 651 §351(1) . . . 241n10, 244n21, 651 §351(2) . . . 651 §351(3) . . . 220, 253, 651

§352 . . . 227n1 §354 . . . 255 §356 . . . 283n1 §356, cmt. b . . . 283n1, 289n22 §357 . . . 295n1 §358, cmt. e . . . 154 §§359–​360 . . . 295n1 §360 cmt. b . . . 309 §360 cmt. e . . . 310n38 §§366–​367 . . . 295n1 §367(2) . . . 312n46 §374 . . . 695n18 Restatement (Second) of Property §5.6 . . . 69 Restatement (Third) of Restitution & Unjust Enrichment §2(2) . . . 324 §9 . . . 331n35 §34 . . . 331n36 §36(2) . . . 329n28 §36(3) . . . 329n30 §36(4) . . . 329n29 §37 . . . 325 §37, cmt. b . . . 325n18 §38 . . . 325, 326 §38, cmt. c . . . 326n22 §38, cmt. d . . . 326n21 §38(2)(b) . . . 326n21 §39 . . . 348n34 §39(1) . . . 347n34 §40 . . . 332n38 §65 . . . 331n34 §65, cmt. c . . . 564 Restatement (Second) of Torts §8A . . . 753 §314 . . . 133 §314, cmt. c . . . 134 §435 . . . 244n21 §551(2) . . . 617n75

839

840

841

Index

Abblebome, Peter, 135 Above-​market prices,  85–​89 Acceptance ambiguous offers, 428–​429 bilateral contracts, 440–​447 choice-​of-​law rules,  452 conditional acceptances, 479–​481 conditional assent, 446–​447 conversation rule, 458–​459 crossed revocation, 451 delay, 451–​452 EDI, 450 effectiveness, 450–​454 electronic, 449–​450 firm-​offer rule, 460–​466 knockout rule, 445–​446 knowledge of offer, 438–​439 lapse, 457–​460 last-​shot rule, 441, 447n53 late acceptance, 139 lateness, notification of, 460 mirror image rule, 440–​441, 481–​482 modes of, 427–​456 new transmission modes, 455–​456 obligations of offeree who has begun performance, 440 offeree’s change of heart, 452–​453 offeree’s motivation, 436–​438, 436n28 one-​sidedness, 462–​463 options, 452 performance by offeree notice requirement, 439–​440

by promise or act, 427–​429 record, defined, 449–​450 rejection followed by, 453 rejection or counter-​offer by mail or telegram, 452–​453 repudiation of, 453–​454 silence, 136–​139, 136n15 subjective, 447–​449 termination of power of, 457–​483. See also Termination of power of acceptance time limits, 454 transmission failure, 451–​452 UCC §2-​207(1) contracts, 442–​446 UCC §2-​207(3) contracts, 446–​447 unilateral contracts, 429–​440, 466–​469 withdrawal, 454 Accuracy in interpretation, 385–​387, 394–​395 Adequate assurance principle, 683–​686 apparent material breach, 684 apparent repudiation, 684 breach by promisor of other contracts, 684–​685 Restatement (Second) of Contracts, 685 UCC, 683–​684 Admiralty law and unconscionability principle, 76–​77nn21–​24,  76–​78 Admissions (UCC), 793–​794 Adventitiously acquired information, 599–​604 Adversely affected party, defined, 627 Advertisements as offers, 420–​423, 573n44 Aggrieved party’s ability to perform, 678–​679 Algorithms,  25–​26 Allocative efficiency, 607–​609

Foundational Principles of Contract Law. Melvin A. Eisenberg. © Melvin A. Eisenberg 2018. Published 2018 by Oxford University Press.

842

842

Index

Ambiguous offers, 428–​429 Andersen, Eric, 689 Anderson, Ed, 105–​106 Anderson, Elizabeth, 18 Anson, Walter, 417n1 Anticipatory damages (UCC), 680 Anticipatory repudiation, 673–​681. See also Repudiation aggrieved party’s ability to perform, 678–​679 damages, 679–​681 defined, 675 disregard, 677–​678 effect where promisee fully performed, 675–​677 general principle, 673–​675 Restatement (First) of Contracts, 675 Restatement (Second) of Contracts, 675 UCC, 675 withdrawal, 677 Apparent material breach, 684 Apparent repudiation, 684 Appleman, John, 138 Apportionment and disgorgement, 358–​359, 361–​362 Arrow, Kenneth, 168, 734–​735 Assumpsit action, 338n7 Attorney fees efficient breach theory, 53 expectation damages, 255 At-​will employment rule, 431–​436 Auctions firm-​offer rule, 465, 465n25 as offers, 424–​426 Augmented sanctions, 687–​696 cure, 691–​693 definitions, 687–​689 economic significance of breach, 690–​691 future performance, likelihood of, 689 material breach, defined, 689 opportunistic breach, 691 promisor’s interest, 693–​695 terminology, 687–​689 Availability and behavioral economics, 166–​167,  166n41 Axioms classical to modern contract law, 25 formalist theories, 10–​11 Ayres, Ian, 59 Bad faith, 252, 513–​516. See also Good faith disgorgement, 347 employee discharge, 431 rejecting performance in, 708–​711 restitution, 320, 322–​323, 329, 694

Baker, Lynn A., 165n37 Bargain. See also Bargain principle consideration, 29, 32 donative promises vs., 104 expectation damages, 182–​186 overview,  31–​32 promises,  31–​32 structural agreements, 32–​37 Bargain principle defenses, 37 exceptions,  37–​49 fair dealing, 39–​40 illusory promise rule, 45–​49 invalid claims, 44–​45, 44n39 legal-​duty rule,  38–​43 mutuality, 37, 45–​49 overview, 32 quality-​of-​consent defenses,  37 reciprocity,  39–​40 reliance, 117–​118 specific performance, 297 Barnett, Randy, 581, 583, 607–​608, 629 Baron, Jane, 103, 108 Baumer, David, 60 Bayern, Shawn, 215n40, 269n1, 356n56, 394nn67–​68,  652n83 Beatson, Jack, 564n17 Behavioral economics, 159–​169 availability, 166–​167, 166n41 behavioral economics, 159–​160 bounded rationality, 162–​163 defective capability, 165–​169 expected-​utility model, 159–​160 heuristics, 160, 166–​167 independent significance, 166 invariance, 160–​162 irrational disposition, 163–​165 prospect theory, 169 rationality, 159–​160 representativeness, 167 risk-​estimation faculties, 168–​169 spatial or temporal proximity, 166 telescopic faculties, 167–​168 unrealistic optimism, 163–​165, 169 Beneficiaries. See Third-​party beneficiaries Ben-​Shahar, Omri, 42–​43, 274–​277, 522–​523,  527 Benson, Peter, 16–​17, 17n24 Berlin, Isaiah, 18 Bernstein, Lisa, 60, 274–​277 Best efforts, 36n15 Bilateral contracts acceptance, 440–​447 conditional assent, 446–​447

843

Index

defined, 419 firm-​offer rule, 460–​464 knockout rule, 445–​446 mutuality, 45 revocation of offers for, 460–​464 UCC §2-​207(1) contracts, 442–​446, 446–​447 Birks, Peter H., 337n4 Birmingham, Robert, 51n1, 63, 608, 610 Boilerplate, 521–​529, 521n2 Bounded rationality, 162–​163, 284, 628, 629n9 Braucher, Robert, 758 Breach apparent material breach, 684 by buyers, 189–​192, 217–​220, 260–​261, 310, 311–​312 cost of completion, 206–​215 costs saved by, 354–​356 diminished satisfaction, 208, 210–​212 diminished value, 206–​215, 262 disgorgement, 214–​215 economic significance of, 690–​691 employee’s breach, 312 employer’s breach, 313 full capacity, 220 gain from, 345–​349 likelihood of completion, 208, 212–​213 material breach, defined, 689 opportunistic breach, 691 probability of, 262–​264, 266–​267 promisee’s breach, 328–​329 promisor’s breach, 321–​327 rescue, 140–​143 sales of goods, 189–​192 by sellers, 192–​194, 261–​262, 306–​308, 310–​311 by service providers, 206–​215 by service purchasers, 150n4, 201–​206 services contracts, 201–​215 unreasonable disproportion, 208–​209 unreasonable economic waste, 208–​209, 211 value held after, 262 warranty, 192 Burden of proof and restitution, 329 Buyers breach by, 189–​192, 217–​220, 260–​261, 310, 311–​312 Disclosure Principle, 619–​620 formulas for measuring expectation damages, 189–​192, 217–​220, 260–​261,  310 overreliance theory, 260–​261 real property sales, 311–​312 sales of goods, 189–​192, 217–​220, 260–​261,  310

843

Specific Performance Principle, 311–​312 trolling for sellers’ mistakes, 619–​620 Cancellation of contract, 65n28 Capital Asset Pricing Model (CAPM), 233–​234 Cardozo, Benjamin N., 693–​694 Carroll, David W., 194n13 Cash gifts and donative promises, 107 Casto, William R., 118n56, 118–​119n58 Categorical rules, 410 Causation. See also Proximate cause cause in fact, 356–​358 disgorgement, 356–​360 joint cause, 358–​359 mitigation, 149 remote cause, 359–​360 Cause in fact and disgorgement, 356–​358 Certainty principle, 227–​238 CAPM, 233–​234 classical contract law, 229 cost recovery, 230–​231 expected-​revenue-​based damages, 231–​232 incurred-​costs damages, 230–​231 interest-​aligning contracts, 232–​233 rational-​basis test, 228 reliance damages, 230–​231 Chance,  32–​37 Change of heart by offeree, 452–​453 Charitable subscriptions, 116–​117, 129 Choice,  32–​37 Choice-​of-​law rules,  452 CISG (United Nations Convention on Contracts for the International Sale of Goods), 451n62 Civil law, 3, 100, 110n40 Classical contract law advertisements, 421–​422 certainty principle, 229 defined, 6 Disclosure Principle, 598–​599 doctrines, 502 donative promises, 113 Hadley Principle, 241–​242 illusory promise rule, 45–​49 interpretation of contracts, 397 last-​shot rule, 441, 447n53 legal-​duty rule,  38–​43 mirror image rule, 440–​441, 481–​482 mutuality,  45–​49 objective standards of interpretation, 397–​398 period of, 9n2 reliance, 117–​118 third-​party beneficiaries, 745–​747, 749 transactional incapacity, 80

84

844

Index

Classical contract law (Cont.) transformation to modern, 25–​28 unfair persuasion, 82–​83 Collins, Hugh, 147 Commodities defined, 7 differentiated commodities, 53 expectation damages, 217–​220 markets,  71–​72 off-​the-​shelf commodities, 217–​220 Overbidder Paradigm, 53 unconscionability principle, 71–​72 Common law civil law vs., 3 donative promises, 109–​110, 110n40 formalist theories, 12–​13 last-​shot rule, 441, 447n53 overruling,  14–​15 Competitive market, defined, 71 Computational errors, 565–​571. See also Mistakes mispricing, 570–​571 no knowledge or reason to know, 567–​569 nonmistaken party’s knowledge, 565–​569 offers too good to be true, 569–​570 reason to know of, 566–​567 Conditional acceptances, 479–​481 Conditional assent, 446–​447 Conditions precedent, 728–​730 Conditions subsequent, 728–​730 Condition-​to-​legal-​effectiveness exception, 546–​547 Confirmation receipt (UCC), 793 Conjunctive test, 44–​45, 755 Consequential damages, 240 Consideration. See also Bargain; Bargain principle bargain theory, 29 defined, 32 formation, 485–​486 hostage agreements, 34–​37 motivation vs., 436n28 nominal consideration, 110–​111, 112n44, 464 prizes and rewards, 485–​486 third-​party beneficiaries, 747 Constitutive rules, 408–​409, 412 Construction contracts, 209n23, 213–​214n36, 313–​314 materialmen, legal status of, 764n94, 765n100 Constructive conditions, 669–​671 Contextualism, 373–​380 course of dealing, 379 extrinsic evidence, 376 integrated agreement, defined, 373n1

performance, 380 Restatement (Second) of Contracts, 373 special-​community usage, 378 trade usage, 378–​379 Contract, defined, 103, 367, 741 Contract for output or requirements, 33n8 Contracting parties. See also specific parties defined, 741 losing party to pay fees of winning party, 266n16 objectives of, 756–​757 Contractual allocations of losses, 250–​251 Contributory negligence, 141n25 Conversation rule, 458–​459 Cooperation duty, 145–​147. See also Rescue Coordinated contracts, 263–​264 Cooter, Robert, 335, 605–​607, 606n39 Corbin, Arthur, 7, 129–​130, 375–​376, 459n6, 478, 535–​536, 744n23 Costs and fees attorney fees, 53, 255 of completion, 206–​215 defined, 180 expert fees, 255 fixed costs, 202–​204 Hadley Principle, 248–​250 incurred-​costs damages, 230–​231 litigation costs, 255, 266 preparation costs, 259 probability of breach, 266–​267 recovery, 230–​231 replacement cost, 179, 189, 261 saved by breach, 354–​356 social costs, 267n17 transaction-​cost arguments, 57 Counter-​offers, 477–​479,  478n65 Course of dealing, 15, 369, 378–​379 contextualism, 373 extreme literalism, 385 plain-​meaning rule, 380 Restatement (Second) of Contracts, 369 uniform Commercial Code (UCC), 369–​370 Course of performance. See Performance Courts choice, 33 morality and policy, 6n1 overruling,  14–​15 Covenant of good faith and fair dealing in employment contracts, 431n12 Cover Principle bifurcated nature of, 221, 221n1 expectation damages, 221–​225 good faith vs. reasonableness, 222–​223 market price, 221–​222, 276

845

Index

positive law, 223–​225 process vs. substance, 222 reasonableness vs. good faith, 222–​223 as remedy, 221 secrecy interest, 276 specific performance, 221–​222, 276 substance vs. process, 222 UCC, 221n1 Craswell, Richard, 182–​183, 265, 267n17, 269n1, 273–​274, 279–​280, 279n37, 466n28, 469n35, 476 Credit, extension of, 89 Creditor-​beneficiary cases, 743–​745, 750, 760–​761,  778 Criminal liability and Statute of Frauds, 788 Crossed revocation and acceptance, 451 Cure augmented sanctions, 691–​693 sales of goods, 701 substantial performance, 701 Custom and trade usage, 378–​379, 634–​636 Dagan, Hanoch, 560–​561, 564n17 Damages. See also Remedies; specific types of damages amount foreseeable, 245–​246 anticipatory repudiation, 679–​681 asymmetric nature of, 207n13 attorney fees, 53, 255 certainty principle, 227–​238. See also Certainty principle consequential damages, 240 direct damages, 240 disproportionate damages, 253–​254 donative promises, 121–​123 expected-​revenue-​based damages, 231–​232 foreseeability, 240–​246 general damages, 240 incurred-​costs damages, 230–​231 liquidated damages, 260 market price, 192nn7–​8, 194–​199, 276 mitigation, 149–​155. See also Mitigation Principle opportunity cost, 218n2 prejudgment interest, 255–​256 punitive, 196, 353n51, 763n93 reliance, 121–​123 special damages, 240 supranormal damages, 247 unpaid prizes or rewards, 487–​488 Dawson, John, 343n20 Death, as termination of power of acceptance, 474–​476

845

Defective capability, 165–​169 Defenses bargain principle, 37 contest promoter’s defense, 486n4 duress. See Duress incapacity, 80 modification, 775–​778 promisor’s defenses against promisee, 775, 778–​779 quality-​of-​consent defenses,  37 rescission, 775–​778 third-​party beneficiaries, 774–​778 Definitions adversely affected party, 627 agreement, 367 anticipatory repudiation, 675 bilateral contracts, 419 civil law, 3 classical contract law, 6 commodity, 7 competitive market, 71 consideration, 32 contract, 103, 367, 741 contracting parties, 741 costs, 180 doctrinal propositions, 4 efficient breach theory, 51 electronic signatures, 785 employee, 312n44 experiential propositions, 5 express conditions, 715 expressions, 7 frustration, 627 gift, 97, 103 good faith, 707n4, 708 impossibility, 627 impracticability, 627 incompleteness, 497 integrated agreement, 373n1 literalism, 380 material breach, 689 mitigation, 149 morality and policy, 5 offer, 418n2 paradigm, 119 promisee, 741 promisor, 627, 741 record, 449–​450, 785–​786 relational contracts, 734–​736 restitution, 345 social and critical morality, 5 social propositions, 5 Specific Performance Principle, 295, 304–​305

846

846

Index

Definitions (Cont.) structural agreements, 461 third-​party beneficiaries, 741 unilateral contracts, 419 usage, 368 wins, 131 world of contract, 103 world of gift, 103 Delay of acceptance, 451–​452 Delegation, 315 Deliberately acquired information, 601 DeLong, Sidney, 54n6 Diamond, Peter, 277–​279, 279n37 Differentiation vs. standardization, 190 Difficulty of determination, 286–​288 Diminished satisfaction, 208, 210–​212 Diminished value, 206–​215 disgorgement, 355–​356 expectation damages, 179, 262 Restatement (First) of Contracts, 208 Direct damages, 240 Disclosure Principle, 595–​623 adventitiously acquired information, 599–​604 allocative efficiency, 607–​609 buyers trolling for sellers’ mistakes, 619–​620 classical contract law, 598–​599 current law and practice, 613–​615 deliberately acquired information, 601 efficiency, 620–​623 exceptions, 617–​620 fiduciaries, 615–​617 foreknowledge, 604–​607 improper means, 615 market information, 612–​613 morality, 596–​597 pure exchange regimes, 609–​610 reasonable search, 618–​619 risk allocated to unknowing party, 617 sellers, 611–​615 social context, 619–​620 trust or confidence relationships, 616–​617 unknowing party on notice, 618–​619 Discrete contracts, 735–​736 Disgorgement, 335–​363 apportionment, 358–​359, 361–​362 causation arguments against, 356–​360 cause in fact, 356–​358 costs saved by breach, 354–​356 diminished value, 355–​356 efficiency arguments against, 342–​343 efficient breach theory, 342 expectation damages, 342–​343, 349–​350 externalities, 353

as fallback remedy, 360–​361 fiduciaries, 337, 351–​352 gain from breach, 345–​349 interests other than profit, 350–​353 joint cause, 358–​359 moral obligations, 344 outside contract law, 337–​338 Overbidder Paradigm, 346 overview, 335–​337 property interests, 338 remote cause, 359–​360 Restatement (Second) of Contracts, 336, 339–​342 restitution vs., 337n4 services contracts, 214–​215 skimped services, 354 specific performance, 349 tracking, 359–​360 unjust enrichment, 345 Disincentives for planning, 62 Disjunctive test, 44–​45 Disproportionate damages, 253–​254 Distress and unconscionability principle, 73–​78 Dobbs, Dan, 295, 336, 336n3, 339 Doctrinal propositions binary vs. multifaceted, 27 defined, 4 objective vs. subjective, 26 standardization vs. individualization, 27 static vs. dynamic, 27 Donative Promise Principle, 97–​132 bargains vs., 104 cash gifts, 107 classical contract law, 113 common law, 109–​110, 110n40 completed gifts compared, 97n1 contract, defined, 103 damages, 121–​123 enforceability, 98 evidentiary concerns, 99 formal, 109–​112 generosity, 108n39 gift, defined, 97 material benefit, 114 moral obligations, 98, 108n39, 112–​116 nominal consideration, 110–​111 preexisting moral obligations, 112–​116 reliance, 117–​132 remedies, 115 Restatement (First) of Contracts, 111–​112 Restatement (Second) of Contracts, 111–​112, 114–​115 under seal, 109–​112

847

Index

simple,  97–​109 social morality, 98 to social service institutions, 116–​117 totemic aspects, 104–​105 trust, creation of, 110n42 world of contract, defined, 103 world of gift, defined, 103 Donee beneficiaries, 748–​750, 752–​753, 755–​756, 758–​760 as infants, 777–​778n148 Restatement (First) of Contracts, 750, 776 Restatement (Second) of Contracts, 777 third-​party beneficiaries, 750, 759–​760 Door-​to-​door sellers, 87–​88,  88n46 Drafts of contracts, 85, 85n44 Duress, 69, 73, 74, 74n14, 92, 283n3, 393 Duty to cooperate, 145–​147. See also Rescue Duty to rescue. See Rescue Duty to warn, 135, 137 alternative proposals under consideration, 478 firm-​offer rule, 462 of potential breach, 140–​143 of potential loss, 144–​146 EDI (Electronic Data Interchange), 450, 450n58 Effectiveness of acceptance, 450–​454 Efficiency mistakes, 551–​552 Mitigation Principle, 149–​150, 149n2 search, 277–​279 Efficient breach theory, 51–​66 attorney fees, 53 defined, 51 disgorgement, 342 disincentives for planning, 62 efficient termination vs., 53–​54 factual predicates, 52–​64 foresight, 62 Loss Paradigm, 64–​66 Overbidder Paradigm, 51–​52, 55–​58, 64 Pareto-​superiority justification,  56–​57 remaking contracts inefficiently, 58–​61 social norms, 63 specific performance, 65–​66, 296n5 transaction-​cost arguments, 57 UCC, 59 weakening contracting system, 62–​64 Efficient search, 277–​279 Efficient termination vs. efficient breach theory,  53–​54 Eisenberg, Melvin Aron, 22–​23, 269n1, 564n17 Eisenberg, Ted, 392–​394, 394n67 Electronic acceptance, 449–​450

847

Electronic Data Interchange (EDI), 450, 450n58 Electronic signatures, defined, 785 Electronic Signatures in Global and National Communications Act (E-​SIGN), 449, 456n75, 785 Elements of contracts, 367–​370 context, 370 course of dealing, 369 expressions, 367 implications, 367–​368 performance, 369–​370 purpose, 370 usage, 368–​369 Emery, Robert E., 165n37 Employee handbooks. See Employment manuals Employees at-​will, 431–​436 breach by, 312 covenant of good faith and fair dealing in employment contracts, 431n12 defined, 312n44 services contracts, 312 Specific Performance Principle, 312 Employers, breach by, 313 Employment manuals, 431–​436 generally, 431–​433 disclaimers, 433–​434 modification, 434–​436 as unilateral contracts, 432 Enforcement charitable subscriptions, 129 specific performance, 298–​299 by third-​party beneficiaries, 747–​752 unconscionable, 568, 571, 573–​574 by virtue of action in reliance. See Reliance Enforcement-​error regimes, 10n5, 269–​274 administrative concerns, 273–​274 background, 269–​270 law-​and-​economists,  270 probabilities, 271–​273 subjective beliefs of promisors, 270–​271 Equal-​dignity rule, 800–​801 Error, risk of, 299. See also Computational errors; Mechanical errors; Mistakes E-​SIGN (Electronic Signatures in Global and National Communications Act), 449, 456n75, 785 Estoppel. See Promissory estoppel Evaluative mistakes, 555–​556 Evidence burden of proof and restitution, 329 donative promises, 99 expert fees, 255

84

848

Index

Evidence (Cont.) extrinsic evidence, 376, 380 parol evidence rule, 533–​547. See also Parol evidence rule subjective probabilities, 271–​273 Executory promises and Statute of Frauds, 797–​798 Expectation damages, 177–​280. See also Efficient breach theory attorney fees, 255 bargain context, 182–​186 certainty principle, 227–​238. See also Certainty principle as compensation, 183, 183n7 costs, defined, 180 cover principle, 221–​225. See also Cover Principle diminished value, 179, 206–​215 disgorgement, 342–​343, 349–​350 efficient search, 277–​279 enforcement-​error regimes, 269–​274 expected-​revenue-​based damages vs., 231–​232 expert fees, 255 fixed costs, 202–​204 formulas, 179–​215. See also Formulas for measuring expectation damages good faith, 515 Hadley Principle, 239–​254. See also Hadley Principle Indifference Principle, 179–​188 insolvency risk, 256 invariant to reliance, 260–​262 limitations, 255–​256 litigation costs, 255 lost profit, 179–​180, 201–​202, 218–​220 lost surplus, 180 market price, 179, 189, 193–​199, 221–​222,  276 measurement, 179–​188 off-​the-​shelf commodities, 217–​220 overhead, 202–​204 overreliance theory, 257–​267. See also Overreliance theory performance, efficient rate of, 183–​184 precaution, efficient rate of, 184 prejudgment interest, 255–​256 reliance damages vs., 180–​188 replacement cost, 179, 261 restitution vs., 321 secrecy interest, 274–​277 services contracts, 201–​215 Statute of Frauds, 805–​807

surplus-​enhancing reliance, efficient rate of, 184–​186 Expectation principle and mitigation, 153 Expected-​revenue-​based damages, 231–​232 Expected-​utility model, 159–​160 Experience and mistakes, 553 Experiential propositions, defined, 5 Expert fees, 255 Ex post considerations, 659–​661 Express conditions, 715–​730 conditions precedent, 728–​730 conditions subsequent, 728–​730 defined, 715 imperfect fulfillment, 716–​719 interpretation as, 723–​728 overview, 715–​716 pay-​when-​paid provisions, 724–​725 perfect fulfillment rule, 716–​723. See also Perfect fulfillment rule promises vs., 715–​716 satisfaction, 725–​728 Expression rules, 407–​413 administrative justification, 411 background, 407–​409 categorical rules, 410 constitutive rules, 408–​409, 412 contract elements, 367 expressions, defined, 7 forms of, 410 general rules, 408–​409, 411 justifications of, 410–​413 maxims, 410 moral rules, 408–​409 policy justification, 411 practices defined by, 408–​409 presumptions, 410 private actors, 412–​413 rules of thumb, 408–​409, 411 Externalities and disgorgement, 353 Extreme literalism, 385–​395 accuracy, 385–​387, 394–​395 empirical support, 392–​394 escaping rules of interpretation, 387–​388 interpretive regime choice, 387 linguistic communities, 388 Extrinsic evidence, 376, 380 Fair dealing, 39–​40 Fairness fair dealing, 39–​40 mitigation, 149 unfair persuasion, 82–​84 unfair surprise, 84–​85

849

Index

Farber, Dan, 124n81 Farnsworth, Allan, 336, 356–​360, 357n59, 360n63, 467–​468n30 Fault, 173–​175 Fauth, Gordon, 102n18 Federal Trade Commission, 83 Fees. See Costs and fees Feldstein, Martin, 167–​168, 734 Feller, David, 290 Fiduciaries Disclosure Principle, 615–​617 disgorgement, 336n1, 337, 350–​352 Firm-​offer  rule auctions, 465, 465n25 bilateral contracts, 460–​464 exceptions, 464–​466 nominal consideration, 464 reliance, 465–​466 structural agreements, 461–​462 termination of power of acceptance, 460–​464 UCC, 464–​465 writing, effect of, 464–​465 Fish, Stanley, 374 Fixed costs, 202–​204 Forbearance to assert claim, 44–​47, 44n39 Foreknowledge, 604–​607 Foreseeability damages, 240–​246 efficient breach theory, 62 foreknowledge, 604–​607 Hadley Principle, 240–​244, 244nn21–​22 Forfeiture perfect fulfillment rule, 719–​720 restitution, 322–​323 Formalist theories, 9–​15, 10n5 axioms, 10–​11, 25 exceptions,  11–​12 overruling,  14–​15 reconstruing,  12–​13 status of, 15 transformation,  13–​14 Formation, 417–​518 acceptance, modes of, 427–​456. See also Acceptance bargain. See Bargain; Bargain principle consideration, 485–​486. See also Consideration implied-​in-​law and implied-​in-​fact contracts, 493–​495 incomplete contracts, 497–​518. See also Incomplete contracts offers, 417–​426. See also Offers prizes and rewards, 485–​491 unjust enrichment, 494

849

Form contracts, 521–​529 boilerplate, 521–​529, 521n2 conflicting terms, 525 elements, 521–​522 informed-​minority argument, 526 knockout rule, 528 paternalistic-​preference argument, 526–​527 real contract as element, 521 Restatement (Second) of Contracts, 524 rolling contracts, 529 UCC, 528 unconscionability, 524 Formulas for measuring expectation damages, 179–​220 actual loss vs. market price, 194–​199 buyer’s breach, 189–​192, 217–​220, 260–​261, 310 cost of completion, 206–​215 deductions, 204–​206 diminished satisfaction, 208, 210–​212 diminished value, 179, 206–​215, 355–​356 disgorgement, 214–​215 full capacity, 220 Indifference Principle, 179–​188 likelihood of completion, 208, 212–​213 lost profit, 179–​180, 201–​202, 218–​220 lost surplus, 180 lost-​volume damages, 190–​191 market price, 179, 189, 193–​199, 221–​222,  276 off-​the-​shelf commodities, 217–​220 performance, efficient rate of, 183–​184 precaution, efficient rate of, 184 replacement cost, 179, 189 sales of goods, 189–​199. See also Sales of goods seller’s breach, 192–​194, 261–​262 service provider’s breach, 206–​215 service purchaser’s breach, 150n4, 201–​206 services contracts, 201–​215 surplus-​enhancing reliance, efficient rate of, 184–​186 unreasonable disproportion, 208–​209 unreasonable economic waste, 208–​209, 211 Foundational standard, 22 Four-​corners rule, 380–​384 Fraud, 69, 92, 252, 329n29. See also Statute of Frauds promissory fraud, 544–​546 Fried, Charles, 584 Friedmann, Daniel, 343–​344, 344n24 Frustration. See Unexpected circumstances Full capacity, 220 Fuller, Lon, 31, 98, 101, 581, 628

850

850

Index

Further-​instrument-​to-​follow provisions, 503–​517 Future performance. See also Likelihood of completion homogeneous goods, near future delivery of, 306–​307 likelihood of, 689 Gaps, 499–​502, 517–​518 gap-​fillers, 502–​503n14 Garvin, Larry T., 684 General damages, 240 Generosity, 108n39 Gergen, Mark P., 319, 707 German Civil Code, 100 Gibson, James, 528 Gifts. See Donative Promise Principle Gilmore, Grant, 124 Goetz, Charles, 102, 144–​145, 155, 185, 192n7, 734–​735 Goldberg, Vic, 735 Good faith, 707–​711. See also Bad faith covenant of good faith and fair dealing in employment contracts, 431n12 cover, 222–​223 defined, 707n4, 708 expectation damages, 515 explicit bargained-​for promise, 504–​507 implicit bargained-​for promise, 507–​514 incomplete contracts, 503–​517 interpretation vs., 710 leading-​on, 516–​517 mitigation, 151–​153 negotiation promises, 503–​517 price protection, 708–​709 reasonableness vs., 222–​223 redundancy, 709 reliance damages, 516 remedies, 514–​516 sales of goods, 700 specific performance, 515 substantial performance, 700 Goods. See Sales of goods Gordley, James, 462, 468–​469 Government contracts Restatement (Second) of Contracts, 770 third-​party beneficiaries, 770–​774, 772–​773n137 Guarantees and Statute of Frauds, 799–​800 Hadley Principle, 239–​254 alternative regime to, 250–​254 amount of damages foreseeable, 245–​246 classical contract law, 241–​242

consequential damages, 240 contractual allocations of losses, 250–​251 costs, 248–​250 criticism of strict application of, 242n14 direct damages, 240 disproportionate damages, 253–​254 foreseeability, 240–​246, 244nn21–​22 general damages, 240 Indifference Principle vs., 241 information-​forcing, 244–​245 modern arguments for, 244–​250 overview, 239–​240 proximate cause vs., 241, 243–​244, 251–​252 special damages, 240 supranormal damages, 247 Hand, Learned, 26, 397, 674 Highly differentiated goods, 309 Hillman, Robert, 130–​131, 529 Hirshleifer, Jack, 604–​607, 610 Hold-​up issue,  41–​43 Holmes, Oliver Wendell, Jr., 25, 111, 297n7, 436n28 Homogeneous goods, near future delivery of, 306–​307 Hostage agreements, 34–​37, 34n10 Howson, Colin, 271n13 Hypothetical test and third-​party beneficiaries, 755 Illusory promise rule, 45–​49 Implications as elements of contracts, 367–​368 Implied-​in-​law and implied-​in-​fact contracts, 493–​495 Impossibility. See Unexpected circumstances Impracticability. See also Unexpected circumstances perfect fulfillment rule, 722–​723 as protection against catastrophic loss, 254n43 strict liability, 175 Improper means of acquiring information, 615 Improvidence and unconscionability principle, 94–​95 Incapacity defenses, 80 exploitation of, 81n30 termination of power of acceptance, 474–​476 transactional,  79–​82 Incidental beneficiaries, 750 Incomplete contracts, 497–​518 bound, 497–​498 further-​instrument-​to-​follow provisions, 503–​517 gaps, 499–​502, 517–​518

851

Index

good faith negotiation promises, 503–​517 incompleteness, defined, 497 indefiniteness, 498–​499, 517–​518 precontractual liability, 497 Incurred-​costs damages, 230–​231 Indefiniteness, 498–​499, 517–​518 Independent significance, 166 Indifference Principle formulas for measuring expectation damages, 179–​188 Hadley Principle vs., 241 mitigation, 151 specific performance, 296–​297 Information-​forcing, 244–​245, 405–​406 Informed-​minority argument, 526 Insolvency risk and expectation damages, 256 Installment contracts, 700 Insurance considerations, 655–​659 Integration integrated agreement, defined, 373n1 partial integration, 542 Restatement (Second) of Contracts, 535–​536 Intended beneficiaries Restatement (Second) of Contracts, 754 Intent-​to-​benefit  test Restatement (First) of Contracts, 752–​755 Restatement (Second) of Contracts, 753–​755 subcontractors, 769 third-​party beneficiaries, 752–​755 Interest. See Prejudgment interest Interest-​aligning agreements, 36–​37, 232–​233 Interpretation, 371–​413 accuracy, 385–​387, 394–​395 aim of, 391–​392 contextualism, 373–​380 different meanings, 404–​406 elements, 397–​406 as express conditions, 723–​728 general principles, 373–​395 good faith vs., 710 information-​forcing, 405–​406 interpretive regime choice, 387 literalism, 380–​395 mutual mistake, 402–​404 objective elements, 397–​406 principles of, 388 Restatement (First) of Contracts, 390–​391 Restatement (Second) of Contracts, 17, 398–​399 Statute of Frauds, 794 subjective elements, 397–​406 theories of, 15–​17 UCC, 387, 794

851

Invalid claims, 44–​45, 44n39 Invariance, 160–​162 Irrational disposition, 163–​165 Joint cause and disgorgement, 358–​359 Joskow, Paul, 644 Judicial relief Restatement (Second) of Contracts, 335 shared-​tacit-​assumption test, 636–​643 Jury trials and specific performance, 299–​300 Kahneman, Daniel, 160–​162, 165, 166, 559 Klass, Gregory, 59 Knockout rule, 445–​446, 528 Knowledge acceptance, 438–​439 computational errors, 567–​569 Disclosure Principle, 604–​607 foreknowledge, 604–​607 mistaken payments, 563 of offer, 438–​439 risk allocated to unknowing party, 617 unilateral contracts, 438–​439 unknowing party on notice, 618–​619 Kostritsky, Juliet, 131 Kramer, Bruce, 622, 622n83 Kronman, Anthony, 304–​305, 598–​602, 598n8, 601n18, 603n23, 604, 610, 610n50 Kuhn, Thomas, 119, 120n66 Kull, Andrew, 108, 324n14 Land sales. See Real property sales Langdell, Christopher, 9–​10, 9n1, 25 Lapse of acceptance, 457–​460 Last-​shot rule, 441, 447n53 Latin, Howard, 169 Laycock, Douglas, 62, 312 Leading-​on, 516–​517 Leff, Arthur, 70 Legal-​duty rule, 38–​43, 43n32 fair dealing, 39–​40 hold-​up issue,  41–​43 reciprocity,  39–​40 Legatees, would-​be, 761–​763 Leptich, John, 571n34 Lien laws, 725n23 Likelihood of completion, 208, 212–​213, 689 Linguistic communities, 388 Liquidated damages, 283–​291 bounded rationality, 284 defective capabilities, 284 as deposits, 290 difficulty of determination, 286–​288

852

852

Index

Liquidated damages (Cont.) limits of cognition, 283–​286, 290 overreliance theory, 260, 265 rational ignorance, 284 reasonableness, 288 second-​look standard, 288–​289 services contracts, 219 special-​scrutiny rule, 283 Literalism, 380–​395 defined, 380 extreme, 385–​395. See also Extreme literalism extrinsic evidence, 380 four-​corners rule, 380–​384 plain-​meaning rule, 380–​384 Litigation costs expectation damages, 255 overreliance theory, 266 Litigation risks and overreliance theory, 265–​266 Long-​term supply contracts, 307–​308 Loss-​aversion, 558–​559n4 Loss Paradigm contractual allocations of losses, 250–​251 efficient breach theory, 64–​66 Overbidder Paradigm vs., 65 Lost chances, 489–​491 Lost profit computation of, 301n17 courts taking conservative approach to, 265n15 expectation damages, 179–​180, 201–​202, 218–​220 Restatement (Second) of Contracts, 201–​202 sales of goods, 220 services contracts, 201–​202, 218–​219 UCC, 189 Lost surplus, 180 Lost-​volume damages, 190–​191 Lumpy reliance, 263 Macneil, Ian R., 57, 733, 735–​736, 735n10, 736nn12–​14 Mahoney, Paul, 53–​54, 57 Mailbox rule, 450–​452, 452n63, 456n75 Market price above-​market prices,  85–​89 actual loss, 194–​199 Cover Principle, 221–​222, 276 damages, 192nn7–​8, 194–​199, 276 expectation damages, 179, 189, 193–​199, 221–​222,  276 sale-​of-​goods cases, as measure of damages, 199n32 secrecy interest, 276 UCC, 189

Markets commodities,  71–​72 competitive market, defined, 71 information, 612–​613 market information, 612–​613 role of, 71–​72 unconscionability principle, 71–​72 Marriage, consideration of, 798, 805 Marschall, Patricia, 60 Maskin, Eric, 277–​279, 279n37 Material benefit and donative promises, 114 Material breach apparent material breach, 684 defined, 689 Materiality and shared-​tacit-​assumption test, 635–​636 Materialmen, 764n94, 765n100 Matheson, John, 124n81 Maute, Judith, 214n38 Maxims, 410 McCamus, John D., 352n50 McTurnan, Lee, 585 Mechanical errors, 557–​575 computational errors, 565–​571. See also Computational errors loss aversion, 558n4 mistaken payments, 560–​565. See also Mistaken payments modern position, 571–​575 overview, 557–​560 in promotional contests, 575n49 reliance damages, 571 Mechanic’s lien laws, 725n23 Medina, Barak, 636 Memoranda and Statute of Frauds, 800 Merger clauses, 543 Miller, Geoff, 392–​394, 394n67 Mill, John Stuart, 734 Mirror image rule, 440–​441, 481–​482 Mises, Richard von, 272 Mispricing, 570–​571 Mistaken payments, 560–​565 actual knowledge by payee, 563 administrability, 565 paradigm case, 560–​563 reliance, 563–​564 restoration regime, 561–​562 Mistakes, 551–​594. See also Computational errors efficiency, 551–​552 evaluative, 555–​556 experience, 553 mechanical errors, 557–​575. See also Mechanical errors

853

Index

mispricing, 570–​571 mistaken payments, 560–​565. See also Mistaken payments mistranscriptions, 577–​578 morality, 552 mutual, 579–​594. See also Mutual mistakes sellers’ mistakes, buyers trolling for, 619–​620 shared mistaken factual assumptions, 579–​594. See also Shared mistaken factual assumptions unilateral, 557–​575. See also Unilateral mistakes Mistranscriptions, 577–​578 Mitigation Principle, 149–​155 causation, 149 defined, 149 efficiency, 149–​150, 149n2 expectation principle, 153 fairness, 149 good faith, 151–​153 Indifference Principle, 151 reasonableness, 151–​152 Restatement (Second) of Contracts, 150, 154, 155 specific performance, 300–​302 UCC, 155 Moderately differentiated goods, 309 Modern contract law algorithms,  25–​26 transformation to, 25–​28 Modes of acceptance, 427–​456 Modification non-​oral clauses, 813–​814 Statute of Frauds, 808–​810, 813–​814 third-​party beneficiaries, 775–​778 Monistic theories, 17–​19 Morality and policy. See also Social and critical morality civil-​code and civil-​code based rules, 72–​73 contract-​law rules, 16 courts, 6n1 defined, 5 Disclosure Principle, 596–​597 disgorgement, 344 donative promises, 98, 108n39, 112–​116 mistakes, 552 moral fault, role of, 72–​73 rescue, 133–​148. See also Rescue social and critical morality vs., 6 third-​party beneficiaries, 748, 757 unconscionability principle, 69–​96. See also Unconscionability principle Motivation to make contract, 436–​438, 436n28

853

Multi-​prime contracts, 767–​768 Murphy, Liam, 134 Mutuality bargain principle, 37, 45–​49 bilateral contracts, 45 mutual misunderstanding as cause of contract failure, 331n36 Restatement (Second) of Contracts, 402 unilateral contracts, 45 Mutual mistakes, 579–​594 adversely affected party awareness, 585–​587 general principle, 580–​594 interpretation, 402–​404 mistaken assumptions, 582n7 risk allocated to adversely affected party, 587–​590 superior information of one party, 590–​591 unbargained-​for risk test compared, 644–​646 unexpected circumstances vs., 637n35, 646n65 windfalls, 591–​594 National Labor Relations Act, 313, 736n14 National Labor Relations Board, 313 Necessary performance, 259 Nicholas, Barry, 175 No-​duty-​to-​rescue rule. See Rescue Nominal consideration donative promises, 110–​111 firm-​offer rule, 464 Restatement (Second) of Contracts, 112n44, 464 Normative theories, 17–​19, 22 Notaries, 110n40 Offerees change of heart, 452–​453 motivation, 436–​438, 436n28 obligations of offeree who has begun performance, 440 performance by offeree notice requirement, 439–​440 Offers, 417–​426 advertisements, 420–​423, 573n44 ambiguity, 428–​429 auctions, 424–​426 bilateral contracts, defined, 419 computational errors, 569–​570 counter-​offers, 477–​479,  478n65 defined, 418n2 knowledge of, 438–​439 late acceptance, 139 offers too good to be true, 569–​570 promissory nature of offers, 418–​420

854

854

Index

Offers (Cont.) rescue, 136–​140 reserves, 424–​425, 424n28 Restatement (Second) of Contracts, 419, 428 revocation of offers for bilateral contracts, 460–​464 silence as acceptance, 136–​139 unilateral contracts, 419, 466–​469 withdrawal of general offers, 472–​474 Off-​the-​shelf commodities, 217–​220 Oman, Nathan, 15–​16 One-​off sellers,  85–​86 One-​sidedness, 462–​463 Opportunism and specific performance, 302–​304 Opportunistic breach, 691 Opportunity cost, 76–​77, 76n23, 121, 182, 218n2, 220, 331, 568, 662 Oral contracts land interests, sales of, 805–​807 marriage, 805 modification and waiver, 814 overview, 802 reliance, 803–​804 restitution, 802 sales of goods, 804, 814 Statute of Frauds, 802–​807 suretyship, 805 Overbidder Paradigm applicability, 53 differentiated commodities, 53 disgorgement, 346 efficient breach theory, 51–​52, 55–​58, 64 Loss Paradigm vs., 65 Overhead, 202–​204 Overreliance theory, 257–​267. See also Reliance buyer’s breach, 260–​261 coordinated contracts, 263–​264 diminished value, 262 expectation damages invariant to reliance, 260–​262 liquidated damages, 260 litigation costs, 266 litigation risks, 265–​266 lumpy reliance, 263 necessary performance, 259 overview, 257–​258 preliminary considerations, 258 preparation costs, 259 probability of breach, 262–​264, 266–​267 replacement cost, 261 seller’s breach, 261–​262 social costs, 267n17 value held after breach, 262

Palmer, George, 343n20 Paradigm, concept of, 119–​120, 120n66 Pareto-​superiority justification,  56–​57 Parol evidence rule, 533–​547 condition-​to-​legal-​effectiveness exception, 546–​547 contradiction, 540–​542 Corbin, 535–​536 exceptions, 537–​540 inconsistency, 540–​542 merger clauses, 543 overview, 533 partial integration, 542 promissory fraud, 544–​546 Restatement (First) of Contracts, 534–​535, 538–​539 Restatement (Second) of Contracts, 535–​536 Statute of Frauds, 810–​811 UCC §2-​202, 536–​537, 539 Williston, 534–​535 Partial integration, 542 Parties. See Contracting parties; specific parties Part performance, 43n34, 322, 792 Paternalism paternalistic-​preference argument, 526–​527 unconscionability principle, 92–​93 Patterson, Edwin, 153 Pay-​when-​paid provisions, 724–​725 Pear, Robert, 151n8 Perfect fulfillment rule, 716–​723 exceptions, 719–​723 forfeiture, 719–​720 imperfect fulfillment, 716–​719 impracticability, 722–​723 prejudice, lack of, 720–​721 purpose of condition achieved, 721–​722 triviality, 723 Perfect-​tender rule, 702 Performance, 667–​703 adequate assurance principle, 683–​686 anticipatory repudiation, 673–​681. See also Anticipatory repudiation augmented sanctions, 687–​696. See also Augmented sanctions constructive conditions, 669–​671 contextualism, 380 efficient rate of, 183–​184 elements of contracts, 369–​370 expectation damages, 183–​184 future performance, likelihood of, 689 homogeneous goods, near future delivery of, 306–​307 necessary performance, 259

85

Index

obligations of offeree who has begun performance, 440 by offeree notice requirement, 439–​440 order of, 669–​671 part performance, 43n34, 322, 792 rescue, 140–​147 Restatement (Second) of Contracts, 369–​370 sales of goods, 792 Statute of Frauds, 795–​796 substantial, 697–​703. See also Substantial performance timing of, 795–​796 UCC, 369–​370 Perry, Stephen, 15 Personal services contracts, 312–​313 Peters, Ellen, 193 Pettit, Mark, 430–​431, 430n6 Pildes, Richard, 10n5 Plain-​meaning rule, 380–​384 Pluralistic theories, 17–​19, 22–​23 Pollock, Frederick, 38 Porat, Ariel, 140–​141, 141n25, 144 Posner, Richard A., 51–​52, 54–​56, 58, 101, 374–​375, 655–​659, 656–​657n98 Potential loss, 144–​145 Precaution, efficient rate of, 184 Precontractual liability, 497 Predictability, 32–​37. See also Foreseeability Prejudgment interest, 255–​256, 255n2 Preparation costs, 259 Presumptions, 410 Price-​gouging,  78–​79 Price-​ignorance exploitation,  85–​89 Price protection, 708–​709 Principles. See also Doctrinal propositions; specific principles generally,  21–​23 foundational standard, 22 normative theory, 22 rules vs., 6. See also Rules Private actors, 412–​413 Privity and third-​party beneficiaries, 743n15, 744–​747 Prizes and rewards, 485–​491 consideration, 485–​486 contest promoter’s defense, 486n4 lost chances, 489–​491 mechanical error in promotional contest, 575n49 remedies, 487–​491 unpaid, damages for, 487–​488 Probability enforcement-​error regimes, 271–​273

855

logical, 273n18 objective, 271–​273 promises,  32–​37 propensity theory, 273n18 subjective, 271–​273, 271n13 Procedural unconscionability, 70 Professional Golf Association, 123n75 Profit, 179–​180, 189, 201–​202, 218–​220. See also Lost profit Promisees anticipatory repudiation where promisee fully performed, 675–​677 breach by, 328–​329 defined, 741 promisor’s defenses against, 775, 778–​779 restitution, 328–​329 Specific Performance Principle, 305 third-​party beneficiaries, 741 Promises. See also Bargain; Bargain principle; Consideration chance,  32–​37 choice,  32–​37 donative, 97–​132. See also Donative Promise Principle enforceability of, 29–​66 hostage agreements, 34–​37 interest-​aligning agreements,  36–​37 predictability,  32–​37 preexisting moral obligations, 112–​116 probability,  32–​37 structural agreements, 32–​37 Promisors augmented sanctions, 693–​695 breach by, 321–​327 breach by promisor of other contracts, 684–​685 defenses against promisee, 775, 778–​779 defined, 627, 741 subjective beliefs of, 270–​271 unexpected circumstances, 627 Promissory estoppel, 119, 124, 126, 128n99 reliance, 130–​131, 517 restitution, 330 Promissory fraud, 544–​546 Pronouns, 7 Propensity theory, 273n18 Property interests. See also Real property sales disgorgement, 338 trespass for purposes of extraction, 137n19 Prospect theory, 169 Proximate cause, 241, 243–​244, 251–​252. See also Causation Public basis of justification, 16

856

856

Punitive damages, 196, 353n51, 763n93 Pure exchange regimes, 609–​610 Quality-​of-​consent defenses,  37 Rational-​basis test and certainty principle, 228 Rational ignorance, 284 Rationality, 159–​160 Rawls, John, 407–​409 Real property sales buyer’s breach, 311–​312 mistaken factual assumption, 582n10 oral contracts, 805–​807 rescission, 808 seller’s breach, 310–​311 Specific Performance Principle, 310–​312 Statute of Frauds, 790–​791, 805–​807 Reasonableness cover, 222–​223 good faith vs., 222–​223 liquidated damages, 288 mitigation, 151–​152 Restatement (Second) of Contracts, 398–​399 searches, 618–​619 unreasonable disproportion, 208–​209 unreasonable economic waste, 208–​209, 211 Reciprocity,  39–​40 Record, defined, 449–​450, 785–​786 Redundancy and good faith, 709 Reformation and Statute of Frauds, 810–​811 Reinstatement, 313 Rejection acceptance, followed by, 453 counter-​offer by mail or telegram, 452–​453 termination of power of acceptance, 477 Relational contracts, 733–​738 defined, 734–​736 discrete, 735–​736 duration, 734–​735 rules, 737 Reliance. See also Overreliance theory bargain principle, 117–​118 classical contract law, 117–​118 donative promises, 117–​132 expectation damages invariant to, 260–​262 firm-​offer rule, 465–​466 life of, 124–​132 lumpy reliance, 263 mistaken payments, 563–​564 oral contracts, 803–​804 promissory estoppel, 130–​131 Restatement (First) of Contracts, 119–​120, 124–​129

Index

Restatement (Second) of Contracts, 122, 125, 128–​129, 465–​466, 803–​804 Restatement (Third) of Restitution and Unjust Enrichment, 564 sales of goods, 804 seriousness test, 125n85 surplus-​enhancing, 184–​186 value held after breach, 262 wins, defined, 131 Reliance damages. See also Damages certainty principle, 230–​231 donative promises, 121–​123 expectation damages vs., 180–​188 good faith, 516 mechanical errors, 571 restitution vs., 323–​324 unilateral mistakes, 571 Remedies. See also Damages; specific types cover as, 221 donative promises, 115 good faith, 514–​516 prizes and rewards, 487–​491 reformation, 810–​811 reinstatement, 313 Statute of Frauds, 810–​811 Remote cause and disgorgement, 359–​360 Replacement cost expectation damages, 179, 261 UCC, 189 Representativeness, 167 Repudiation. See also Anticipatory repudiation of acceptance, 453–​454 adequate assurance principle, 684 apparent repudiation, 684 encouraging, 51n1 Rescission, 775–​778, 807–​808 Rescue, 133–​148. See also Mitigation Principle breach, 140–​143 cooperation duty, 145–​147 late acceptance, 139 no-​duty rule, 133–​136 offer and acceptance, 136–​140 performance, 140–​147 potential loss, 144–​145 Restatement (Second) of Contracts, 133–​135,  143 silence as acceptance, 136–​139 social norms, 135 unconscionability principle, 73–​74 unilateral contracts, 139–​140 Reserves, 424–​425, 424n28 Restatement (Third) of Agency disgorgement, 337, 359

857

Index

Restatement (First) of Contracts anticipatory repudiation, 675 classical contract law, 6, 25, 44 conjunctive test, 44–​45 creditor-​beneficiary cases, 750 diminished value, 208 donative promises, 111–​112 donee beneficiaries, 750, 776 incidental beneficiaries, 750 intent-​to-​benefit test, 752–​755 interpretation of contracts, 390–​391 parol evidence rule, 534–​535, 538–​539 reliance, 119–​120, 124–​129 third-​party beneficiaries, 749–​750, 775–​776 unilateral contracts, 467–​468 unreasonable economic waste, 208 Restatement (Second) of Contracts adequate assurance principle, 685 adversely affected party awareness, 585–​587 anticipatory repudiation, 675 charitable subscriptions, 116–​117 condition-​to-​legal-​effectiveness exception,  546 conjunctive test, 755 contextualism, 373 contradiction, 540 conversation rule, 458–​459 course of dealing, 369 delegation, 315 different meanings, 404–​405 disgorgement, 336, 339–​342 disjunctive test, 44–​45 disproportionality, 253 donative promises, 111–​112, 114–​115 fault, 173 form contracts, 524 government contracts, 770 hypothetical test, 755 illusory promise rule, 45–​46 improper means of acquiring information, 615 integration, 535–​536 intended beneficiaries, 754 intent-​to-​benefit test, 753–​755 interpretation, 17, 398–​399 judicial remedies, 335 lost chances, 490 lost profit, 201–​202 materiality, 635–​636 merger clauses, 543 mistaken party’s fault, 637 mitigation, 150, 154, 155 moderately differentiated goods, 309 modification, 43 mutual assent, 402

857

nominal consideration, 112n44, 464 obligations of offeree who has begun performance, 440 offers, 419, 428 parol evidence rule, 535–​536 partial integration, 542 performance, 369–​370 prejudgment interest, 255–​256 purpose, 370 reasonableness, 398–​399 rejection or counter-​offer by mail or telegram, 452–​453 reliance, 122, 125, 128–​129, 465–​466, 803–​804 reliance damages, 571 rescue, 133–​135, 143 restitution, defined, 345 risk allocated to adversely affected party, 587–​588 service-​purchaser’s breach, 201–​202 special-​community usage, 378 Statute of Frauds, 789, 803–​804 strict liability, 173 subjective acceptance, 447 subjective meanings, 401 substitute transactions, 154 third-​party beneficiaries, 753–​758, 776–​778 trade usage, 378–​379 trust or confidence relationships, 616–​617 unconscionability, 69 undue influence, 83 unfair persuasion, 83 usage, defined, 368 Restatement (Second) of Property unconscionability, 69 Restatement (Third) of Restitution and Unjust Enrichment disgorgement, 347n34 justifiable reliance, 564 restitutionary damages on breach, 324–​327 Restitution, 319–​332 absence of enforceable contract, 330–​332 bad faith, 320, 322–​323, 329, 694 burden of proof, 329 counter-​restitution by promisee, 323n10 disgorgement vs., 337n4 expectation damages vs., 321 forfeiture, 322–​323 oral contracts, 802 overview, 319–​321 part performance, 322 promisee’s breach, 328–​329 promisor’s breach, 321–​327 promissory estoppel, 330

85

858

Index

Restitution (Cont.) reliance damages vs., 323–​324 restitution, defined, 345 services contracts, 327 Statute of Frauds, 330 UCC, 328–​329 Restoration of property, 209n25 Restoration regime, 561–​562 Revocation of acceptance, 700 Revocation of offers. See also Termination of power of acceptance for bilateral contracts, 460–​464 crossed revocation and acceptance, 451 indirect revocation, 470–​471 unilateral contracts, 466–​469 Ricks, Val, 118n56, 118–​119n58 Risk. See also Unbargained-​for risk test allocated to adversely affected party, 587–​590, 633–​634 allocated to unknowing party, 617 error, risk of, 299 estimation faculties, 168–​169 insolvency risk, 256 litigation risks, 265–​266 risk preference, 161n12 specific performance, 299 unbargained-​for risk test, 644–​646 Risk-​estimation faculties, 168–​169 Roberts, Caprice, 295 Rolling contracts, 529 Rosenfield, Andrew M., 655–​659, 656–​657n98 Rowley, Keith A., 673n2 Rules default rules as gap-​fillers, 502–​503n14 principles vs., 6 rules of thumb, 408–​409, 411 Sales of goods admissions, 793–​794 buyer’s breach, 189–​192, 217–​220, 260–​261,  310 common law background, 699 confirmation receipt, 793 contractual allocations of losses, 250–​251 coverage, 791–​792 cure, 701 differentiation vs. standardization, 190 exceptions, 792–​794 formulas for measuring expectation damages, 189–​199 good faith, 700 goods made specially to order, 792–​793 goods not readily available, 308

highly differentiated goods, 309 homogeneous goods, near future delivery of, 306–​307 installment contracts, 700 interpretation problems, 794 long-​term supply contracts, 307–​308 lost profits, 220 lost-​volume damages, 190–​191 market price as measure of damages for, 199n32. See also Market price moderately differentiated goods, 309 off-​the-​shelf goods, 219–​220 oral contracts, 804 part performance, 792 perfect-​tender rule, 702 reliance, 804 rescission, 808 revocation of acceptance, 700 seller’s breach, 192–​194, 261–​262, 306–​308 Specific Performance Principle, 306–​310 standardization vs. differentiation, 190 Statute of Frauds, 791–​794, 801 substantial performance, 699–​703 UCC, 700–​703 Salvage cases, 76–​77nn21–​24,  76–​78 Satisfaction and express conditions, 725–​728 Satisficing, 163n26 Scanlon, Thomas, 98, 174, 462 Schwartz, Alan, 22–​23, 302, 346n29, 385–​395, 385n29, 394n67 Scott, Robert E., 22–​23, 102, 144–​145, 155, 185, 192n7, 385–​395, 385n29, 394n67, 734–​735 Second-​look standard, 288–​289 Secrecy interest and expectation damages, 274–​277 Securities, purchase or sale of, 795 Security interests in collateral, 795 Self-​insurance, 656, 658–​659 Sellers breach by, 192–​194, 261–​262, 306–​308, 310–​311 Disclosure Principle, 611–​615, 619–​620 door-​to-​door sellers, 87–​88,  88n46 formulas for measuring expectation damages, 192–​194, 261–​262 mistakes of, buyers trolling for, 619–​620 one-​off sellers,  85–​86 overreliance theory, 261–​262 real property sales, 310–​311 sales of goods, 192–​194, 261–​262, 306–​308 selling price disclosures, 86, 86n45 Specific Performance Principle, 302, 306–​308, 310–​311 unconscionability principle, 85–​88

859

Index

Seriousness test and reliance, 125n85 Services contracts breach, 201–​215 construction contracts, 313–​314 cost of completion, 206–​215 deductions from damages, 204–​206 diminished satisfaction, 208, 210–​212 diminished value, 206–​215 disgorgement, 214–​215 employee’s breach, 312 employer’s breach, 313 expectation damages, 201–​215 fixed costs, 202–​204 likelihood of completion, 208, 212–​213 liquidated damages, 219 lost profit, 201–​202, 218–​219 off-​the-​shelf commodities, 217–​219 overhead, 202–​204 personal services contracts, 312–​313 reinstatement, 313 restitution, 327 service provider’s breach, 206–​215 service purchaser’s breach, 150n4, 201–​206 skimped services, 354 Specific Performance Principle, 312–​315 supervision rule, 314 undue-​need-​for-​judicial supervision rule,  314 unreasonable disproportion, 208–​209 unreasonable economic waste, 208–​209, 211 Shared mistaken factual assumptions, 579–​594 adversely affected party awareness, 585–​587 general principle, 580–​594 risk allocated to adversely affected party, 587–​590 superior information of one party, 590–​591 windfalls, 591–​594 Shared-​tacit-​assumption test, 626–​643 custom and trade usage, 634–​636 exceptions, 630–​636 fault, 636–​643 inference from circumstances, 634–​636 judicial relief, 636–​643 materiality, 635–​636 relevant circumstance occurrence possibility, 630–​632 reliance damages, 642–​643 risk allocated to adversely affected party, 633–​634 tacit assumptions, 627–​630 Shavell, Steven, 185, 257–​258, 606–​607, 606n41 Shiffrin, Seana, 93 Shipping and salvage cases, 76–​77nn21–​24,  76–​78

859

Signing by parties Electronic Signatures in Global and National Communications Act (E-​SIGN), 449, 456n75, 785 Statute of Frauds, 800 Silence as acceptance, 136–​139, 136n15, 137n19 Simon, David, 195–​196 Simon, Herbert, 163n26 Simpson, A.W.B., 417n1 Skimped services, 354 Smith, Ernest, 621, 622n82 Smith, Stephen, 16 Snyder, David, 386–​387 Social and critical morality, 5–​6. See also Morality and policy defined, 5 Disclosure Principle, 619–​620 donative promises, 98 efficient breach theory, 63 moral norms vs., 6 overreliance theory, social costs of, 267n17 rescue, 135 social propositions, defined, 5 specific performance, 298–​299 Social costs of overreliance theory, 267n17 Social service institutions, donative promises to, 116–​117 Spatial proximity, 166 Special-​community usage, 378 Special damages, 240 Special-​scrutiny rule, 283 Specific performance, 295–​316. See also Specific Performance Principle adequacy test, 295 Bargain Principle, 297 cover, 221–​222, 276 defined, 295 disgorgement, 349 efficient breach theory, 65–​66, 296n5 enforcement, 298–​299 error, risk of, 299 good faith, 515 Indifference Principle, 296–​297 informational effects, 297–​298 jury trials, 299–​300 mitigation, 300–​302 opportunism, 302–​304 seller’s lawsuits, 302 social norms, 298–​299 supplementary proceedings, 298n9 Specific Performance Principle, 304–​316. See also Specific performance application, 306–​315

860

860

Index

Specific Performance Principle (Cont.) buyer’s breach, 311–​312 construction contracts, 313–​314 defined, 304–​305 delegation, 315 employee’s breach, 312 employer’s breach, 313 goods not readily available, 308 highly differentiated goods, 309 homogeneous goods, near future delivery of, 306–​307 long-​term supply contracts, 307–​308 moderately differentiated goods, 309 personal services contracts, 312–​313 promisee-​centeredness,  305 real property sales, 310–​312 reinstatement, 313 sales of goods, 306–​310 seller’s breach, 306–​308, 310–​311 services contracts, 312–​315 supervision rule, 314 traditional tests compared to, 304–​305 undue-​need-​for-​judicial supervision rule,  314 Stake, Jeffrey Evans, 558–​559n4 Standardization vs. differentiation, 190 Statute of Frauds, 783–​811 admissions, 793–​794 confirmation receipt, 793 coverage, 791–​792 criminal liability, 788 equal-​dignity rule, 800–​801 E-​SIGN,  785 exceptions, 792–​794 executory promises, 797–​798 expectation damages, 805–​807 goods made specially to order, 792–​793 guarantees, 799–​800 history, 4 interpretation problems, 794 justification for, 786–​788 land interests, sales of, 790–​791, 805–​807 legal consequences under, 788–​790 marriage, consideration of, 798, 805 memoranda, 800 modification, 808–​810 non-​oral-​modification clauses, 813–​814 oral contracts, 802–​807. See also Oral contracts oral modification, 808–​810 oral rescission, 807–​808 overview, 783–​786 parol evidence rule, 810–​811 part performance, 792 pleading and procedure, 811

reformation remedy, 810–​811 reliance, 803–​804 requirements, 798–​802 rescission, 807–​808 Restatement (Second) of Contracts, 789, 803–​804 restitution, 330, 802 sales of goods, 791–​794, 801. See also Sales of goods satisfaction of statute, 798–​802 securities, purchase or sale of, 795 security interests in collateral, 795 signing by parties, 800 suretyship, 796–​797, 805 timing of performance, 795–​796 types of contracts within, 790–​798 UCC, 784, 791–​795, 801 UETA, 784–​786 Statutes and unconscionability principle, 95–​96 Stigler, George, 163 Strict liability, 173–​175 Restatement (Second) of Contracts, 173 Structural agreements, 32–​37 defined, 461 firm-​offer rule, 461–​462 Subcontractors intent-​to-​benefit test,  769 owners’ suits against, 768–​770 prime contractors’ sureties, suits against, 763–​766, 765n100, 765nn102–​103 Subjective acceptance, 447–​449 Subjective beliefs of promisors, 270–​271 Subjective meanings, 401 Subjective probabilities, 271–​273 Substantial performance, 697–​703 common law background, 699 cure, 701 good faith, 700 installment contracts, 700 overview, 697 perfect-​tender rule, 702 revocation of acceptance, 700 sales of goods, 699–​703 test for, 698 UCC, 700–​703 willfulness, 698–​699 Substantive unconscionability, 70, 89–​95 Substitute transactions, 154. See also Mitigation Principle Sugarman, Steve, 108n39 Summers, Robert S., 193, 224, 625, 680, 685, 809 Supervision rule, 314 Supplementary proceedings, 298n9

861

Index

Supranormal damages, 247 Sureties, subcontractors’ suits against, 763–​766 Suretyship oral contracts, 805 Statute of Frauds, 796–​797, 805 Surplus, 180 Surplus-​enhancing reliance, efficient rate of, 184–​186 Surprise,  84–​85 Surrender of right to assert claim, 44–​47, 44n39 Tacit assumptions, 627–​630 Telescopic faculties, 167–​168 Temporal proximity, 166 Termination of power of acceptance, 457–​483. See also Revocation of offers conditional acceptances, 479–​481 conversation rule, 458–​459 counter-​offers, 477–​479 death, 474–​476 firm-​offer rule, 460–​464 incapacity, 474–​476 indirect revocation, 470–​471 lapse, 457–​460 lateness, notification of, 460 mirror image rule, 481–​482 nominal consideration, 464 one-​sidedness, 462–​463 rejection, 477 revocation of offers for bilateral contracts, 460–​464 unilateral contracts, 466–​469 withdrawal of general offers, 472–​474 Terminology, 4–​7. See also Definitions classical contract law, 6 commodity, 7 doctrinal propositions, 4 experiential propositions, 5 expressions, 7 moral norms, 5 principles, 6 pronouns, 7 rules, 6 social and critical morality, 5–​6 social propositions, 5 Thayer, James Bradley, 380 Thel, Steve, 124–​130, 125n85, 126n87 Theories,  9–​19 axioms, 10–​11, 25 efficient breach, 51–​66. See also Efficient breach theory formalist, 9–​15. See also Formalist theories interpretive,  15–​17

861

monistic,  17–​19 normative,  17–​19 pluralistic, 17–​19,  22–​23 public basis of justification, 16 Third-​party beneficiaries, 741–​780 classical contract law, 745–​747, 749 conjunctive test, 755 consideration, 747 contract, defined, 741 contracting parties, defined, 741 creditor-​beneficiary cases, 743–​745, 750, 760–​761,  778 defenses, 774–​778 defined, 741 donee beneficiaries, 750, 759–​760 early English and American law, 741–​743 explicit provisions about, 761 government contracts, 770–​774, 772–​773n137 hypothetical test, 755 incidental beneficiaries, 750 intended beneficiaries, 754 intent-​to-​benefit test, 752–​755 Lawrence v. Fox, 743–​745 modern law, 748–​750 modification, 775–​778 morality and policy, 757 moral obligation, 748 multi-​prime contracts, 767–​768 objectives of contracting parties, 756–​757 principle, 750–​759 privity, 743n15, 744–​747 promisee, defined, 741 promisor, defined, 741 promisor’s defenses against promisee, 775, 778–​779 rescission, 775–​778 Restatement (First) of Contracts, 749–​750, 775–​776 Restatement (Second) of Contracts, 753–​758, 776–​778 subcontractors, 763–​766, 768–​770 unity of interest, 748 would-​be legatees, 761–​763 Tiersma, Peter, 418–​419 Time-​of-​effectiveness issues, 451–​454 Totemic aspects of donative promises, 104–​105 Tracking and disgorgement, 359–​360 Trade usage, 634–​636 Restatement (Second) of Contracts, 378–​379 Transactional incapacity, 79–​82 Transaction-​cost arguments, 57 Transmission modes of acceptance, 451–​452, 455–​456

862

862

Index

Trebilcock, Michael, 18–​19, 597–​598, 598n8, 599n10, 603, 605n38, 658–​659 Trespass for purposes of extraction, 137n19 Triantis, George, 653–​654 Trimarchi, Pietro, 254, 646n66, 648n69, 656 Triviality and perfect fulfillment rule, 723 Trust, creation of, 110n42 Trust or confidence relationships, 616–​617. See also Fiduciaries Tversky, Amos, 160–​162, 165, 166 UCC. See Uniform Commercial Code UCCC. See Uniform Consumer Credit Code UCITA (Uniform Computer Information Transactions Act), 456n75 UDAP (Unfair and Deceptive Acts and Practices) statute, 95 UETA (Uniform Electronic Transactions Act), 449, 456n75, 784–​786 Ulen, Thomas, 305, 335, 605–​607, 606n39 Unbargained-​for risk test, 643–​653 example, 647–​651 mutual mistake compared, 644–​646 nature of relief, 651–​653 test, 643–​644 unexpected circumstances, 626 Uncertainty. See Certainty principle Unconscionability principle, 69–​96 above-​market prices,  85–​89 admiralty law, 76–​78 commodities,  71–​72 competitive market, defined, 71 credit, extension of, 89 distress,  73–​78 door-​to-​door sellers, 87–​88,  88n46 form contracts, 524 improvidence,  94–​95 markets, role of, 71–​72 moral fault, role of, 72–​73 norms,  73–​96 one-​off sellers,  85–​86 paternalism,  92–​93 price-​gouging,  78–​79 price-​ignorance exploitation,  85–​89 procedural unconscionability, 70 rescue,  73–​78 Restatement (Second) of Contracts, 69 sellers,  85–​88 statutes,  95–​96 substantive unconscionability, 70, 89–​95 transactional incapacity, 79–​82 UCC, 69 UCCC, 83, 95–​96

UDAP, 95 undue influence, 83 unfair persuasion, 82–​84, 84n43 unfair surprise, 84–​85 Undue influence, 83 Undue-​need-​for-​judicial supervision rule,  314 Unexpected circumstances, 625–​663 adversely affected party, defined, 627 ex post considerations, 659–​661 frustration, defined, 627 impossibility, defined, 627 impracticability, defined, 627 insurance considerations, 655–​659 judicial relief, 626 mutual mistake vs., 637n35, 646n65 overview, 625–​627 promisor, defined, 627 shared-​tacit-​assumption test, 626–​643. See also Shared-​tacit-​assumption  test unbargained-​for risk test, 643–​653. See also Unbargained-​for risk test Unfair and Deceptive Acts and Practices (UDAP) statute, 95 Unfair persuasion, 82–​84, 84n43. See also Duress Unfair surprise, 84–​85 Uniform Commercial Code (UCC) generally, 4 acceptance, 441–​442 adequate assurance principle, 683–​684 admissions, 793–​794 agreement, defined, 367 anticipatory damages, 680 anticipatory repudiation, 675 buyer’s breach, 310 confirmation receipt, 793 contract, defined, 367 contractual allocations of losses, 250–​251 contradiction, 541 course of dealing, 369–​370 cover, 221n1 efficient breach theory, 59 firm offers, 464–​465 form contracts, 528 gaps, 502, 518 goods made specially to order, 792–​793 inference from circumstances, 634 interpretation of contracts, 387 interpretation problems, 794 lost profit, 189 market price, 189 mirror image rule, 482 mitigation, 155 parol evidence rule, 536–​537, 539

863

Index

part performance, 792 performance, 369–​370 replacement cost, 189 restitution, 328–​329 sales of goods, 700–​703 silence as acceptance, 139 Statute of Frauds, 784, 791–​795, 801 substantial performance, 700–​703 unconscionability, 69 warranty breach, 192 Uniform Computer Information Transactions Act (UCITA), 456n75 Uniform Consumer Credit Code (UCCC), 83,  95–​96 Uniform Electronic Transactions Act (UETA), 449, 456n75, 784–​786 Unilateral contracts acceptance, 429–​440 at-​will employment rule, 431–​436 background, 429–​431 defined, 419 employment manuals, 431–​436 knowledge of offer, 438–​439 mutuality, 45 obligations of offeree who has begun performance, 440 offeree’s motivation, 436–​438 performance by offeree notice requirement, 439–​440 rescue, 139–​140 Restatement (First) of Contracts, 467–​468 revocation of offers, 466–​469 Unilateral mistakes, 557–​575 computational errors, 565–​571. See also Computational errors loss aversion, 558n4 mistaken payments, 560–​565. See also Mistaken payments modern position, 571–​575 overview, 557–​560 reliance damages, 571 United Nations Convention on Contracts for the International Sale of Goods (CISG), 451n62 Unity of interest and third-​party beneficiaries, 748 Unjust enrichment asymmetric nature of damages, 207n13 disgorgement, 345 formation, 494 Unpaid prizes or rewards, 487–​488 Unrealistic optimism, 163–​165, 169 Unreasonable disproportion, 208–​209

863

Unreasonable economic waste, 208–​209, 211 Usage custom and trade usage, 634–​636 defined, 368 as elements of contracts, 368–​369 special-​community usage, 378 trade usage, 378–​379, 634–​636 Vogel, Carol, 592n35 Waldfogel, Joel, 105–​108 Warranty breach, 192 Waste of socially productive capacity, 149 of socially wasteful transaction costs, 597, 606–​607 unreasonable economic waste, 208–​209, 211 Weintraub, Russell, 40, 652–​653 Wessman, Mark, 486n6 White, James J., 42–​43, 193, 224, 680, 685, 809 Willfulness, 252 substantial performance, 698–​699 Williamson, Oliver E., 628, 629n9, 736n12 Williston on Contracts,  6–​7 Williston, Samuel. See also Restatement (First) of Contracts algorithms,  25–​26 anticipatory breach or repudiation, 674 donative promises, 121–​122 extreme literalism, 388–​391 formalist theories, 9 interpretation, 398 offers, 424 parol evidence, 534–​535, 538 revocation, 467–​468, 468n30, 470–​471,  471n41 termination of offerees power of acceptance, 459n6 terminology,  6–​7 third-​party beneficiaries, 743n23, 745–​746, 746n31, 747n42 Windfalls, 591–​594 Withdrawal acceptance, 454 anticipatory repudiation, 677 general offers, 472–​474 World of contract, defined, 103 World of gift, defined, 103 Would-​be legatees as third-​party beneficiaries, 761–​763 Writing requirements, 783–​814 Yorio, Edward, 124–​130, 125n85, 126n87

864