Contracts Class Notes 9/19/03


Groves v. Wunder


Groves leases some land to Wunder.  It’s next to a railroad and it’s useful primarily because it’s full of gravel.  Wunder will take out the gravel over seven years.  Wunder pays Groves $105,000.  Don’t forget that the Great Depression occurs in the middle of the term of the contract.  The lease was made in a boom time and it ended in the Depression.  Wunder can’t sell much gravel, so it gets real difficult to level the land; he can’t afford to do so.  So he just walks away.


The court keys in on the fact that the defendant breached deliberately.  Is that really a big deal?


There was definitely a breach and definitely a loss.  But how do we measure that loss?


It would cost $50,000 to level the land as called for in the contract.  On the other hand, it would be worth $12,000 more if it had been leveled than it’s worth now (namely, $0).  Which amount should the plaintiff recover?


The court ends up giving the plaintiff the big cash.  This is intended to be compensatory, but is that really so?


The dissenters said that he could have taken the $55,000 and bought, for example, four more tracts like the one he had, which they claim is an unfair windfall for the plaintiff.


People have since argued for years about who was right.


Illustrations from the Restatement (First) § 346


Consider the “ugly statue” problem.  B has paid $2800 of the total $5000 contract price to A to build this fountain.  A does some work but then quits.  It would cost $4000 to finish the job.  B will recover the reasonable cost of completion ($4000) minus the unpaid contract price ($2200) which equals $1800.


When B goes to court, he has paid a total of $6800 for the fountain that he should have only paid $5000 for.  He had an $1800 hole in his pocket, and that’s what A must pay him.  This is a pretty predictable and fair result.


Consider the “oil well” problem.  A and B have adjacent plots of land, and they think there might be oil underneath.  A contracts with B to build an oil well on A’s land.  Other people in the area build oil wells and find out that there’s no oil.  A decides not to build the oil well, and B sues.  B will only be able to collect nominal damages because B suffers no loss.  Another way to put it is that actually constructing the well would involve “unreasonable economic waste”.


Why did B agree to help build this oil well on A’s land?  He wanted to find out if there was any oil.  He got this information in a different way, so the well wasn’t worth anything to him anymore.


For the Restatement (Second) equivalent of § 346, look at §§ 347 and 348.


What has been bought and paid for?  In Groves, the plaintiff “paid” for a “leveling promise”.  Without that promise, the plaintiff would have “paid” less, or in reality, the defendant would have paid more for the lease.


In Peevyhouse, the farmers were primarily trying to get money for the coal on their property.  The leveling promise wasn’t as important or valuable to them as the coal royalties.


These are close, hard cases, and were each decided by one vote with vigorous dissents accompanying each decision.  Sometimes you get facts under which it is excruciating hard to follow the Golden Rule[1].


Why did the mining company break the lease and not level?  There may have been less coal there than they expected; in other words, the deal didn’t work out the way they accepted.


At contract formation, both parties tend to wear “rose-colored glasses”: they imagine that the contract will be performed, there won’t be a breach, and that each party will come out well.  This is probably true in 75-80% of contracts that are made.


When you enter into a contract, you don’t think about the bad stuff that might result.  One function of lawyers is to think about the worst-case scenario and let their clients know that “yes, it can happen to you, so beware!


Lawyers and accountants are bad people.


Are Groves and Peevyhouse contradictory?  In Groves, it was a pure economic investment, while in Peevyhouse, the people actually lived on the land that was being strip-mined.  In that sense, the results seem odd.  Groves appears to be a “minority rule”, while a Peevyhouse-like result appears more often.


Liquidated damages and penalties


Restatement (Second) § 356 says that the parties to a contract cannot create a penalty for its breach.  How come?  Why can’t we put whatever we want into our contract?  What if performance is really important to us?  Wouldn’t we want some big penalties in that case?


Why do we take away part of the parties’ right to make whatever contract they want?


Well, contracts ain’t torts.  As a matter of public policy and economic efficiency, penalties in contracts have no purpose.


Another reason we don’t allow penalties is that the parties are wearing “rose-colored glasses” as we mentioned.  They don’t take as much time and thought in agreeing to damages as they do in establishing the terms that they think will actually be carried out.


There is an economic argument that some breaches are efficient, and such breaches should not be penalized.  On the other hand, the penalty clause, rather than eliminating economic gains from breach, may allow the injured party to share in such gains.


For some especially reprehensible torts, we give more than compensatory damages.  In rare cases, the law will provide for penal damages in a contract case.


Why might we want to allow penalty clauses?  The parties may have a better idea than judges of how great the harm might be.


City of Rye v. Public Service Mut. Ins. Co.


The court finds that it’s unclear just how much the damages to the city would amount to.


The reason the city doesn’t get the value of its surety bond is that there is a risk of corruption on the part of city officials against developers if the precedent of awarding such large penalties is created.


Muldoon v. Lynch


The widow of Mr. Lynch wants a big tombstone over his grave.  She puts into an agreement with the builder a clause that provides for ten dollars a day in damages for every day the builder is late.  She doesn’t recover these damages because the court finds them to be “a spur” (think of the thing you do to a horse to make it go faster).  The court says this is bad and we’re not going to enforce it.




“Agreed damages at the outset” becomes a “liquidated damages clause” if it’s good and it will be enforced.  If it’s no good and unenforceable, it’s called a “penalty clause”.


A penalty clause doesn’t invalidate the entire contract; instead, you just pretend that the clause was never there and enforce the rest of the contract.


Pacheco v. Scoblionko


The parent pays the entire camp fee before camp begins.  The kid can’t go to camp, so the parent asks for his money back.  The camp says no and points out a clause in the contract that says you do not get any of your refund back if you ask for it after a certain date.  The court rules that the clause is unenforceable.


In the absence of such a clause, how much do we give the plaintiff?  The plaintiff gets restitution, but the camp can deduct any losses it suffers due to the plaintiff’s repudiation.  In other words, the camp can keep its savable expenses.


Why did the plaintiff get all his money back?  The defendant failed to offer evidence as to what damages the camp suffers due to the plaintiff’s repudiation.  It was the defendant’s burden to prove such damages because the defendant was the proponent of the clause that was found to be unenforceable.[2]


Note that the Restatement (Second) § 356 is almost identical to UCC § 2-718(1).


What will make an “agreed damages clause” enforceable?


Wilt v. Waterfield


The clause at issue in this case is knocked down.  The problem is that the clause applies the same amount of damages to a wide variety of harms.  It’s an “undifferentiated clause” that applies the same measure of damages to all the different sort of bad things that can happen.


In the modern view, we’ll uphold a clause like this if the prescribed damages happen to be reasonable in light of the actual or predicted harm.


If we can accurately measure the harm done upon breach, it’s very unlikely we’ll uphold an agreed damages clause because we can give actual compensatory damages.


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[1] The injured party needs to be put in the position performance would have done.

[2] The Seventh Circuit is more amenable than other jurisdictions to upholding penalty clauses.  You can tell because they put the burden of proving a clause is invalid upon the party challenging the clause.