Contracts
Class Notes
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.
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.
Vocabulary
“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.
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?
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.