Defenses to Contract Formation and Enforcement

The ability of individuals and businesses to build off of each other’s strengths through the formation of legally enforceable agreements, contracts, has greatly enhanced the progress, specialization and economic prosperity of our modern age.2 Contracts, in the entrepreneurial setting, permit an entrepreneur with an improved idea to rapidly “outsource” and build off of the work, experience, specialties and strengths of others and meet the holistic needs of a business operation including suppliers, manufacturers, marketers, retailers, personnel, professional consultants and the like. As these cooperative and specialized efforts swarm around an “improved idea” such ideas are perfected and actualized with increasing precision and success. Not only does the entrepreneur benefit, but its partners as well. As an entrepreneur’s specialized partners are permitted to focus on their given expertise, through contracts, their processes are improved. As partners are exposed to an “improved idea,” they solve new problems which further enhance their specialty.

Despite the overwhelming benefits provided by contracts in our modern age, contracts have their challenges. Contracts are a static attempt to capture the present cooperative intentions of two or more diverse parties for a shared but unknown future. Cementing diverse intentions for the unknown is what keeps contract lawyers up at night. Recognizing this innate challenge which contracting presents, the law has adopted several rationale for not recognizing or enforcing contracts.

With the intent of providing insight and connection into the sometimes impersonal rationale of contract law (and without reference to family law), I would like to introduce a warm pastel picture of Prince Charming and Princess Bride at their wedding celebration, perched on the palace balcony which overlooks their alpine kingdom on the bay, their subjects and the distant setting sun. Prince Charming and Princess are holding hands having just exchanged wedding bands. What do we expect next? The wedded couple will jump on their stallions and ride side by side into the sunset of bliss, happiness and fulfillment.

What really lies ahead? Complaining subjects, violent invaders, faltering infrastructure, famine, plague and disease, not to mention the interpersonal conflicts that arise in the royal family as a result of these and other life challenges. The Princess feels robbed; her envisioned life of stallions and sunsets has crumbled under the pressures and responsibilities of governing the kingdom. She places increasing blame on the Prince who is always out hunting and gallivanting with royalty while the burdens of ruling rest squarely on the Princess.

The Princess wants out of the marriage contract and a return to her previously simple country life when she sold produce in the town square. She seeks either an annulment (marriage contract was never formed or should never have been recognized by the law) or divorce (marriage contract should no longer be enforced). She has plenty of reasons, including: her own questionable capacity (she was 17 and drunk when she exchanged vows); duress (she was surrounded by armed guards and coerced to say “yes”); misrepresentation (he promised her she would gallivant while he would rule); indefiniteness ( she was not informed of the many responsibilities of a princess); writing (the Prince’s claim that she had previously agreed to assume leadership responsibilities should have been in writing); mistake ( duh…this guy was totally incapable to rule); the circumstances had changed (the Prince had taken a mistress), frustration of purpose (the Prince was sterile and therefore no heir could be produced); public policy (commoners were forbidden to marry royalty by law); good faith (the Prince was dishonest and unfaithful).

Just as the young Princess Bride asks that her marriage contract be invalidated or unenforced, so to do once starry eyed or unwary business partners. As mentioned above, such partners may challenge that a legal contract was ever formed. This can be done by proving that the parties never had a “meeting of the minds” or true understanding of the obligations alleged to have been entered into. This failure may be a result of the agreement never having been memorialized in writing, indefiniteness, the capacity of a party being compromised, fraudulent misrepresentations, mistake, coercion or duress.

A Statute of Frauds defense to contract formation requires that certain contracts must be in writing to be enforceable. These include contracts involving: prenuptial agreements (the Prince should have documented the Princess’s willingness to administer the kingdom); contracts that won’t be performed within a year of their making; the sale of real property; the guarantee of the debt of another (surety, executor); the sale of goods over $500; the sale of personal property over $5,000, and; the sale of securities.3 Requiring parties to document their intentions at the time of contracting should minimize dispute over what the terms of an agreement may be thus aiding objective enforcement of a contract should either party contest or breach a contract’s provisions. In the case of third parties assuming debt obligations, it protects potential third party guarantors and administrators (persons charged with administering a Will) from assuming unwanted debts (Oh, don’t worry, my Dad will guarantee payment of the rent).

One means of proving a contract deficient is to show that such contract is indefinite or uncertain. Our Princess may claim that in no way do the words “do you accept this man to be your lawfully wedded husband” communicate the necessary roles and responsibilities, or “terms of service” that would fall upon her as a princess. In the commercial context, a few of the “essential” elements of a contract may include: the parties, the nature of the goods or services, the price, timing of payment or performance.

A party may also contest a contract was formed by proving the capacity or authority of that party at the time of contract was deficient or impaired (our young and drunk bride, for example). The understanding of two parties at the time of contracting is often described as a “meeting of the minds”. If the ability of one of those minds to comprehend the nature of the commitment being made was compromised at the time of contracting, and the other party knows it, then such contract may be unenforceable.5 Most states have identified persons over the age of 18 to be sufficiently mature and capable to enter into enforceable agreements.6 In addition, those who suffer from mental illness or disease or are otherwise impaired in their comprehension because of substance abuse may also be able to void their obligations, especially if the other party new of such mental deficiency and the benefit of the contract has yet to be enjoyed by the incapable party.

Another claim proving that there was no clear understanding is that the contract was fraudulently induced. In our fairy tale, the princess claims she was told by the prince that “she would gallivant while he would rule”. When one party misrepresents a fact in order to induce another to enter into a contract, and the other party relies on such representation as rationale to enter into the contract a court may find the contract is void as a result of being “fraudulently induced”. Because of the propensity for “he said, she said,” reaching back in time through the history of the parties courtship (salesmanship and negotiation), the law has developed several important elements necessary to prove fraud worthy of making a contract void. First, the fraud must concern an important existing fact. In our fairy tale, aspirations about future roles and future commitments may not be specific or concrete enough, such as a representation that “the car is in perfect condition.” Second, the false representation must be contrary to current knowledge or recklessly made. Was it clear that our Prince had no intention of ruling when he made the representation? Third, the representation must be made in order to induce a party to enter into the contract. In our case, did the Prince casually mention his propensity for ruling in discussions unassociated with courtship? Fourth, the defrauded party must rely on the representation. Had the Princess purchased party gowns and did she depend on the Prince fulfilling his statement? Fifth, and last, would a party have entered into the contract, regardless of the misrepresentation? Was our Princess so head over heels with the Prince that she would have married him, no matter the personal cost or sacrifice? As you can see, it may be one thing to feel defrauded, but it is quite another to prove that you have been defrauded. Determining the “knowledge” of the fraudulent party and the “reliance” of the defrauded party are difficult propositions to establish.

What about our Princess Bride’s claim that she had simply made a mistake? In hindsight it is easy to recognize our mistakes, but should that be grounds for failure to recognize a contract? This idea that enforceable agreements require a “meeting of the minds” or understanding of the parties provides room for the defense of bilateral (both parties) or unilateral (one party) mistakes. A mutual mistake requires both parties to be mistaken about a “basic assumption or important fact upon which they based their bargain.”7 A unilateral mistake requires one party to be mistaken about an “important feature of the contract even though a reasonable effort was made to understand that feature” and, the “mistake was so serious that enforcement would be unconscionable.”8 Our Princess Bride claims that our Prince was incapable of ruling, an important feature of a Prince, which resulted in her having to assume all of the responsibilities of ruling. But shouldn’t our Princess have done her “due diligence” and known of the Prince’s deficiencies during courtship as she observed his failures and disinterest in passing preparatory lessons in the King’s court? Finally, is it unconscionable for a Queen to have to rule? Several Queens before her had been thrust into governing roles upon the death of the King.

One basic tenet of freedom is the “freedom to contract”. Therefore a party who is physically forced into, or is a recipient of, an “improper threat” that leaves a party with no alternative but to agree to, a contract should not be held to such a contract (think of our Princess bride surrounded by armed guards at the time of “I do”). Though the idea of physical threat is quickly captured by the mafioso “sign this or else” baseball bat in hand, the concept of improper threat is a little less clear.

A threat is improper if it would result in a crime (I will burn your store down), a criminal prosecution (I’ll turn you in for tax fraud), or is the breach of a duty of good faith (I’ll quit my five year contract in year four, before the Super Bowl, unless I get another five year extension)9.

In addition to promoting mutual understanding, the law also works to promote mutual benefit in protecting the weak or unwary from the unscrupulous and advantaged whose contracts may be unconscionable, illegal or lack good faith and fair dealing.

Merriam-Webster defines “unconscionable” to mean: “extremely bad, unfair, or wrong….not guided or controlled by conscience.” Unconscionability can be found when “the contract terms are so one- sided as to oppress or surprise an innocent party, or (ii) the contract terms result in an overall imbalance in the parties obligations and rights that is inconsistent with accepted customs and business practices.”10 Unconscionability is more likely to be identified when there is an imbalance in the bargaining power of the two parties as manifest by a “boilerplate” contract which is not the subject of discussion or negotiation.11 Unconscionable contracts may include a contract for consumer goods disclaiming any and all warranties, or broad activity liability waivers which excuse the negligence of employees serving as guides or instructors. In this same vein, the law does not enforce contracts that are against public policy. Contracting with a hit man, for drugs or with a terrorist organization listed with the State Department creates a voidable contract.12

Another rationale for non-enforcement of a contract is that the purpose of the contract has been frustrated, or the purpose of the contract is no longer practical to perform. Frustration of purpose in our fairy tale may include a claim by the Princess that the Prince is sterile and is unable to produce children, one of her primary purposes in marrying. Impracticability of performance in the commercial context may include a “force majeure” or “act of God” such as an earthquake or storm which prevented a party from delivering goods. In both instances it is important that the claiming party is “without fault” (did not cause the intervening event) and that the non-occurrence of the intervening event was a basic assumption on which the contract was made.” 13 The Prince would be hard pressed to prove that the Princess’s infertility was not a pre-existing condition and instead resulted from a supervening event.

Partners in business, as partners for life, seek to create a relationship and benefit greater than the sum of their individual parts. The binding and enforceable nature of a contract seeks to honor and sustain the mutual benefit contemplated by these parties, a benefit upon which the parties can rely. Because of this interest in sustaining the intended benefits of contracts, courts are remiss to void or render a contract unenforceable. When they do, a court often finds that the parties failed to come to a clear mutual understanding, or “meeting of the minds”, either because of a parties compromised capacity to contract, misrepresentations by one or both parties, mistake, coercion, duress, incomplete terms or terms which should have been in writing. We have also learned that a court may find the terms or purposes of a contract void or unenforceable because they are, so unfair as to be “unconscionable”, illegal, useless or excused.