Memorandum
Date: February 1, 2005
To: Contracts, §3
From: Avery Katz
Re: Feedback on the final exam
Here is a model answer laying out what I consider to be the main issues raised on our contracts exam, as well
as their likely resolution. This answer was composed after I read your exam papers, and so incorporates most of
the points that you came up with in writing the exam, as well as those I had identified in advance. Thus, it goes well beyond what I expected any individual student to produce on his
or her exam paper (and it also exceeds the word limit by a considerable margin).
Accordingly, as I stated in class, it was not necessary for you to discuss all of these issues to get a high score.
Good answers might have ignored some issues to go into greater depth on others, but missing a major cluster of
issues would have hurt your score. Pending permission from the authors, I will also post on the website the top
three student answers to each of the questions to the exam. What made these answers good was their coverage of
arguments, detail and sophistication in their use of facts and in seeing both sides of the issues, and clarity
in organization and explanation. If you drew different inferences from the facts than I or the top answers did,
you may still have gotten credit, so long as your inferences were plausible and you supported them with legal argument.
I did not give credit for merely restating the facts without relating them to the legal or planning issues at
hand, and I gave little credit for reciting black–letter law in the abstract without applying it to the facts.
A few people did waste some space this way.
Your individual exams are available for inspection at the office of my assistant, Joseph McGrath
(jmcgra@law.columbia.edu, 500/10 JG, 4-3268,). I did not make many written comments on the exams themselves; instead, I used a system of symbols
to indicate my reaction to particular arguments and inferences. A key to these symbols is attached. I also kept
a score sheet containing my own notes on each exam. If you want to discuss your individual exam, please feel free
to contact me. You will find it useful, however, to read this model answer as well as the top answers before we
meet.
It was a pleasure teaching the class, and I wish you all well. Please keep in touch.
Question 1: Sketch of suggested answer
On this question, as with any planning question, you could successfully have gone in a number of directions. The following list sketches the possibilities.
Rights and duties under the contract
Any advice to the parties depends on the legal situation they face. Accordingly, it is helpful to start with a discussion of the parties’ rights and duties under the contract, which can then be applied to each of the parties’ perspectives.
ABC’s right to terminate the contract
The contract is good for a fixed time period and we are not told when it expires or whether it rolls over. Similarly, we are not told whether there are any explicit or implied promises (e.g. franchise handbook ) that would limit the right to terminate at the end of the term, whether there are other situations that would justify early termination, or whether there are notice requirements associated with termination. Thus in absence of further information, we should assume that the contract is binding on both parties for the full term absent material breach by one of them.
So far there have probably been no breaches by either side, only threats to breach. Bobby Brewster (BB) has not entered a competing endeavor and has not yet withheld royalties (although this is a bit ambiguous because we are not told when the royalties are due.) ABC has not yet changed its business model. Both parties may have created insecurity for the other, justifying a demand for assurances, but we didn’t cover the insecurity doctrine in class and thus I didn’t expect you to discuss it. There is a colorable argument that BB has breached the best efforts promise (see) but given the ambiguity, it is likely not a material breach. Thus, neither party can evade its remaining duties under the contract without being in breach itself.
Promises not to compete
The contract contains are two explicit promises not to compete: ABC promises not to establish an office in the franchise area during the life of the franchise, and BB promises not to enter into any competing endeavor for two years following the life of the franchise. Both promises are explicitly limited to the franchise area, so do not apply to efforts outside the area. But the duty of good faith could be used to extend these promises beyond their explicit scope. In this regard, relevant facts include: ABC’s new business strategy and the growth of Web-based commerce, both of which reduce the relevance of geographical franchise areas; BB’s recent investment in the franchise; that BB’s promise affects his ability to earn a livelihood; that BB’s ability to compete may depend on proprietary information provided by ABC; and that ABC wants to buy out BB and has been refused. In all, to the extent that out-of-area competition interferes with the purposes of the non-compete clauses, there is a fair chance the duty will be extended. The risk of an extended duty not to compete, however, is probably greater for ABC, who drafted the contract and is the more powerful party.
ABC’s promise is further conditional on BB not being in default. However, we are not told what default means, although presumably it means something short of material breach. ABC’s ability to declare default is probably limited in similar fashion by a duty of good faith.
With regard to remedies for breach of these duties, promises not to compete are generally enforceable by injunction, subject to the standard limits on getting an injunction, including equitable discretion. But money damages are likely to be difficult to show under the circumstance. Thus there is a reasonable chance of getting an injunction if breach can be shown, at least as to the explicit promises
ABC’s promise to assist with client development.
Here there is room to argue about the scope of the duty, both with regard to intensity and with regard to area. Even though ABC does not promise any particular level of effort, some duty of reasonable efforts should probably be implied.
The contract does not explicitly state that the franchisee has exclusive rights to serve individual affiliates working or living in her area; in fact, this cannot be since individuals can work in one area and live in another. But we are told that some sort of exclusivity is the parties’ expectation and it may rise to a course of dealing or course of performance. Weighed against this is the ordinary discretion a franchisor has in to exercise business judgment in adjusting its business model. So it is possible that ABC would breach this promise if it routed individual clients to offices in areas where they neither worked or resided.
Damages for breach of this duty would in principle equal the additional revenues (or value of the franchise) that would have been earned with promised assistance; though in practice this would be very difficult to prove. Nonetheless, specific performance would be unlikely since it would be difficult to make effective.
BB’s promises to exert best efforts and to pay royalties.
The promise to pay royalties is explicit and clear. Either the royalties are paid or not.
Th meaning of the best efforts clause is not so clear. In this regard, relevant facts include: the fact that BB has been devoting significant time and attention to night school classes, the fact that she is doing so in her free time, the fact that the value of an MBA would not be relationship-specific, the fact that revenues have fallen since BB took over, and the fact (?) that the industry is in flux. These facts could cut either way. For instance, BB’s pursuit of a night degree could be argued to be an asset that will assist her in the business, or a separate personal investment that distracts her from the business.
Damages for failure to pay royalties are straightforward, but remedies for failure to exert best efforts suffer from same problems as remedies for failure to provide assistance with clients, supra.
Material breach
Possible future material breaches could include: BB’s withholding royalties without stronger justification, explicit violation of the non-compete or assistance clauses, substantial reduction in BB’s efforts, and substantial reduction in ABC’s client development. Any of these would allow the aggrieved party to rescind the contract.
Other breaches would probably be deemed non-material, though, including entering into competition outside the franchise area, a less than substantial reduction in BB’s efforts, and a less than substantial reduction in ABC’s client development. These would lead to claims for damages, but would not allow recission.
Rights to information and client lists
There is no obvious reason under contract law why ABC cannot retain right to information it provides and to its client lists, but practical enforcement of these rights may be difficult. To some extent BB may be able to retain information and clients from memory without access to the actual written lists. In addition, the clause does not explicitly prohibit BB’s taking existing clients to a new office, only the lists and the information. It will be difficult to separate the value of ABC’s and BB’s relative contributions to acquiring and retaining a given client. So these rights effectively turn on enforcement of the non-compete clauses.
Other issues
There are other legal arguments available, but they are probably less colorable. BB probably would need rather more than we are told here to show the contract was unconscionable. ABC would have a hard time showing change of circumstances justifying suspension of its duties (although there may well be enough to support a good faith modification).
Advice for ABC
Course of action 1: threaten to declare BB in default.
As indicated above, BB’s refusing to pay royalties would likely be a material breach, but it is unclear whether they are due yet. Refusing to cooperate with ABC’s new strategy is a vague claim, possibly not a breach at all, and unlikely a material breach. And we do not know if the contract provides for default short of material breach. Thus, this threat well be empty aside from its value in forcing payment of royalties.
The threat also has other disadvantages. It is risky because there is a chance that a court might find ABC in breach of duties of assistance and good faith, and it also risks alienating BB from the relationship. It may also cause loss of morale for other franchisees (though the facts suggest this is not a major consideration )
So such a threat is most likely valuable as a way to get royalties for the time being, in association with a general strategy of waiting until the franchise contract expires.
Course 2: try to buy BB out
If ABC’s offer to buy BB out is accepted, it would probably be a legally valid modification; the change of market circumstances and fair price would reinforce this conclusion. However, there is a risk of a court subsequently finding such an offer to constitute duress, if the bargaining occurs in shadow of a default threat to breach.
In practice, this strategy may be of marginal value because the offer has been refused once already and BB may be unwilling to accept at a reasonable price.
Course 3: try to buy BB into new business strategy
Again, this would be a binding modification if accepted. It may be acceptable to BB if new clients are steered her way, since there is no indication she has made location specific investments.
Given its doubts about BB’s abilities, ABC may not want to buy BB in. But the franchise may turn around as she gains experience and completes her MBA, and in any event it will be necessary to negotiate and draft terms establishing priority over clients.
Course 4: go ahead without BB, either immediately or upon expiration of the franchise
This risks a lawsuit, but BB’s claims are fuzzy. Potential liability includes lost revenues due to breach of promise of assistance, breach of good faith for competition. Whether this approach makes sense depends on how valuable BB’s cooperation is to the success of ABC’s new business strategy.
Practical transactional issues
In choosing among the foregoing strategies, more information is needed on each of the following questions: (1) whether ABC’s new strategy is value-maximizing when the interests of the franchisees are concerned, (2) whether ABC’s new strategy causes loss to BB’s investment in the franchise, and (3) whether BB’s long-run investment in her business is maximized by affiliation with ABC.
In addition, in writing future contracts, it is important to pay attention to incentives for efficient investment and information exchange. These incentives are discussed at greater length below in the advice to BB.
Advice for BB
Many of the considerations relevant to ABC’s bargaining strategy are also relevant to BB’s. The following indicates issues that are specific to BB.
Course of action 1: jumping ship to XYZ
If BB jumps ship while the ABC franchise contract is still in force, she will be in breach of that franchise contract and will be liable for lost royalties that would have been earned thru her best efforts. In addition, she may be liable to ABC in restitution for the value of information and training that ABC supplied to her.
As indicated above, the covenant not to compete is likely applicable only in the franchise area, so she is safe in taking a job in the downtown office of XYZ, but she may not be able to serve clients who live or work on the UWS, and there is a long shot risk that the covenant will be extended to cover the downtown area as well.
With regard to taking clients with her to XYZ, BB probably has the right to take clients she has developed on her own, and a colorable right to take other clients so long as she does not take the formal lists. If ABC contests this with a lawsuit, however, the effective scope of this right will likely depend on her being able to prove that her efforts were the main factor contributing to the development of the account.
Course of action 2: stay with ABC
Here, all the same issues appearing above in the memo to ABC are relevant, along with any subjective considerations particular to BB (such as loyalty, loss of trust at not being consulted on the new strategy, etc.)
Course of action 3: Negotiating new terms
Here there were many useful suggestions you could have made. In my view, the most important contractual issue is assigning priority to clients during the life of the franchise, because if ABC or XYZ is not going to use a geographical system of priority, the system that is used will significantly influence the value of BB’s investment. The second most important issue probably is giving more specific content to the best efforts and assistance clauses. And the third most important issue may be assigning rights to clients following the termination of a franchise. With all of these issues, it will be difficult to measure compliance with promises and conditions, due to the difficulty of measuring effort and results.
Possible drafting responses to these problems include adjusting payment terms (e.g., changing the royalty rate, shifting more compensation to the lump sum term), specifying criteria for best efforts and adequate assistance (e.g., listing specific actions as required or as safe harbors, listing specific targets such as a minimum number of names supplied), changing the parties’ threat points in renegotiation (e.g., clarifying the right to terminate, providing a buyout clause , requiring the terminating party to reimburse its counterpart for any reliance investment).
Question 2: Suggested answer
Keith must worry about three potential disputes—with Willie Wilkoff, Doringer Partners, and Nigella Lawsuit. Let's take these in order.
1. Dispute with Wilkoff
At the very least, the Wilkoff dispute raises a Statute of Frauds issue. Are the exchanged emails sufficient to satisfy the requirement of a writing? Arguably they are. The emails are “electronic writings” and lay out the basic terms of the deal. Remember, the Statute is concerned with fraudulent claims; the emails here are sufficiently detailed to eliminate this concern. But what about the signature requirement? Arguably, this requirement can be satisfied by the fact that Willie's email can be traced to his computer. Even if these arguments are losers, however, Keith might still be able to avoid the Statute of Frauds by showing that he relied reasonably and in good faith on Willie's offer, assuming he made an offer.
Did Willie make an offer? Various facts point to the seriousness of the negotiations: Willie sent an email with detailed information about the building; he arranged for Keith, his architect, and his inspectors to visit the building; he sent Keith a legal description and copies of blueprints. Thus, when Keith said “the ball's in your court,” he made an offer that implicitly incorporated all prior negotiations, as in Fairmount Glass Works . Yes, the prior negotiations were informal, and the offer was even more informal, but the informality of the negotiation merely reflected the fact that Keith and Willie were old friends.
Against this conclusion it could be argued that the aforementioned facts show only that Keith and Willie entered preliminary negotiations, as in Owen v. Tunison . Willie merely said that he had found a building that “would meet your needs.” Although he later told Keith “the ball's in your court,” he was merely encouraging Willie to make an offer. This conclusion becomes more convincing once we acknowledge industry custom. In real estate sales, the buyer usually makes the offer. More importantly, real estate transactions are typically set out on detailed forms that specify all relevant terms; no such forms were used here. And, in New York City , it is well-accepted that no real estate purchase is made without a detailed description of financing, permits, etc.
These are strong arguments, but they overlook the fact that a judge may be reluctant to apply NYC customs against a neophyte such as Keith, unless he had actual or constructive knowledge of the customs (recall Frigaliment ). Additionally, the arguments overlook the context of the negotiations: Keith and Willie were old friends; the form of the offer may depart from industry custom, but it is fully consistent with the relationship between the parties. As in Lucy v. Zehmer , a reasonable person in Keith's position probably would have believed that Willie was making an offer. A court may be willing to give custom less importance when the circumstances of the transaction suggest, as they do here, that the parties intentionally departed from it.
Even if Willie made an offer, did Keith accept it before it was revoked? Keith could argue that any reasonable person would believe that he was accepting the offer when he wrote, “We've got a deal.” And it's implausible that Willie was unaware of Keith's acceptance while he was away in Nepal . Willie sent his “in your court” email on April 22, seven days after leaving for Nepal, suggesting that he had access to and was monitoring his email account. On the other hand, a judge might think that an informal email is an unreasonable mode of acceptance for a real estate offer. Indeed, Keith's email was so informal (and contained a joke) that it a reasonable person might not in fact have thought it was serious.
Even if Keith did not accept the offer explicitly , a court might still conclude that an option contract was formed, under Rest. § 87(2), when Keith relied upon Willie's offer and took steps to hire a contractor and chef for the Rump Tower . Willie knew that Keith was in a hurry to develop the building and therefore had reason to know or expect that Keith would begin work immediately. This argument faces an obvious objection, however: what kind of developer runs headlong into a development project without a formal contract of sale?
Assuming a contract was formed, what remedies are available to Keith? Specific performance is a definite possibility because we are dealing with land, which is traditionally seen as unique. Although this remedy is often unavailable when the land has been purchased in good faith by a third party (see Ragosta v. Wilder ), here it was purchased—arguably in bad faith—by Willie from his own company. It may therefore be less problematic for a court to award specific performance. On the other hand, the remedy may be unattractive to Keith, who must pay the full purchase price in order to receive the land, the value of which may have declined considerably after NYC lost its Olympic bid.
An alternative remedy is expectation damages. Keith can sue for the contract-market differential. If Keith is indeed planning to build a parking lot, he could sue for the additional cost of developing a comparable parking lot. His mitigation damages, however, may be negative if the price of a comparable parking lot is less than the price he would have paid Willie. Keith could also sue for foreseeable consequential damages, but there are potential problems here (on this, see below).
Reliance damages might be more attractive than specific performance, especially if these damages cover Keith's potential liability to Doringer and Lawsuit (analyzed below). Keith's contract with Doringer seems a foreseeable type of reliance. Willie knew Keith wanted to renovate the building quickly in order to have it ready for the 2012 Olympics. Keith's email also made clear that he was beginning work immediately. Given the parties' history of communicating by email, it would be unreasonable for Willie to claim that Keith's email was inadequate notice. On the other hand, Keith's liability to Lawsuit seems more speculative, especially because Lawsuit's own damages seem unforeseeable (more below).
But a claim for reliance damages might fail for a simple reason: Keith breached his contracts with Doringer and Lawsuit before Willie breached his contract to sell the land. In other words, Keith would have been liable to these parties regardless of whether Willie breached or not
Turn now to the dispute with Doringer Partners: can Keith avoid liability for breach? He could try to excuse his performance on grounds of frustration, mistake, impossibility, or absence of an implied condition. Keith could argue, for example, just as the renter's contract with the landlord was frustrated when the coronation of King Edward VIII was cancelled in Krell v. Henry , Keith's contract with Doringer was frustrated when NY lost its Olympic bid. Alternatively, Keith could argue that his performance should be excused in light of Willie's breach. Consummation of the contract with Willie, he could argue, was an implied condition of the contract with Doringer (this argument is made difficult, however, by the obvious fact that Keith breached the contract with Doringer before Willie breached).
It seems doubtful, however, that arguments based on frustration, mistake, implied condition, etc. would succeed. Was the expectation that NY would win its Olympic bid a basic assumption shared by both parties ? Doringer was probably unaware that Keith was hoping to profit from the Olympics; if so, Keith surely assumed the risk that NYC would lose. Even if Doringer was aware of Keith's plans, it seems implausible that both parties thought there was no risk surrounding NY's inherently risky bid to be the site for the 2012 Olympics. Someone surely bore the risk, and the most likely party is Keith. If the risk had been allocated to Doringer, it surely would have charged a premium—not a discount—when it entered the contract with Keith. (Similar analysis could be applied to the alternative argument that obtaining the land from Willie was an implied condition of the contract with Doringer.)
Keith might argue that, when he paid the $500,000 deposit to Doringer, he purchased an option to terminate the contract in the event NY lost its bid or Willie refused to convey the land (cf. Krell v. Henry ). Without more information about industry custom or the other terms of the contract, however, it seems at least equally likely that the deposit was just an advance payment on the contract and did nothing to shift these risks.
Assuming Keith cannot avoid liability for breach, we need to consider the issue of damages. Doringer will surely want to enforce the liquidated damages clause, but a decent argument could be made that the clause is unreasonable. Most importantly, the measure of damages is invariant to the point in time when breach actually occurs. That feature of the clause is set in stark relief here: the clause awards compensation of $3 million, but Doringer's actual costs are only $300,000, 10% of the stipulated sum. A court might, therefore, conclude that the stipulated sum is disproportionate and unenforceable. Against this conclusion, Doringer could argue that the clause is not a mere “liquidated damages clause.” Because it covers “lost opportunities and potential loss of commercial reputation,” which are difficult to measure ex ante, the clause merely puts Keith on notice (a la Hadley v. Baxendale ) that Doringer will suffer special damages in the event of breach. To make this argument succeed, however, Doringer would need to show that its total damages (including special damages) amounted to at least $3 million. This seems unlikely.
Assuming the liquidated damages clause is unenforceable, Keith's liability will turn, in part, on whether Doringer is a lost-volume seller. Most courts treat contractors as lost-volume sellers, but Doringer is also an architecture firm and the only work done here was architectural. As in R.E. Davis , Doringer would need to prove that it had additional capacity to serve other clients and that it would have been cost-effective to serve those other clients at the same time it served Keith. We need additional facts here. For example, it would be helpful to know whether Doringer regularly hires free-lance architects when it receives more orders than its staff can handle.
If Doringer is treated as a lost-volume seller, there are two possible measures of expectation damages. One is equal to actual costs incurred ($300,000) plus lost profit ($1 million, less overhead). Total damages would be about $1.3 million, less the deposit paid ($500,000). But this measure might be too low. Remember that Doringer was willing to do this job for 10 to 15 percent less than other contractors. Doringer took a cut because it expected security from the liquidated damages provision. If that provision is unreasonable and therefore unenforceable, Doringer could argue that it should recover the consideration paid for that provision, namely, 10% multiplied by $9 million ($900,000). Under this view, then, Doringer's total damages are $1.3 million plus $900,000, which equals $2.2 million. The $500,000 deposit would, of course, be deducted from this amount.
If Doringer is not treated as a lost-volume seller, it could request damages equal to the contract-market differential. We need more information to compute this. Alternatively, Doringer could argue for reliance damages equal to $300,000, provided the costs incurred have no alternative uses. In this case, Doringer would need to return $200,000 of the deposit. Still another option is for Doringer to argue for restitution damages equal to the value of its performance. The primary issue here is whether Keith actually received a benefit. Did he receive copies of the architectural work done? If so, a good argument could be made that the value of Doringer's performance is worth at least $300,000. Doringer offered to do the work for 10 to 15% less than other contractors, implying that Keith would have paid significantly more for comparable performance from another contractor. Following this line of logic, a court might measure damages as follows: costs incurred ($300,000) grossed up by 10 to 15% (i.e., multiply $300,000 by 1.10 or 1.15). Total damages would be less than $345,000. Under this measure of damages, Doringer would need to return about $155,000 of the deposit.
3. Dispute with Nigella
Turn now to the dispute with Nigella Lawsuit. The first question here is whether Nigella accepted the offer before it was revoked. She might argue that she accepted the offer either (a) when she announced in the Washington Post that she was moving to New York or (b) when her butler told Keith that she had closed her restaurant and taken a vacation in Tahiti . Alternatively, Nigella might argue that Keith's offer became an option contract, under Rest. § 87(2), when she relied on it by closing her restaurant.
These arguments are a stretch. Acceptance via newspaper seems unreasonable for two reasons—first, the parties had previously dealt by telephone, suggesting that Keith expected acceptance to come via a similarly direct mode of communication. Second, we have no evidence that Keith, living in New York , actually read or heard about the Washington Post interview. Nor would a reasonable person infer that Nigella had accepted the offer based on the Butler 's vague remarks that she had closed her restaurant and taken a trip to Tahiti . Did the Butler have authority to accept contracts on Nigella's behalf? Unlikely. A reasonable person would have thought, based on the Butler 's remarks, that Nigella had merely closed her restaurant temporarily in order to take a well-earned vacation.
An argument based on Rest. § 87(2) is even weaker. A reasonable person might think that Keith's offer would induce Nigella to visit New York and investigate the restaurant industry, but not to shut down her Chicago restaurant. It was foreseeable that Nigella would close her Chicago restaurant at some point in time, but it was not foreseeable that she would close it immediately, before even formally accepting Keith's offer. Certainly, her trip to Tahiti was not a foreseeable or substantial form of reliance. Instead, this case resembles Dickinson v. Dodds: because Nigella offered no consideration for the 10-day period she was given to think over the offer, Keith was free to revoke the offer at any time, which he did.
Assuming Nigella can prove the existence of a contract, which seems unlikely, we should consider the issue of damages. Nigella, must mitigate, but it's unclear how she should do this. Her reputation may be ruined in Chicago thanks to her insulting comments in the Washington Post. She could move to New York , but it's not easy to start a new restaurant, and the fate of a restaurant is very unpredictable. Putting aside issues of mitigation, Nigella has the usual damages options—expectation, reliance, and restitution.
Key to symbols used to mark exams:
On some exams I circled particular words or phrases that I found questionable or unclear, and attached these
symbols to them. Circled words with no symbol attached indicate errors in spelling or diction.