Top Student Exam Answers - Contracts: Fall 2005

Your decision to suspend construction of the Midwest City plant and cancel the Tasty Wheat contract exposes GrainBelt to potential liabilities.

Liabilities To Midwest City

It is likely a court will find there was a valid contract between Midwest and GrainBelt to build a plant. First, there was ample consideration (tax and zoning concessions totaling 20M dollars a year) for the promise to build a factory. Second, under the doctrine of estoppel the promise to build the plant could reasonably be expected to induce forbearance on the part of the town to not pursue other development opportunities. You have several weak defenses. You can argue that the tax and zoning concessions were related to the sale of the property and not to the building of the plant. This is unlikely to convince a court. The size of the concessions could reasonably be interpreted to induce an obligation on GrainBelt.

Midwest can show a valid offerlacceptance because GrainBelt manifested assent in the press release stating, "all is possible because of our move to Midwest City." However, you can counter - this was a press release (direct at people outside of Midwest) with informal marketing language and couldn't reasonably be seen as assent to build the factory. On the other hand a court might be swayed by the fact - the wording came from GrainBelt's president and made promises of roads and schools which would directly benefit Midwest City.

If there is a valid contract you have two primary defenses to your breach: impracticability, and frustration. First, you can argue Canada's trade restrictions (supervening events) frustrated you from the purpose of locating the plant in Midwest. GrainBelt's hurried response to the restrictions (a hasty report by the 'advance' planning group) indicates unforeseeability. However, GrainBelt's experience in Canada might have alerted them to upcoming regulations. Additionally, a court might find the restrictions don't frustrate the purpose of building the plant in Midwest. Your company's plans to build in California indicate the purpose is not totally frustrated but merely inconvenienced.

Second, you can argue that because the company faces possible bankruptcy it is impracticable for GrainBelt to build in Midwest. However, GrainBelt's plans to build in California point to your ability to continue to construct plants despite financial problems. In order to prevail on an impracticability defense GrainBelt would need to show locating the plant in Midwest (versus California) would prevent diversification in foreign markets and lead to bankruptcy.

If there is a contract you could face reliance, expectation, and specific performance remedies. Expectation damages (to put Midwest in the position had the contract occurred) include lost tax revenues. However, because Midwest City has offered tax breaks this might not be significant. In addition, expectation damages must be established with 'reasonable certainty' and future taxeslbenefits to the city might be hard to measure. Because of the speculative nature of expectation damages a court might award reliance damages- costs Midwest incurred in the transaction (roads/schools built) and lost opportunities if these are reasonably foreseeable. It is unlikely that the court would award Midwest an injunction ordering continued building (this would act as specific performance). The injunction might act as involuntary servitude on GrainBelt forcing them to continue work. In addition, on public policy grounds courts might see construction of a factory without a company to run it as inefficient.

Without a contract GrainBelt might still be liable for reliance damages. Your press release and partial performance (6 months construction) might be seen as an inducement to outlay funds. However, these damages might be limited. It is not clear Midwest has expended a significant amount of funds - although they might be able to argue that the discount on the price of the property was an expenditure.

Liabilities To Tasty

In determining potential liabilities to Tasty we must determine if there was a contract. This is a transaction of goods and is governed by the UCC. I do not think a court is likely to find you have a contract with Tasty. The agreement probably violates the statue of frauds- it is for the sale of goods over 500 dollars and would take 36 months. You assented to the terms via phone call not in writing. In addition, the phrase "looked good" could be interpreted by a reasonable person as the terms 'looked good' for a starting point. In addition, the short time period between the fax and your call indicates you did not have time to discuss the contract. However, Tasty might counter that the fax is the writing. In addition, Tasty could argue your response could reasonably be construed as assent based on the extent of prior negotiations.

If there is a contract you would be liable for expectation damages. Tasty might argue they are a volume seller since grain is a fungible commodity. In this case they would be entitled to lost profits (any cover they made would not be considered.) This would amount to 360k (36months * 10k profit a month). However, I think you have a strong argument that Tasty is not a volume seller based on limited capacity (15 tons a month) and escalating production costs. In this case (UCC 2-708) Tasty is entitled to the difference between the market price (at tender) and unpaid contract price and incidental damages (this could include the liability they have to distributors). This might not lead to any liability for you because the market price is 2k more than contract. In this case UCC 2-708(2) says to look at profits minus proceeds of resale. If we look just at 12 months-Tasty completely mitigates. It is harder to judge what occurs from 12-36 months. However, your liability is also dependent on the outcome of litigation with the distributors- you would be liable for this under incidental costs.

However, if there is no contract between GrainBelt and tasty you might also be liable under reliance. Tasty can argue they were induced to make preparations (secure relationships with distributors) and liability/costs they have incurred are your liabilities.

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Question 1, Answer 2

Claims by Tasty (T)

GB could argue there isn't an agreement between them and T given §2-201 of the UCC, though there was a faxed offer, there was no written response, no indication anything was signed, (sale over $500). Alternatively, they might argue that their communications cannot be interpreted as a mutual assent to a contract, but merely preliminary negotiations. However, the offer by T set a price, and time frame, and its language "happy to offer" would be interpreted by a court as a valid offer, (seems definite communication), given the parties seem to have already been communicating and seemed to have confirmed the volume of sale was 10000. T's response, "looked good", given the context, they were talking over phone, would expect communications to be informal, seems like a valid acceptance, as it would be heard by a reasonable person. Under UCC's liberal approach to contract formatiodindefiniteness, it's likely to be determined to be a valid agreement, §2-204, and they breached this by reneging on performance.

If there's an agreement, then T (seller), would seek damages under §2-708. GB would argue that T shouldn't be entitled to damages with respect to the first year's wheat shipments, they sold the wheat to someone else, and at a higher price, therefore their expectation has been protected. T could argue that it's a volume seller, and thus would have sold that wheat also, on top of the wheat they sold to GB, and should be awarded lost profits under §2-708 2) ($120,000) (Neri). GB could counter that given T's production limitations, efficient output for them was 10000, they wouldn't have produced above that because of higher marginal costs, and thus there wouldn't have been two sales and they should not be on the hook (we know at 15000 costs become prohibitively expensive so at the most half). GB would be liable for the other 2 years of sales, a lost profit under §2-708 of $240,000.

T could argue it's entitled to reliance damages, that based on GB's assertions, it entered into agreements with wheat distributors which it then had to breach (no buyer for the last 24 months of the agreement), incurring liability which GB should be responsible for. These sellers sold their product to someone else for same price, could argued no damages available to them under §2-708, (same reasoning above). However, they're likely volume sellers, would argue that they would have made those sales anyway, and thus should be given lost profits under §2-708 2).

**(I assumed 708 1) wouldn't be applied by a court here because uncertainty of market price, tender would be every month, the market price against which you would judge the entire contract I assume wouldn't be keyed to the first tender).

GB doesn't have good defenses to these claims, it couldn't argue impracticability based on the trade developments, given at the time of breach this hadn't happened, it just breached to get cheaper wheat.

Even if there wasn't an agreement, just preliminary negotiations, GB's behavior, likely would lead to reliance damages (Hoffman).

Claims by the city

It's unclear from the facts whether a formal written agreement was entered into between the parties (statute of fraud issues, real property), though unlikely construction of this scale wouldn't have one. (contract at the least implied in fact by conduct, they are building). Consideration was the tax breaks, lower price, land for the company, the value to the local community in terms of the payment/jobs/community spirit. If GB were to breach, it would leave a partially made wheat plant on the city's land. The city wants specific performance, and this is case where expectation would difficult to calculate, what is an operating wheat plant be worth to the city (besides purchase price, if not paid yet)? This would involve intangible benefits, and economic impact that would be highly speculative to measure, and liability would be limited to what was foreseeable (company knew of anticipated benefits though). Thus the case for specific performance would be reasonable if the court felt administration wont be a burden, it isn't a contract for employment (might be easier to make a company comply then one person).

GB will argue it shouldn't be liable to the city based on impracticability or mistake. It might argue that the contract has become commercially impracticable as a result of the trade dispute with Canada. This likely is an unexpected event, nothing in the facts suggests it was foreshadowed, though international trade issues not uncommon. A court would likely find that it is reasonable to say that GB assumed this risk, in the business, acumen with respect to the laws affecting them, better born by them. This defense falls because unlikely the situation is commercially impracticable. The facts suggest a risk of bankruptcy if the company fails to diversify. A risk, may not mean the severity that is require by the impracticability doctrine. Further, the facts don't suggest why the need to service other international markets besides the US because of the dispute with Canada, would make the operating of this plant impracticable. They could still produce in the Midwest, and ship to ports for international destinations, it seems the company doesn't want the plant anymore, location best suited for servicing the Midwest, Canada, and the latter is potentially no longer an available market. They would argue mistake by saying it was a basic assumption that the Canadian market be open, that this materially effected performance, and that GB didn't bear the risk of this happening. As above, this would likely fail because a court would reasonably assume that GB would assume the risk. Also questionable trade to Canada was a basic assumption.

Alternatively, the city might argue reliance damages, under § 90 of the restatement based on the press release. This claim has little strength, they would have to prove that outlandish promises made by the company should be reasonably expected to cause someone to rely, this doesn't seem likely, a reasonable person wouldn't interpret their statements as suggesting that the company was guaranteeing roads would be built etc ...

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Question 1, Answer 3

Santos and Tufts v. Netsoft

Santos and Tufts (Ps) have a strong claim against Netsoft for a breach of good faith duty to provide "fair royalties" under their contract. Netsoft's right to run its company is offset but its duty to comply with the contract (FalstafJ): while Ps assumed the risk royalties would be low, Netsoft must make a good faith effort to ensure they are possible since this was a part of the contract price.

The Court will probably not order specific performance: it is more efficient to award Ps damages to be taken from Netsoft's increased revenue. Expectation damages could be calculated as the contractual percentage of the profits Linker could have been expected to bring in over time, but this is difficult to measure. A court could instead use reliance as an approximation for expectation, as in Security Stove: Ps clearly expected to profit from the Netsoft deal as much as they did from Microsoft, which would be $3 million (although this may be a slight overestimate because certain intangible benefits beside profit drew Ps to Netsoft). Restitution damages are inappropriate because the benefit conferred to Netsoft misrepresents the potential Ps sold: even if the product was less popular than expected, Netsoft assumed that risk by purchasing and Ps' damages should not be reduced as a result.

Microscape has a valid claim against S&T for breach of duty to continue bargaining in good faith after establishing a pre-contractual agreement. The pre-contractual agreement is almost certainly valid, unless it was a standardized form with unusual terms, or there was unconscionable inequality in bargaining power (both are unlikely). It had a specific amount, and a date for intended action. Although S's signature may have been required, T represented that he had authority to sign. Even though T may have not intended to be bound, he appeared to have that intent. S&T thus breached this agreement when they rejected Microscape's offer without giving Microscape the opportunity to close the deal.

This breach could entitle Microscape to expectation damages or reliance damages (Hoffman). Although this is breach of a duty of good faith and not a breach of contract, the principle underpinning UCC 2-7 13 and 2-71 2 would probably be applied. Damages measures would be difficult however because the product's uniqueness undermines an estimate of market- or cover-differential value; equally, Microscape's anticipated profits from the transaction are impossible to gauge. Using a reliance approximation we can infer that Microscape expected profits of $5 million, but this penalty may be too broad for what courts may see as the lesser offense of breaching a good faith duty to contract (because the expectation was never certain).

The Court in this instance is unlikely to want to "fill in" damages terms. At the same time, specific performance is implausible because the rights now lie with Netsoft. Microsoft may have a claim that T breached a duty to disclose information, or that he committed the tort of misrepresentation. However at the time of signing it appears T did intend to be bound; it was S's suggestion to keep shopping. While Microscape has a valid legal claim against S&T, the difficulty in approximating damages may prompt the court to let the damages fall where they lie.

ii. The analysis above shows that S&T are in a fairly strong position to bargain with Netsoft for the return of their product. Netsoft doesn't plan to use the software again, and they are probably eager to avoid litigation given their other disputes. S&T could push for a novation or a resale in exchange for dropping their claim: unlike Schnell v. Nell, this will be adequate consideration because their legal claim is strong, and potentially worth $3 million. S&T7s position may be affected by their plan to contract with Microscape, because S&T will be mitigating their damages and so reducing their claim against Netsoft. For this reason, S&T are probably unable to push for cash damages in addition to the release of the software.

Microscape does not have a strong claim for damages against S&T, but they will probably be able to sue for specific performance or a negative injunction (Lumley) if S&T receive the software from Netsoft (the Court will be willing to enforce this because it avoids the difficulties of estimating damages, and instead encourages private bargaining, Walgreens). Microscape has further leverage over S&T because they are larger and wealthier and could force S&T to go through costly litigation - even if damages may not be determined, this has potent non-legal consequences for reputation as well as economic funds. Fortunately T&S are willing to deal with Microscape, so the interests of the two parties can be aligned. However, Microscape's position means S&T will not be able to push for their original price of $5 million. This course of action is advisable if S&T can receive greater benefit from recontracting with Microscape than they would by suing Netsoft for damages (and not receiving the software). This is probably the case, because by settling with both parties they will avoid litigation, and S&T will gain prestige and perhaps future work if the software is used in future - even if they do not receive the same financial compensation as they would simply bringing suit against Netsofi.

In recontracting with Microscape, S&T can avoid similar problems by receiving an upfront price and foregoing royalties. If they wish to ensure the future sale of their product (which a royalties requirement helps achieve), they can establish sales targets which Microscape must make a good faith effort to reach. If they do want to use royalties, they should be written with more specificity (again, targets), and protected by a liquidated damages clause (or a bonus clause, which courts favor more). These terms increase the risk of litigation and reduce Microscape's flexibility, so S&T will have to lower their price. They may still be in S&T 's interest if they want to protect their product. An arbitration clause could reduce the cost of future disagreement, and would probably be favorable to both parties.

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Question 2, Answer 2

Netsoft

You have a strong claim against Netsoft for breaching their duty of good faith to pay you revenues. Your agreement provided you a "fair royalty based on future revenues" from Linker. Netsoft will argue that because royalty percentage was not specified, and because you gave them full discretion regarding the software's use, no duty has been breached-the contract allocated to you the risk that of Linker's unpopularity. However, any discretion they were awarded is limited by their duty of good faith in performance. The fact that they have paid no royalties is substantial evidence of bad faith. A court will likely find, given Linker's previous profitability, both you and Netsoft intended for the deal to generate revenues payable to you, and will protect your intentions. They will probably fill in the open royalty percentage by looking at comparable business deals.

Damages:

Yours is a unique software, so market comparison-based expectation damages will be difficult. You probably expected that Linker revenues would increase substantially through its association with Netsoft, so pre-sale revenues won't work. The best proxy may be the $3 million difference between your two offers. You can demonstrate this as reliance damages-the amount of money you forewent, in order to make a deal with Netsoft. Alternately, we could plead this as a restitution claim: $3 million worth of technology that Netscape obtained at an unreasonably discounted price.

However, your best option with Netscape may be to settle. Netscape is already defending an enormously consequential suit, and probably wants to stay out of the courtroom on a "good faith breach with two young software developers, when its business practices are already under scrutiny. This gives you substantial bargaining power, especially when combined with your sizeable and probably successful claim against them. I suggest asking Netscape to see the $2 million as a rental and use fee for your software. While this may be steep, they may have used some of Linker's functionality to upgrade Boggler, since "related intellectual property" was part of your deal, and they can't return their information gains. They are cutting back Linker use, so they will probably let it go, and their eagerness to stay out of court may convince them to leave the $2 million where it lies.

Microscape

Microscape has a potentially serious claim against you for breaching your agreement to negotiate with them in good faith. Judith, the document you signed showed your intent to be bound to a deal with Microsofi, contingent on working out any open terms to your mutual satisfaction. The agreement was clear and short, the terms specific and you are a sophisticated bargaining party. Courts will at least enforce it to provide clear signals to future parties.

You may point to the fact that you did not have Jake's approval to sign such an agreement, and that its validity was contingent upon his agreement. You did not express this contingency to Microscape, so it was not part of your understanding. As the President and COO, you have apparent authorization to make this type of deal. Despite your agreement to negotiate, you did not contact them again until several months later, to inform them you had made a deal with another company--dispositive evidence of bad faith in negotiation. Microscape will argue that it limited its options by not shopping around for other beneficial software, and that it took actions in reliance, by securing financing for the deal.

Damages have the greatest potential to weaken Microscape's argument. They may claim entitlement to full expectation damages, by proving that but for your bad faith, the deal would have been completed. [Venture] The agreement's specificity as to price, date, and in particular, future remaining actions of the parties give them a strong argument. However, calculation of those damages will again be very difficult--we don't know how much revenue Linker would have made for them. Reliance damages, in the alternative, are probably comparatively minimal-the transaction costs of securing their financing. Opportunity costs would be too unforeseeable at the negotiation stage.

How to proceed

You may be able to get Microscape to drop the suit in exchange for the right to purchase Linker. In a revenue-based deal, you need to include at least some of the following suggestions:

Specific revenue provision: Percentages should be pre-determined. If Microscape plans to improve other programs' functionality with Linker, then you could get a percentage of each program's revenue. Since particular programs' popularity may wane, you can designate generic categories, with a specific percentage for leading, 2nd tier, and 31d tier programs. If they use it only with Destroyer, than you can get a percentage of their advertising revenues. Linker translates well to advertising functions; companies could pay MS each time their page was accessed through a link, and Linker could get a percentage.
Clearly defined duty of good faith: Making specific revenue provisions will help. You can also bargain for input in deciding how Linker should be used, or clarify how discretion should be exercised. However, MS will probably want some flexibility to change its business strategies. Therefore, the contract should clarify what constitutes a breach of good faith: if revenues to you fall below a certain percentage of their total revenue, you have a.. .
Liquidated damages clause: Perhaps the best way to protect your expectations from the deal. Given the long-term nature of your contract, LD shouldn't be a lump sump, but should be tied to the amount of royalties you've already received, and limited to periods of one year, protecting the basic minimum you expect to receive. That way you can still benefit when MS is doing well, but if they are doing badly or make a bad-faith decision not to use Linker, then your expected earnings will be protected, and courts will be more likely to enforce the provision.

Finally, you should include an arbitration clause, to avoid future situations like this one. While you are not in the strongest bargaining position via Microscape, the incalculable nature of their damage claim and their desire to acquire your software help. You should also mention future software developments you may have in the works, as possible future dealings may encourage them to go forward.

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Question 2, Answer 3

Santos and Tufts (ST) have a strong claim against N for failure to pay royalties in the last year, and for breach of a good faith duty ($205) to market Linker (L) and provide them with fair royalties in the future.

It seems that N does not plan to pay any royalties ever. Since consumers have the product (they're choosing not to use it), not paying is a contract violation - unless there were no revenues. If N distributed the software free, they might not have to pay royalties, however, this would probably also violate the implied good faith duty.

The contract does not spell out what N's good faith effort should be. There is no "best efforts" clause (Bloor); there is also no description or course of performance (giving royalties) to suggest content for the "fair royalty". The written agreement memorializes prior negotiations, and has no integration clause. N should be able to supplement the terms with par01 evidence of their discretion on the use of the software if the jurisdiction follows the second restatement. Given this apparent lack of mutuality, there is probably an implied reasonable efforts term. (DufJ) This is especially the case when ST are (relative) neophytes and there are incentives for N to be opportunistic.

A court is unlikely to allow N to claim the unpopularity of L makes marketing it impracticable. Despite reduced revenues, N seems to have some duty (probably not as much as Bloor without a "best efforts" clause) to attempt to generate revenue which a failure to market L would violate.

Since N is not paying the full "price" for L (2-709), ST can ask for a "fair" royalty (looking at similar sales) on whatever revenues have already come in and on future revenues from the sale of L (their expectations from the contract). Since N does not intend to market L, this amount must be found elsewhere. Since Boggler (B) replicates 95% of L's functions, it may be a decent market substitute and the court may award an ongoing royalty from future sales of B as equivalent to ST'S expectations. The $3 million extra M offered might be a minimum (reliance) measure of expectations. (Reed).

If the court finds those measures unsatisfactory, it might decide to put the parties back where they began (or ST can ask for this). In this case, ST would regain the rights to L, but would have to return the $2 million they have received. N would probably dislike the idea of allowing M to get L.

Microscape (M)

At the very least, ST and M had an agreement for good faith negotiations (TIAA). The written agreement signals both parties intention to be bound (ST'S inexperience weighs against this) and is not uncommon (TIAA). The price suggests no royalties were envisaged, and is already agreed. If M can show it was willing to comply with all other terms, then it can probably claim a breach. (TIAA). Since both S and T were willing to sell to M, they cannot claim a good faith breach.

Neither party pursued further negotiations (it seems M did not contact ST before Feb.) - so both parties violated the good faith negotiation clause. Although ST may be more in violation, a court of equity would probably look to their relative inexperience and the fact that neither party truly complied and find no duties on either side.

If ST were found in violation, however, damages would be hard to calculate or collect. Although they could look to ST'S recovery from N (measured perhaps by B sales), there are probably differences in both companies' strategies and marketing that would suggest (to M at least) that this would undercompensate for expectations. Although, there are few substitutes for L, and damages are uncertain and hard to collect (§360) the court is unlikely to award specific performance. So long as N was a good faith buyer (more facts necessary), M cannot get L. Nor can M show reliance, or any benefit requiring restitution. Their monetary compensation might (assuming a very favorable judge) include whatever ST gets from N, but this will probably not compensate them for the loss of L.

Strategies

Since N has potentially large liability (>$3 million) for L and no future use for it, they would probably give up their rights to it to limit their liability. Though this might allow M's browser to compete directly with B, any lead in the software industry is usually fleeting, and they may value getting rid of ST (and the bad publicity of the lawsuit) enough to let M profit. N may even be facing a claim for tortuous interference from M (§766Torts), which ST could get dropped in a deal. Even if N bargains hard, ST can ask for rescission and take the software anyways - although this will cost them $2million.

M has a tenuous claim on ST (also limited by ST'S solvency) and cannot get its hands on what it really wants (L) without ST'S cooperation. I would advise ST to offer to sell L to M if they drop the charges. If M seems reticent, ST should point to a potential settlement with N covering their liability to M (probably not more than what N would owe ST anyways). If they're willing to lower the price, they can ask for a number of good terms.

Unless they sell outright, future disputes may be unavoidable but can be limited. If ST want a royalty (lowering the upfront price) I would suggest that they link it to distribution of the software (not revenues) or at least insert a best efforts clause into the agreement that gives duties to the parties. They might request a veto on marketing decisions with L - costing more, but limiting potential for opportunism. Asking for royalties as a percentage of M's future revenue or profits (or for payment in shares) would align M's interests with ST'S and minimize incentives to cheat. All these measures will limit future disputes.

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