Top Student Exam Answers, Contracts: Fall 2008

Note: These were, in my judgment, the best answers received under examination conditions. They should not be taken as model answers, in that they all contain extraneous material as well as omitting useful information. Some even reach incorrect conclusions. However, they all take intelligent approaches to the questions, are well organized and reasoned, and make sensitive use of the facts.

Because answers were scanned from originals to prepare this page, be aware that odd characters and typos may have been unintentionally inserted into the text.

 

Question #1, Answer #1 Question #2, Answer #1
Question #1, Answer #2 Question #2, Answer #2
Question #1, Answer #3 Question #2, Answer #3





Question 1, Answer 1

The primary issue is the question of liability between PSI and Lotus. PSI can argue that Lotus breached the contract by failing to turn in the progress report on time, and Lotus can argue that PSI breached by rescinding the contract without any material breach on its part. PSI's claim appears to be on shakier ground.

PSI argues that it has a right to rescind because the contract was an option contract conditional on compliance with on-time delivery of the monthly progress report. When Lotus delivered the progress report two days late, it failed to render performance of the condition and was in breach as per Restatement 45 or UCC 2-601 (since the contract is for the sale of mobile homes, it can be considered for goods under the purview of the UCC but the monthly progress reports may be separated out as a service).

However, Lotus can make a good argument against this claim in that its delay in submitting the monthly progress report was not a material breach. The main condition of the contract was for the timely delivery of modular homes (which Lotus did), the progress reports were a secondary condition whose violation does merit rescission. Moreover, Lotus "cured" the non-compliance by delivering the report only 2 days late, which certainly falls within a reasonable time frame (Restatement 237 or UCC 2-508 if the report is part of the good). It had previously exercised good faith in complying with the conditions (turning in the report early) and there is no reason to believe that it acted any differently here. It follows from this argument, that PSI violated its own implied duty of good faith in exercising discretion over the contract terms by rescinding the agreement after it had already received Lotus' report for the month of April. PSI's actions, which may seem opportunistic (in light of the fact it had already received 1/2 of the work and was claiming right to the liquidation damages as well), may constitute the first breach of the agreement by reneging on a firm offer by not allowing Lotus to complete its performance (i.e. the Brooklyn Bridge hypo).

Even if PSI can argue that Lotus materially breached, Lotus can raise a defense of change of circumstances when its team of workers left to pursue other jobs to avoid liability. The labor shortage was unexpected and the impact was severe. However, PSI, can show, that this risk was allocated to Lotus in its bid for the project when it agreed to provide labor. Alternatively, if PSI can successfully prove that the contract was in fact conditioned on the timeliness of the delivery, Lotus has a good claim promissory estoppel claim in that it accepted the offer to deliver the modular homes by beginning performance Restatement 87(2).

While Lotus' argument is stronger, if it is in fact found in breach, PSI will argue that it is entitled to the bond given in consideration of its offer. This raises the issue of whether the liquidated damage clause can be enforced under UCC 2-718. While the amount is not unreasonable on its face, (it covers little over 1/4 of the contract price when 1/2 the works remains to be delivered) and was included by Lotus to reassure customers against its inexperienced workers, etc., it may still be rendered unenforceable as damages are fairly easy to calculate in this setting (cost of completion plus any costs associated with delays, etc.).

If it is enforced, Lotus should still be able to claim restitution damages under quantum meruit for the unreturned goods. This could come out to 2M (1/2 of contract price for 1/2 of contract performance) or 2.5M (for costs incurred at the time of breach) or 1.5 M (if PSI's cover price is to be shared). From this Lotus must subtract the 1.1.M in liquidated damages to determine what it is owed. If it the liquidated damages clause is not enforced, PSI can argue for expectation damages under UCC 2-712 but as its cover price for the 10 home is less than the contract price for the 20 homes which it has not paid, this is not a useful measure (and there appears to be no delay, etc. in hiring Acme to give rise to consequential damages under UCC 2-715). As it has made no payments, there is also no restitution argument in its favor although again, Lotus can again bring a claim in quantum meruit and receive damages in a similar range of figures as above this time without having to subtract any liquidated damages but subtracting the additional .5M for P's cover.

If PSI is found in breach (which is the more likely outcome), Lotus is entitled to its expectation damages under UCC 2-706 of 2.35M (4M contract price minus 2.5M resale price plus and incidental damages under UCC 2-710 of .85M for the extra costs of completing the second contract) plus any other incidental damages associated with finding the second buyer. This may be reduced by any cost increases that were unforeseeable to PSI such as those resulting from hiring the non-homeless workers. Lotus cannot show it is a lost volume seller (note its problem with capacity in completing the order) as per UCC 2-208(2) nor would this be useful as it would net the same amount given that the second contract it entered into was a losing contract. A reliance measure, under the promisor estoppel theory, would come out much the same as justice would require that the resale value be subtracted from costs incurred at the time of breach. Restitution under quantum meruit would be the most favorable measure from Lotus's perspective as it could be entitled to anywhere from 2M for half for the work to 2.5M in incurred costs at the time of breach without having to subtract the value of the sale to Quad (the incremental cost for selling to quad was only .85M so it would also get the benefit of the second contract payment for 2.5M minus that amount). This may give Lotus a windfall but considering that Lotus acted in good faith, the nature of its organization, and PSI's possible opportunism, the court may allow it. Neither party would appear to want specific performance under UCC 2-716 as they have both covered.

Dispute with Hewson

Lotus is on much shakier ground here. Hewson's employment agreement provides for termination with cause. It is debatable whether this is the case here. Hewson did not engage in any violations of the law (clause I), or intentionally damage company assets (clause ii). The situation to PSI did result in a loss; however, it does not appear it was intentional. The labor shortage led to the late report and he exercised "best efforts" as his duties mandated in scrambling to find an alternate buyer to lessen the impact of the breach (he could have just sold the remaining houses for 500K in scrap but did not). "Willful failure" to substantial perform duties is also not a good argument for termination for the same reason. The best grounds for Lotus's termination of Hewson lie with his intentional breach of company policies. The purpose of the company was to employ the homeless to better their lives and his decision to hire nonhomeless workers to complete the contract with Quad compromise that purpose. While Hewson knew that in make his decision (making the act intentional), he was also in difficult position. He was to exercise "best efforts" in his performance and given the alternative (let the company go bankrupt over the dispute), he arguable did what was "best" given the impossibility of complying with both terms of his agreement. Under Restatement 201, the more reasonable meaning (arguably Hewson's) of "intentional" would prevail.

If Hewson were to bring suit against Lotus for wrongful termination (though it appears he has gone back to religious work), Lotus may liable for expectation damages of lost past (his salary for the year if not paid) and future earnings minus any mitigation through work for another charity organization or similar role. The latter appears difficult to approximate given that they may not be many such organizations and whether they give any salary at all given their nonprofit nature. Reliance is similarly difficult to calculate as Hewson as it would likely include that portion of living expenses, etc. that Hewson relied on his salary to cover. Restitution would cover any past earnings not paid (Britton) and perhaps any materials Hewson developed to train workers, etc. as he may have done in running the organization but none of this damage calculations seem adequate giving rise to a good argument for specific performance and the reinstatement of his job. While courts are reluctant to award specific performance in employment disputes (Lumley) and his relationship with the board would be strained, this case is unique. Hewson founded the company and it has a personal value to him in the work that he that goes beyond monetary compensation.


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Question 1, Answer 2

Lotus's Rights and Liabilities to PSI

The first question facing Lotus is whether we were in material breach of the contract, for which PSI could declare the contract void. PSI's receipt of the progress reports on April 3 did not constitute a material breach, but that we were delinquent on PSI's delivery schedule may be a greater liability. Timeliness is emphasized within the contract terms and thus we cannot claim we were unaware of the need for prompt execution. While it cannot be implied from this that delivering a progress report two days late was defined as material in the contract, it may be such that PSI was within its rights to halt payments by our failure to make timely delivery.

There is a minor question as to whether "due" under the Progress Report clause was intended to mean a postmark date, under which we would not be in breach, or a date of receipt. This is a problem of interpretation. Because our sole function is to manufacture homes at an offsite facility and deliver them to the buyer, this contract is governed by the UCC. The court will thus likely look to custom and trade usage under UCC §2-208 to define this term. However, given the uncertainty, we should analyze the problem as if we were in breach of the progress report clause.

The question of materiality regarding the progress reports weighs heavily in our favor. While we were technically in breach, it is unclear that a delay of a mere two days caused PSI to incur any damages whatsoever. All they can be said to suffer is a two day period of uncertainty, and it will be difficult for them to argue that they were deprived of any expected benefit under the contract. Any expenses they may have incurred as a consequence of the late progress reports we could likely easily cure, yet they did not give us this opportunity. On the other hand, declaring the contract void would do significant damage to us and would threaten our solvency. That PSI immediately hired Acme to complete our work may also be an indication of a lack of good faith on their part, as it is evidence that they were simply looking for any evidence of a violation of a minor contractual term in order to declare the contract a nullity.

However, the emphasis on our late progress reports may have been pretext for the real reason PSI desired to avoid the contract. The contract specified we were to have 75% of the homes, or fifteen, delivered by the first of April, while we only had ten delivered by that point. We already had the ten homes in production, and their ultimate delivery date may in fact have met the July 15 deadline. However, as PSI had the burden of laying foundations and installing eighty homes with other subcontractors, it is possible that our delayed delivery caused PSI significant problems and monetary damages regarding other subcontractors to which they were obligated. As such information was available to us prior to submitting our bid, we cannot claim that such losses were unforeseeable. However, because the timeliness factor was emphasized in the contract with regard to the entire contract as a whole, and because PSI has not claimed any damages whatsoever regarding our delayed delivery, it is likely that this delay will not be found to be material either. That PSI chose to use the Progress Report clause as their ostensible reason for breach likely means they would have difficulty proving any damages with regard to timely delivery, and as such we would prevail on this issue.

If the materiality question is settled in our favor, we still risk forfeiting the $1.1 million deposit if it is construed as consideration for an option contract, as PSI stated in their Purchase Order (PO), rather "- than a provision for liquidated damages, as stated in our bid. While PSI will argue that its PO was an "offer" that we accepted through our performance of the contract, it is clear that the PO is more appropriately defined as a "definite and seasonable expression of acceptance" under UCC § 2-207. No further communication was needed nor implied to be required before the commencement of the contract. Under UCC § 2-207(2), changing the nature of the $1.1 million from a liquidated damages clause as we specified in our "first-shot" to consideration for an option would clearly constitute a material alteration to which we did not assent, given that we only expected to profit $500,000. That the $1.1 million never actually changed hands would also point to its being liquidated damages rather than consideration. Therefore, the terms of our bid should govern. Should we be found in breach, we would be liable for the $1.1 million only, as it clearly reflects the expected difference in contract-market expectation (the three prevailing bids of the for-profit contractors amounted to a $1 million increase) and cannot be construed as a penalty.

As it is likely that PSI will be found in breach of the contract, the question of damages arises. We will want to seek expectation damages on the contract. Although Lotus's attempt at cover backfired and resulted in a $100,000 loss, PSI would still be liable for this expense as Lotus made a reasonable effort in contacting several realty developers. That Lotus was placed in a difficult bargaining position regarding cover is the fault of PSI's breach. Under the contract, Lotus stood to make $500,000. After its attempts to cover, Lotus at the end of the day incurred expenses of $4,350,000. To place Lotus in the position of contract completion, PSI is liable to us for $2,350,000, or our expenses with profit minus the payment from Quad.

Lotus's Right and Liabilities to Hewson

Lotus's purpose is to provide a means for homeless people to obtain self-sufficiency by providing them with training and a living wage. As such, Hewson's hiring of the non-homeless to complete the PSI contract is a technical violation of our mission and a breach of company policy. However, Lotus also required that Hewson perform on a "best efforts" basis, and it is arguable that his hiring of the non-homeless was merely an attempt to prevent Lotus from incurring a greater loss than it otherwise would were it forced to sell the remaining homes for scrap. While Lotus's fundamental purpose was the training of the homeless, it could not fulfill this purpose if it were to fold. A court could thus find that the employment contract with Hewson naturally implied within the best efforts clause that he was allowed him to take such action as deemed necessary to insure the organization remained solvent, including hiring the non-homeless. Given Hewson's background as a minister and the fact that he founded the organization for the purposes of aiding the homeless, it is likely that he took all possible efforts to hire homeless individuals to fulfill the PSI contract. Because we did pay Hewson a salary, the court may also find this as evidence to mean we did not intend that no funds should go to non- indigent parties.

We should argue that Lotus is by nature a charitable organization and all actions are contractually subject to the direction of the Board of Directors. As such, Hewson may be found to have violated the employment contract. All funds were to be devoted to our charitable purpose, and it is a stretch to argue that funds paid to for-profit workers constituted such. It is not evident that Hewson offered the higher wage to homeless parties, which would have decreased the number non-homeless hired at the expense of the homeless. Furthermore, Hewson simply did not have the independence to make such a decision himself, as such a clear violation of our mission should have been a decision made by the Board. Hewson's actions thus constitute an "intentional breach of company policies," and Lotus was within its rights to terminate his employment. However, because of the swift action required under the circumstances, the court will likely find that Hewson made all possible best efforts.

If the court does find in Hewson's favor, we should argue that the availability of mitigation may limit the damages he can recover. Hewson could have found similar work with a nonprofit organization, and instead chose to simply return to the ministry, making his damages nothing. His return to the ministry might also bring greater donations and tithing as he devotes more time to his congregation, and we will want to investigate whether this is the case as it would offset the amount we would be required to pay. As it stands, if we lose on the mitigation issue, it would be difficult to prove expectation because it is unclear how long Hewson would have remained employed. As such, he may instead be entitled to reliance damages, which would have to be calculated by any opportunity he had foregone, most likely in the form of lost tithing.


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Question 1, Answer 3


Your rights and liabilities with respect to PSI

In a suit between you and PSI, you will claim damages for PSI's termination of performance, while PSI will claim damages for your breach of contract. Since modular homes are movable at the time of identification to the contract, they should be considered as "goods" under the provisions of UCC 2-105(1), and the UCC applies.

What is the nature of the $1,100,000 term?

There is disagreement between your bid and PSI's Purchase Order, with a question as to which one forms part of the contract. PSI's Order described your agreement as an option contract, in consideration of $1,100,000. Your bid, however, described the $1,100,000 as liquidated damages. This Battle of the Forms is analyzed under UCC 2-207(2).

Under 2-207(2), PSI's terms are proposals for addition to the contract. However, if the agreement is between merchants, the terms become part of the contract. PSI will argue that Hewson ran Lotus daily and had done so for seven years, qualifying him as a merchant under UCC 2-704(1); and that Hewson should be charged with the knowledge of a merchant under UCC 2-704(3). You may counter-argue that Lotus is a non-profit organization, and that Hewson is primarily a minister. However, a court will likely take into account Hewson's longstanding experience in the industry and side with PSI's interpretation.

However, even if Hewson is a merchant, 2-207(b) provides a way out for you. PSI may argue that its terms did not materially alter the contract, as the monetary obligations of the parties are substantially similar ($4,000,000 to Lotus if Lotus performs; $1,100,000 to PSI if not). But that argument is weak. PSI's terms drastically rearranged your rights and obligations under the contract; the $1,100,000 was turned from liquidated damages into consideration for an option. To give a hypothetical example, if an earthquake had rendered performance impossible after performance began, Lotus would need to pay nothing under the Lotus version, as it had not breached; but it would need to pay $1,100,000 under the PSI version. Thus, the court will likely find the term to be within the scope of 2-207(b) and fall back on your version of the term.

Even if the court refuses to use your term under 2-207(b), however, you can still raise unconscionability under 2-302. For example, you can point out that $1,100,000 is far above normal consideration for an option contract. A court may sympathize with you here and fall back on your version of the term.

Was your late submission of the progress report a material breach?

Under Restatement 2nd 241 and 242, whether your late submission constituted a material breach determines whether PSI was justified in repudiating the contract.

PSI will argue that the contract emphasized timeliness in its language. The materials emphasized a series of stages, with a delay in one stage affecting the next. PSI may also argue that in industry practice, late delivery of even a report is seen as casting serious doubt on the ability of a subcontractor. Hence, your lateness was a material breach, and PSI could repudiate.

You can argue that sending a report two days late hardly deprives PSI of what he expected (the modular homes) in a way hard to compensate for, and hardly went beyond the bounds of good faith. The transgression here is so minor that PSI could not repudiate.

The fact that PSI found the flimsiest of pretexts to replace you suggests that PSI may be dissatisfied with other aspects of your performance. If so, PSI may bring up those misgivings to strengthen its case that you materially breached. But if the progress reports are all PSI has to go by, the court will likely find that there was no material breach.

If this was not a material breach, what are the damages?

If PSI was unjustified in stopping performance, it must bear the extra costs it incurred in hiring Acme on its own. It can recover from you the damages resulting from the late report, but those are probably negligible. Moreover, you can sue Lotus for expectation damages.

One way to calculate damages is through the UCC. Under 2-709(l)(a), you can recover the price of the homes already delivered, i.e. $2,000,000. Under 2-704(3), your completion of manufacture is justified, and you can recover incidental damages associated with resale under 2-710. The amount of incidental damages you can recover is $850,000, calculated from the costs you incurred in completion of manufacture and resale after breach ($1,850,000) minus the amount you would have incurred anyway from the point of breach ($1,000,000). You sold the homes for an extra $500,000 to Quad, but you are not accountable to PSI for that under 2-706(6). The total damages would then be $2,850,000, plus any other incidental damages in storage, etc. omitted above.

The second way, which uses the calculation of expectation damages as sunk costs plus expected profit, is as follows. Your sunk cost at the time of breach was $2,500,000. After breach, you spent $1,850,000 and received $2,500,000. Your net loss is $1,850,000. To put you back in the position of your expected profit of $500,000, PSI owes you $2,350,000.

The difference between these two methods is that the second method takes into account the $500,000 extra paid by Quad, while the first method does not due to 2-706(6). As an estimate, PSI would owe you $2,500,000.

Damages from the $1,100,000-term would depend on the resolution under 2-207. If the court favors PSI's terms, then you would lose the $1,100,000. But if the court interprets the $1,100,000 as liquidated damages, you can argue that PSI's damages from your breach are measurable, and that $1,100,000 is far more than the damages reasonable for a late report. PSI will argue that the language of your term does not say "material breach", only "breach"; that PSI suffered hard-to-measure reputational damage. PSI may also argue that it is you who put the term in, so it is not unconscionable to enforce it, and that you included the term to reassure buyers due to your patchy reputation, so you should be held accountable to it. On balance, $1,100,000 looks excessive for a two-day-late progress report, so the court is unlikely to enforce it per 2-718(1).

Finally, you can seek specific performance. You can ask the court to order PSI into hiring you again, or enjoin Acme from constructing the remaining ten homes. Given the timeframe of a lawsuit, however, such an injunction will likely be unavailable.

If this was a material breach. what are the damages?

If the court finds material breach, you will be able to claim quantum meruit on the delivered homes for $2,000,000. In addition, PSI will be able to sue you for their expectation damages. Under 2-712, PSI can recover the dIfference between your contract price and their cover price with Acme, which is $1,000,000, plus incidental damages PSI incurred.

Alternately, assuming the court found the $1,100,000 to be liquidated damages, PSI has better chances of obtaining it if material breach is found. In addition to the same arguments that PSI would made if there were no material breach (see previous section), $1,100,000 is close to $1,000,000, and PSI can argue that the extra $100,000 accounts reasonably for hard-to-measure losses.

It is too late to enjoin you from working for Quad as that contract is complete.

Your rights and liabilities with respect to Hewson

Your rights against Hewson

If you win your suit against PSI, then you will recover around $2,500,000 and make a profit of around $700,000. Hewson's actions caused no damages to you and you would not have a suit. But if you lose your suit against PSI, then you will recover only $1,000,000 and suffer net loss of $850,000. It is then likely that Hewson would be liable to you for that loss, since the same factors that prejudiced against you in your suit with PSI would also prejudice against Hewson in your suit with him.

Your liabilities against Hewson

Hewson will argue that the Article of Incorporation does not stipulate that Lotus will hire homeless persons only. Moreover, Hewson hired non-homeless workers when Lotus' solvency was threatened. The existence of Lotus is a precondition for its other goals. Accordingly, Hewson may sue you for wrongful termination.

Here, you can argue that Hewson's negligence landed Lotus at the brink of insolvency, so he cannot use that to justify his actions, and that your termination of Hewson was premised not only on his hiring of non-homeless workers under the "intentional breach of company policies" term, but also on his negligence under "willful failure to substantially perform assigned duties".

The efficacy of your arguments will turn on your suit with PSI. If you lose that suit, your argument that Hewson was negligent would be stronger.

If you lose this suit against Hewson, Hewson may recover expectation damages, consisting of lost wages and incidental costs. Courts however are reluctant to issue injunctions in employment contexts and so will not force you to rehire Hewson.


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Question 2, Answer 1


 
Dear Mr. Conrad:

In order to offer advice on how to settle your dispute with Stellar and to insulate any damage it may to do your merger with Triad, it is best to first analyze what the potential claims are. Your contract with Stellar was a good one. It managed many of the risks and opportunism between you and Stellar that was inherent in your relationship. Now that you are considering escaping the contract, however, this can be seen as both virtue and vice.

Potential Claims

Stellar's claim against you will involve a breach of contract by merging with Triad. Through the merger, you are depriving Stellar of their right to exclusive manufacture of your parts. Your contract with Stellar was a unilateral contract, as gave you complete discretion on the quantity of parts you needed from them. Technically, then, you may have been right that because Bynar will no longer exist after the merger, there will be no liability.

However, there are several arguments against this interpretation. When negotiating the price reduction contract in 2007, Stellar may argue that you had a duty to disclose that you were considering selling Bynar. Before storming out, Stella mentioned that had she known this information, she would not have agreed to the price reduction. Disclosure of this fact may have corrected a mistake as to a basic assumption of the price reduction contract. (RSC §161). To counter this, we can point to your changing state of mind during this period. Having already tried to negotiate a merger with Triad and then an alternative manufacturing deal with Rhombus, perhaps you no longer considered business with them a possibility, and thus had no duty to disclose. The court may be unwilling to believe this, however, because of the difficulty of proving one's thoughts, especially when they so clearly protect your interests, and because of the close relationship you had formed with Stella. Over your many years business with Stella, there may have been an expectation that this information would be communicated, regardless of if being actively considered at the time. If so, a duty to disclose would have been created and expectation damages would be warranted.

Similarly, there is a mistake argument that Stellar's entering the price reduction contract was based on the false belief that Bynar would still exist for years to come. This is a dangerous assumption, however, with many of the same arguments in favor and against as above.

Furthermore, we can argue that there were unexpected circumstances that made breaching the contract necessary. With the rapid change in the high-tech medical equipment industry, Bynar had to act in order to preserve itself. While it initially tried a good faith attempt at renegotiating the contract to include a price reduction, this ended up failing as the competition in the industry persisted. Orders and profits were falling, so your only recourse was to merge with Triad. This is arguable. A decline in profits does not warrant avoiding your contractual duties to Stellar; you owed your best efforts in staying afloat and merging with Triad could be seen as the easy way out. (Bloor) . This will be a question for the court to consider based on actual losses being suffered by you, and possible solutions that you did not attempt.

Damages owed to Stellar are very uncertain. With it being a unilateral contract, expectation damages are inherently unknown. There is no way to estimate how many parts you would have ordered, what the relevant energy and material costs would have been, or what level of consulting fees would have been paid. Stellar may argue for using previous years' numbers as an estimate, but this is flawed because of the marked decrease in sales and profits noted. Additionally, it is unclear how much longer Bynar would even continue operations. Reliance damages are similarly murky. There is no way to know what business Stellar gave up by entering into the contract. Even with some proof of potential deals, this would run into the same problem with expectation damages. Restitution damages seem unwarranted, as we can assume Stellar has been paid. Finally, specific performance is unlikely because it's a service contract. With damages being so unclear, this gives both sides a strong incentive to settle the dispute rather than go to trial.

Finally, Stellar may bring a tort claim against Triad or Rhombus for intentional interference with contractual relations, which could award punitive damages. This is noted by them asking for you to pay half the legal expenses in any litigation brought by Stellar against them.

Strategies

Your first solution would be to do nothing and hope the merger goes through anyways. This has several problems. If Triad's board of directors were to learn of the potential liability they may be unlikely to approve the merger. We could use the information above to convince them of how limited our liability is, but even this is uncertain and depends on how risk-averse the board is.

The most extreme solution would be to cancel the merger with Triad to avoid all liability to Stellar and continue operating Bynar. This isn't wise, however. First, you have already created serious problems with Stellar by suggesting there is going to be a merger. Second, because of the business trouble Bynar is in, it is probably efficient to breach and get some money out of Bynar with a merger while you still can, and Stellar probably doesn't want to be tied down with an exclusive agreement to a dying company. Both of you could be making money elsewhere in a new relationship.

Generally with such a close relationship between the parties, non-legal solutions would work quite well. Here, however, because you want to leave Bynar and the contract altogether, they are much less effective. Presumably, though, you may want to continue working in the industry, so reputational interests should motivate you to settle with Stellar. Conversely, Stellar doesn't want to establish a reputation as locking companies into contracts against their will. Given the seriousness of the situation, this may not add up to enough incentive to settle.

In order to increase the chance of settlement, there are several possible strategies we can employ. First, we can further define what was meant by the terms in our contract to help establish if any breaches incurred. For example, we could concede a narrow view of "technical notes" described in the contract to only include those absolutely necessary for the implementation of Stellar's production lines. This would allow Triad to easily take over the manufacturing, while preventing Stellar from giving up evidence of its thought process and plans in work-product. Additionally, we could similarly define "technical information" narrowly to allow Stellar to use the experience it gained from working with us on planning other client's product lines. This strategy, however, is difficult to do ex post, as both sides will just be arguing for the definition that helps them the most, not what is most contractually efficient. Also, Triad may find some of these concessions objectionable because Rhombus will want to use as much information as possible while still being within their rights.

Second, we can negotiate with Triad to give Stellar priority for any manufacturing needs that are not accomplished by Rhombus or which may be more efficiently handled by them. This could include creating a consulting and referral relationship between the two.

Third, a lump sum could be negotiated with Stellar. This runs the risk as being seen as a liquidated damage award whose enforceability would depend on its relative size given the actual damages. We could avoid this by characterizing it differently, as say a buy-out. This may not fool the court, though. To actually pay this lump sum, you may need some of Triad's capital given your cash flow problems. Additionally, a lump sum payment would not allocate any of the risks involved and there would be significant negotiation involved because of the different expected values of each party. With the threat of litigation, difficult negotiations want to be avoided.

Fourth, a royalty system could be set up between Rhombus and Stellar, with Stellar receiving a portion of their medical equipment manufacturing revenues. Getting Triad to agree to this is extremely questionable. Perhaps some sort of limit could be set on this, but there is essentially no way to know what portion of the revenues are because of Bynar or Rhombus' existing business.

Fifth, Stellar could be given a small equity share in Triad or Rhombus. To avoid involving Triad, perhaps the best way to arrange this would be to alter your compensation package to include an equity share which you could transfer to Stellar.

With all of these potential strategies, it is important for Stellar to agree to drop any suits against you. This will gamer you more bargaining power with Triad, as they will be relieved to not have to worry about legal claims and the board will be more willing to approve the merger.

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Question 2, Answer 2

To best evaluate possible settlement solutions it is first important to understand Bynar's possible liabilities to both Stellar and Rhombus.

Possible Claims By Stellar

Stellar could have a good argument that Bynar violated its duty to disclose when it failed to mention that it was in merger talks with Rhombus. The UCC states that common law doctrines should apply in duty to disclose cases but it also stipulates a duty of good faith. Stellar could argue that the continued existence of Bynar would be a basic assumption of any requirements contract made with them and thus Bynar was bound to disclose the possibility of merger. However, the merger talks had ended by the time Bynar started negotiating with Stellar so Bynar might counter that there was nothing to disclose at the time. Nevertheless, it would seem that Bynar had a possible merger in mind while in talks with Stellar because it tried to remove the non-compete clause from the new contract. Thus Bynar might be liable to Stellar for the failure to disclose. Stellar could request that the rescission of its rights under the old contract be voided and seek to collect the lost profits from the sale of its goods at a reduced price between January 2007 and the present.

Stellar might also claim that the merger would constitute a breach of Bynar's promise not to purchase any contract products from third parties or produce them in-house. Under the January 2007 contract Bynar is obligated until January 2012 to fulfill its requirements for the contract products through Stellar alone. While Bynar has not breached its non-compete clause yet, by allowing itself to be acquired by Rhombus, Bynar is effectively agreeing to transfer all of its business to a third party. Thus, Bynar would be fulfilling its requirements with another firm before the end of the contract term, which is a violation of its agreement with Stellar. Furthermore, as the successor of Bynar, Rhombus would be violating its duty not to pursue in-house production of the contract products. Even if Stellar would be unable to hold Rhombus liable as Bynar's successor, Stellar probably has a claim against Rhombus for tortious interference with its contract with Bynar because the merger would substantially decrease the profits Stellar would earn under the current agreement. Based on these claims Stellar could seek expectation damages of lost profits for the remainder of the contract term. This might be difficult to calculate given the current fluctuations in price and demand but a court could probably estimate this based on Rhombus's earnings from the increased production to supply Bynar's old business.

Bynar might be able to justify its actions by arguing impossibility or change in circumstances because of increased competition and the downturn in the market for its goods. Bynar has found it difficult to stay solvent and has suffered significant decreases in profits in the last two years. In this market, Bynar might cease to exist even without a merger. There is no UCC provision for change of circumstances applying to buyers so Bynar would have to make a common law argument. This would require that the change in market be totally unforeseen and that Bynar did not accept the risk of this event in the contract. Traditionally, it has been difficult to make a successful argument for change in circumstances under this doctrine. It would be seem that a firm operating in a specialized market should bear the risk for any downturn or fluctuation in prices. Furthermore, one could argue that as a player in this market, Bynar should have been able to anticipate any upcoming changes and plan accordingly. Thus, it will be difficult to sustain the argument that Bynar is justified in merging with Rhombus and breaching its duties to Stellar because of the change in the market for its goods. Thus, both Rhombus and Bynar face potentially significant liabilities to Stellar under the 2007 agreement.

Possible Claims by Rhombus

Conrad might also be liable to Rhombus for any damages resulting from litigation with Stellar over its above-mentioned claims. During preliminary negotiations, Conrad agreed to indemnify Rhombus for half of any payments it might be required to make to Stellar and for half of any legal expenses it might incur because of the claims. However, this was settled without signing any contract or even reaching a final agreement on the merger. Thus Conrad is not formally bound to this term. Nevertheless, parties can incur contractual obligations during preliminary negotiations and they need not always be in writing for a court to enforce them. Based on his handshake deal to meet with Dionne in ten days to finalize the deal, Conrad might be bound by a duty of good faith to continue negotiating. In TIAA v. Tribune the court bound the parties to continue negotiating in good faith to reach an agreement. In that case however, the parties had signed a formal commitment letter including "binding agreement" language. While Conrad's actions do not present an equally clear intent to be bound, he probably has a good faith duty to continue negotiating because the parties seem to have agreed on the basic structure of the deal and are in the advanced stages of contingency planning. This good faith does not bind him to his promise to indemnify Rhombus however, because under the Statute of Frauds, agreements to pay the debt of another party must be recorded with a signed writing. However, since Conrad has a duty to continue negotiating, he may ultimately be forced to agree to a similar term if he cannot get Stellar to drop its claims.

Settlement

Thus, Bynar could face significant liability to both Stellar and Rhombus and its best interests would be served by reaching a settlement of these claims. Since the dispute involves potential claims between all three parties, Bynar should consider including Rhombus in the settlement talks with Stellar. Stellar might have separate claims against Bynar and Rhombus. If Stellar only agrees to drop the claims against Bynar, Conrad might still be liable for the additional claims against Rhombus because of the merger negotiations. Furthermore, including Rhombus in the talks would increase Bynar's available settlement tools. However, trying to balance the competing interests of three different companies could make settlement more difficult and Bynar has in interest in keeping the dispute from Rhombus until it can be settled. Ultimately, it must be acknowledged that the terms of any settlement will have an effect on the merger deal with Rhombus. Any concessions that Bynar seeks should include the waiver of claims directly against Rhombus as well.

In exchange for dropping all claims, Bynar could offer Stellar a lump sum payment based on its possible damages under the requirements contract. For example, it might be appropriate to agree to void the January 2007 contract and award Stellar the 20% difference in price that it suffered on all sales up until the old agreement would have expired. This sum would probably be significantly discounted from the possible lost profit damages on the new contract. Furthermore, any settlement agreement reached would represent a savings on the administrative costs of litigation. However, Bynar would probably have to agree to cover some of this payment in conjunction with Rhombus. Alternatively, Bynar could offer to simply trade one non-compete clause for another. It could agree to let Stellar out of its obligations not to produce similar parts for competitors if Stellar would agree to let the merger go forward. Bynar might also agree to allow Stellar to keep the technical notes and designs from Bynar products so long as they are not disclosed to third parties. However, Rhombus might object to these terms as they would reduce the value of the merger with Bynar.

Finally, Bynar might suggest ways to bring Stellar in on the benefits from the proposed merger. For example, part of the settlement could be in the form of Rhombus stock, which would presumably rise on news of the Bynar buyout. The parties might also construct some sort of royalty scheme based on the profits Rhombus makes off of the products that Stellar would have supplied until 2012. Rhombus might even agree to continue to pay for Stellar's consulting services through the remainder of the contract as it adapts to produce the new Bynar products. Obviously, Bynar could not promise any of these terms without the cooperation of Rhombus, and as they will reduce the surplus value of any merger deal, Bynar will probably have to agree to some reductions in its own compensation or to cover some of the costs of settlement. However, there are savings to be had by avoiding litigation, and as the legal adjudication of these claims might threaten the merger itself, it will ultimately be in the interest of all three parties to settle.


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Question 2, Answer 3

A. Stellar (S) v Bynar (B)

1. Enforceable Duties

There is a valid UCC requirements contract between Sand B under 2-306.

2. Modification

S may argue that the 2007 modifications were made under duress or in bad faith (UCC 2-209). There was likely no duress because it's unclear S had no alternatives (e.g. was it at the point of bankruptcy?). In addition, I don't think a court will find bad faith: B had a valid commercial reason to seek modification – the worsening commercial climate.

S may also argue that the modification shouldn't stand because it simply decreased the price for a pre-existing duty, Ligenfelder , but this formalist analysis of consideration has been abandoned in modern courts.

S may also argue that the modification was contingent on B not selling itself. However, the "merger" statement on the contract probably precludes S from bringing in parol evidence to prove this point. Both Sand B were sophisticated parties and such a term would likely have been included in the contract.

3. Breach

If B is sold to Rhombus (R) and stops purchasing parts from S, S has two good arguments that B will have breached.

First, R's in-house production of parts after absorbing B probably breaches the term enjoining B from in-house production.

Second, S may argue that B breached the duty of good faith "best efforts" implicit in the exclusive requirements contract, 2-306(2). S may point to Conrad's apparent golden parachute and argue that he is acting opportunistically without taking into account S's needs. B may point out that misaligned incentives arc inherent in relational contracts and are not themselves dispositive of bad faith. Furthermore, B should argue, the changed commercial circumstances was the driving factor behind the proposed merger with Triad – not Conrad's exit payment. However, I think a court will likely find bad faith here since B isn't considering S's needs.

B may argue that S has instead breached by refusing to return design specifications and notes. However, B likely misused its discretion in bad faith here.

Separately, S may have a claim against R of tort of interference with contractual relations.

4. Defenses

B may attempt a claim of impracticability but I think the court will instead look at changing circumstances as a factor in deciding whether B breached the duty of good faith.

5. Damages

Were B to breach, S would be entitled to expectation damages, which can be difficult to calculate for relational contracts. S might estimate its expected profits over the future life of the contract using its past dealings with B.

However, since breach hasn't happened yet, S may request an injunction blocking the merger. While the court may worry about efficiency losses, it may instead decide that an injunction will allow B, S, and R to negotiate a fair payment around allowing the merger without having the courts decide this value.

B. Triad / Rhombus (R) v Conrad (C)

I. Enforceable Duties

C and R likely have an enforceable contract governed by common law to continue negotiating in good faith within the scope of terms already agreed upon. TIAA .

2. Breach

If C simply breaks off negotiations, he will likely be in breach of the duty to negotiate in good faith. However, R and C could mutually agree to end discussions without fear of liability on either side.

If R's board finds out about the dispute with R and orders Dionne to cut off negotiations, R would likely not be in breach because C and R agreed the deal is conditional on Triad's board's approval.

If C continues to negotiate with R, he should disclose the dispute with S to Triad's board of directors or risk being in breach of the duty to disclose under Rst § 261 or bcing liable for the tort of fraud. Given that C realizes that Triad's board might refuse to deal with B if there is a dispute, this fact is likely a basic assumption of the deal. Furthermore, R's previous refusal to deal in 2005 is additional evidence that lack of a dispute is a basic assumption of the contract. TR's board is mistaken about the lack of a dispute and C's non-disclosure would likely be a failure to act in good faith and fair dealing.

3. Defenses

Both B and R could raise incapacity defenses – that Conrad and Dionne didn't have authority to deal on behalf of their respective companies, but these defenses are unlikely to succeed given their positions as CEOs. However, getting agreement from their respective board of directors was likely an important contingency for both Conrad and Dionne.

R may attempt to equitably estop C / B from using S's suing of B or R as an excuse for breach given C's representation that he didn't expect legal trouble from S. However, Dionne's and C's agreement making C share in the legal liability shows that R and Dionne didn't blindly rely on this statement, making such estoppel unlikely.

4. Damages

A court would likely find expectation damages too uncertain and indefinite to award because many of the major terms are still open. However, if R breaches, C may be entitled to the money he was personally promised.

If C doesn't disclose the B-S dispute, he may be liable for punitive damages for his bad faith non-disclosure and possible tort of fraud.

C. Advice for Settling

1. Party's Interests

S wants to keep making a profit on B's exclusive purchases from it. C wants to get his attractive compensation package, not be liable for significant legal costs, and have B avert disaster so that C's reputation is untarnished. B wants to be bought or merge as a soon as possible given its cash flow problems. R wants to get B's physical and intellectual property assets and doesn't want to pay damages to S or even be embroiled in a legal battle with S.

2. Settlement Idea

Given B's likely liabilities to S in case of a merger or possible injunction against a merger, both of which would end up with B's bankruptcy, S's lack of satisfaction, and C's tarnished reputation, I suggest C negotiates a joint-settlement with Sand R that would include the following terms and would likely leave all parties involved in a better state:

(a) S agrees to hand over design notes and other intellectual property related to B

(b) S agrees to drop any potential legal claims against B, C, and R

(c) R compensates S for the value of the business that 8 would owe it.

Part (c) can be accomplished in one of two ways.

First, by setting a one-time price. Given the probable lack of trust between Sand B/CIR and the difficulties of relational contracting, this may be the best option for all involved. However, given the significant upfront costs for R, it may reduce the favorability of the deal for both B (R might offer a lower price) and C (R might offer C less for leaving after the merger). In addition, if R is unsure of the value or B's assets, it might be unwilling to make a large initial outlay.

Alternatively, Rand S can enter into a relational contract that gives R royalties that should tack the profits and business it was expecting to get over the duration of its existing contract with B. We want to make this relational contract as beneficial as possible to both Rand S and reduce any possibilities for future legal troubles based on misunderstandings.

S may be wary of getting royalties based on revenues of B's products since it's unclear how B's products will be used (for example, R may simply decide not to use any of B's products). Furthermore, R may not want to be bound by a duty of "best efforts" to keep using B's products in some particular way.

Therefore, I suggest that S's royalties be based on overall profitability of R. This will keep R's and S's interests significantly aligned. This can be achieved by an explicit agreement to share profits, a minimum floor on payments, and an option for S to require an annual accounting so that it can assure it's getting its fair share. However, R may be unhappy about opening its books to a competitor. Alternatively, it would probably be easier and cheaper for R to simply issue stock to S.

Furthermore, given the difficulties of calculating actual damages in the event of breach, I suggest that there be a liquidated damages clause. Finally, Sand R should stipulate to arbitration in the case of a dispute, which is likely to be more convenient and less costly than litigation.

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