Top Student Exam Answers, Spring 1995
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.
Question 1, Answer 1
Crabtree (C) could pursue a claim against Stovall (S) for breach of contract and seek expectation damages in the amount of $7 million (= $58 million paid thus far + $38 million cost to complete = $89 million price). While costs regarding the other contractors have been incurred due to delays, it is unlikely that these damages can be reasonably attributed to S's breach, and they are therefore omitted from this calculation.
S' likely defense will be that C's failure to perform its duties constituted a material breach of the contract, excusing S' refusal to complete the job. Under this argument, S would also have a claim under quantum meruit for $10 million ($68 million in cost incurred - less $58 million already paid).
Alternatively, S could claim that they substantially performed the contract. However, in light of the significant amount of work remaining to be done, this defense seems implausible.
In claiming a material breach by C that would excuse their nonperformance, S would likely cite the oral assurances supposedly given by C regarding the air compressors, the delays due to the repair of the damaged compressors, the disagreement over who would excavate the cut-off trench, and delays in providing materials.
There is some dispute over the adequacy of the air compressors and whether or not C had given oral assurances that they would suffice. S, being a recently established business, might claim that C was better positioned to know that the compressors were inadequate and was responsible for providing adequate equipment. However, we are told that this company was created by two junior partners from another established firm, which indicates that they are not neophytes, and should have known what they were getting themselves into. If S had concerns about the adequacy of the equipment, it could have included specifications in the subcontract, which apparently went so far as to specify that C would supply compressors.
C should not be blamed for the delay due to the repair of the compressors damaged due to the fire, as this event was entirely unforeseeable by both parties. S could argue that machinery breaking down is a fact of life, and that C should have had replacements available, as perhaps the mill should have had a spare shaft available in Hadley v. Baxendale. However, it is difficult to gauge the strength of this argument without more information. For example, did C have replacement parts available? are typical repairs usually made quickly, contrasted with the apparently major damage caused by a fire? If yes, then it is not reasonable to hold C responsible for the delays caused by the unforeseen (and unattributed) fire.
S also holds C responsible for delays in providing necessary materials. However, delays are a routine aspect of the construction business, and should not excuse the failure of S to perform. S should have completed the job and then sought payment for any additional costs incurred due to C's delays, rather than walk away when the job was 70% completed, particularly since they were being paid regularly and C had recently waived the 10% holdback. Assuming that they had completed the project for an additional $35 million, they would seek damages of $44 million (less any further payments received) under an expectation measure [= $103 cost incurred - $58 million paid thus far (-$1 million) anticipated profit (loss)] . This results in a net payment of $9 million, which is essentially the $10 million in unpaid costs less the anticipated loss of $1 million.
S would be better off seeking restitution for costs incurred, since they actually anticipated a small loss on the project. They would seek to be returned to their original position, which would remove the anticipated loss item, resulting in net damages of $10 million for costs incurred.
S could have avoided the need to settle these issues in court by specifying in the contract that additional costs incurred due to C's shortcomings would result in an increase in price. The argument that they are new players in the market should not excuse their nonperformance, as the founders were both experienced in the trade. They made a business decision to aggressively price their services on this contract in the expectation that it would lead to more business in the long term. The reasons cited do not support a contention by S that C's conduct was a material breach, excusing the breach by S.
With respect to Yellowknife (Y), the critical issue is whether the liquidated damages clause would be enforced by a court should C refuse to pay. Assuming that C refuses to pay and the clause is enforced, they could be responsible for roughly $70 million in damages to Y as determined under the clause. We are told that due to changed market conditions, the actual additional cost to Y due to the delays in construction would only be to run generators overtime and wheel in some electricity from a nearby power grid during peak demand. If the clause is not enforced and damages are determined under an expectation measure, would be entitled to a considerably lesser amount, i.e., the cost of these additional activities.
Should C elect to not pay the damages and test the clause in court, Y could make a strong argument that at the time the contract was formed, the liquidated damages were based on their best estimate of costs, and that Y should receive the benefit of their bargain. What appears to be a windfall is actually the fortuitous outcome (for Y) of the risks both sides took when they entered into the contract. If market conditions had changed such that the actual cost to supply energy from alternative sources had increased rather than decreased, Y would have been exposed to losses in excess of the damages provided through the contract clause. Just as C could reasonably expect that the damages would not be increased above the stipulated amount, they should not be decreased due to changes in market conditions since contract inception.
Generally, for a liquidated damages clause to be enforced, it must have been the intent of the parties, the anticipated damages must have been uncertain or difficult to estimate at the formation of the contract, and the damages must be reasonable. It would appear that all three of these conditions are satisfied here.
However, in light of the changed market conditions, C could argue that the monthly penalties are excessive, as they were based on Y's overstated estimates of the cost of providing energy from other sources. C relied on Y's expertise and superior market knowledge in the development of the stipulated damages clause. Clearly Y was in a better position to estimate the damages incurred due to a delay in construction. Furthermore, they included a 20% load for undetermined miscellaneous expenses. If any aspect of the clause seems to be a "penalty", it is this load for uncertainty above and beyond expected damages. Based on the current market conditions, forcing C to pay the liquidated damages would result in an undeserved windfall for Y. It is possible that a court would be reluctant to enforce this liquidated damages clause, in light of Y's actual minor damages.
Portsmouth (P) agreed to provide all the mixed concrete needed for the project at a fixed price.
It is not clear whether the timing of this delivery was included in the language of the sub-contract. Since the summary is silent, I assume not. However, timing is apparently important to P (if for no other reason, fluctuations in market value).
A requirements contract such as this imposes a good faith obligation on the seller to supply the goods under UCC 2-306. There is an exception for unreasonable amounts demanded, but the amount required here does not appear to be the issue. Neither does the ability of P to supply the concrete seem to be a problem, as they are willing to do so at a higher price. If P refuses to sell the remaining concrete at the agreed upon price, C should buy it from someone else at the market price ("cover") and then seek damages from P in the amount of the excess of the market price paid over the fixed price, under UCC 2-711 and 2-712. In this case, P would likely get credit for the amount it sold below the fixed price in December.
Without knowing the quantities involved, it is not clear that such a claim by C would be worth pursuing. With respect to Skeletarch (SK), it is again not clear that timing of delivery was part of the contract. Assuming that it is, I think that C has breached by not accepting delivery or providing specifications, or whatever is preventing SK from delivering. In this event, SK may have a claim for the opportunity cost lost due to unused production reserved for C. Such a claim would likely seek expected profits lost in that time period due to SK's inability to deal with other parties.
On the other hand, if there was no timing specified in the contract, then SK is the breaching party. In that case, C should again cover by purchasing the supports from someone else, and trying to recover the difference in price from SK under UCC 2-711 and 2-712. SK's defense would likely come from UCC 2-615, stating that their agreed performance has become impracticable by the non-occurrence of a basic assumption on which the contract was made, i.e., timing and the ability of C to accept. To use this defense, SK must allocate a portion of its available production to C in a "fair and reasonable manner" and notify C of the delay.
Question 1, Answer 2
The party that breached the contract should be determined before the claims between Crabtree Construction (CC) and Stovall can be discussed. The underlying question is whether CC substantially complied with the terms of the agreement. If CC did, Stovall is in breach of contract, because it stopped work on the dam. If CC did not substantially perform its side of the contract, then it breached the contract. Using the guidance of Rest.2d.341,342, Stovall does not have to finish performance of the contract if CC failed to perform the contract in a way that prevents Stovall from reasonably benefiting from the contract. The failure must be of a material term or material failure to perform.(Rest.) Stovall entered into this contract for experience, and not to lose money on the deal. CC contracted Stovall to build a dam within a specified time and price. Stovall will show several areas where CC has not held up its part of the agreement. The loss of experience is hard to quantify and remedy. Therefore, Stovall will try to show that CC's failure to adequately perform caused Stovall to incur losses greater than it could reasonably have been expected to anticipate.
While CC may not have materially breached the contract by failing to perform any of the individual contract terms, it may have breached the contract as a whole. The several breaches may cause an aggregate loss to Stovall. Using the wording of the Rest.2d.241, Stovall may be discharged for being deprived of the benefit of the contract, by not incurring a loss. Therefore, Stovall must quantify the amount of loss that was caused by each failure to perform by CC. If any individual loss or the aggregate loss is much greater than that which could have been foreseen by Stovall, than CC is in breach of contract.
Stovall offer several breaches on the part of CC. First, CC consistently delivered materials late causing cost overruns. CC will respond that the delivery terms were not material, or they would have been included in the contract. Stovall will argue that CC, as the provider of materials, was the least cost avoider, thus CC should have taken steps to insure adequate delivery . Second, the air compressor expenses were paid by Stovall, but used for other parts of the construction by CC. Third, the air compressor was not replaced for sixty days after it was damaged. Fourth, Stovall will claim that CC induced it into the contract as stated by claiming that the air compressor would operate steam shovels. CC will claim that Stovall should not be able to recover on this allegation, because Stovall, though a novice, is in the industry and should have made inquires on its own to determine the operation specifications of a steam shovel.
If the court finds that CC breached the contract, then Stovall may have a claim. for expenses it incurred until the time it stopped working on the dam. Restitution damages provide the best and most accurate measure of damages here. Stovall did $68,000 dollars of work, and CC benefitted by this same amount. It does not matter how much Stovall would have lost if the contract were completed. Since the contract was not close to complete, the contract price can not be used to measure partial performance. In this suit quantum-meruit, Stovall would be entitled to cost of work done minus payments by CC or a damage award of $10,000.
Stovall's attempt to obtain expectation damage or reliance would be harder to show. Under straight expectation theory or putting Stovall in the position of performance of the contract, the damage award would be much lower. Stovall would have incurred heavy losses if the contract was completed. It would also have a hard time quantifying and proving losses of future contracts. In terms of reliance, Stovall was a new company, therefore it would have a hard time showing any contracts it could have been performing instead of this one.
If Stovall is found to have breached, then CC can ask for relief in the completion of the dam within the subcontract price of 89 million dollars. CC properly mitigated the breach by hiring another contractor to finish the work for $38 million. Since the cost of the dam to CC will now be 96 million, Stovall will be liable for 7 million plus any costs associated with hiring a new subcontractor. Stovall may counter-claim for undue enrichment on the part of CC for using the air compressor Stovall paid the expenses for.
Also, in a separate claim or counter-claim of the first scenario, CC will argue that Stovall was unduly enriched by the excavation work by CC. This work was in the contract price with Stovall. Stovall will respond that the contract was never modified, in writing, as is required. In addition, there was never any final intent for the contract to be modified, as shown by Stovall's attempt to complete the work.
The final note is that CC must be found in substantial non-compliance for Stovall to recover . The court will look at the fact that it would have cost Stovall l03 million for an 89 million dollar contract. The court will try to avoid giving Stovall an excuse to back out of the contract if the cost overruns were more a result of Stovall's inexperience. Also, the court will not look favorably at Stovall's collection of the 10% withheld, though it subsequently failed to complete the contract under the modified terms.
The dispute between Portsmouth and Crabtree will depend on the party in breach. The contract was for the sale of concrete at a specific price pursuant to CC's needs. The contract does not include any specific delivery terms. Portsmouth will have to prove that CC acted in a manner that made it rely on a December order . If CC has breached the contract for a December order, then Portsmouth acted properly by reselling the concrete under UCC 2- 703. Portsmouth will be entitled to the contract price minus the resale price plus any incidental damages. The court will award these damages in accordance with UCC 2-206 which looks favorably to a resale at market price. Since the contract is breached, Portmouth can negotiate a new contract for future cement sales.
If Portsmouth can not prove that CC breached, than it will be liable for future cement sales. CC will have to show that Portmouth could not have relied on the specific December sale, because their contract was on as needed basis. CC contracted with Portsmouth for a specific cement price because it was risk adverse. By setting a price, the risk of price fluctuations was borne by Portsmouth. The increase in market price of cement 10 cents over the contract should have been reasonably foreseen. CC has two options. First, it can cover under UCC 2- 712 and recover later for the difference between the market price and the contract price plus any incidental costs in procuring a new buyer. Second, it could agree to the terms of Portsmouth and then later sue for the difference in price. This suit would occur because the modification was without separate consideration. Portmouth was already responsible for the contract price, and it offered nothing more in return for a higher contract price. The first option is much more attractive. Specific performance would not be available, because the product is not unique as in UCC 2-716.
Skeletarch(Sk) has a much stronger claim against CC. The contract governing this relationship had delivery schedules that were to be met. Since the orders were specific to the plant site and were of a large quantity , CC should have known the Sk would set aside production space. Reliance damages would be hard to measure. It would be hard to prove how much of the forty percent set aside for CC would have been utilized. Restitution would be inadequate, because the Sk has not provided a benefit to CC that has not been paid for. Expectation damages would be appropriate, because it could be measured by the contract price and delivery schedule. Sk would be entitled to the price of goods it was to deliver minus the cost avoided by Sk for those goods. Note, expenditures to adapt the factory would be a part of the costs, because they would have been necessary if the contract had actually been executed. CC does not have a claim against Sk unless it can prove that the delivery dates were not firm, and that Sk should have reasonably foreseen delays in orders. If Sk is found to be in breach, than CC will have a claim for specific performance for a unique product under UCC 2- 716. In the alternative, CC should negotiate with Sk to offer advance payments, and some considerations for delays in ordering the steel.
The final claim results from a contractual agreement for penalties for delays in production of the hydroelectric plant. CC will, in a sense, be paying liquidated damages for its failure to construct the plant within the time frame set by the contract. Yellowknife (Yk) contracted with CC to be the master contractor to build the plant. As a master contractor, CC took the responsibility to hire subcontractors and supervise their performance. It will not be able to argue change of circumstances because of contract disputes. These circumstances were the risks it bore when CC took the contract. Yk entered into the contract to avoid contractor and supplier risks. CC will, however, be able to challenge the liquidated damages clause. First, liquidated damages are appropriate only when the damages at breach are hard to measure. Here, the damages are the cost of procuring power from an outside power source, investment opportunity costs, and financing charges. These damages would likely be measurable using standard methods. Second, the liquidated damages must have a direct relation, and be proportionate to the actual harm caused by the breach. Yk's projection of the energy use in the region was inflated and the harm done by the delay did not require purchasing outside energy . The contract term explicitly states that the penalties are for procuring outside energy . In addition, the use of the damages for dividends is not directly related to the delay of the plant construction. Yk needs to prove that the plant in operation would have allowed the full dividends to be paid. The court will not apply a liquidated damages clause if the penalties are not directly for the loss due to the delay of the plant, and the proportional to this damage.
Question 1, Answer 3
The resolution of the claims between Crabtree and Stovall depends on determining which party breached the contract. Crabtree should point out that Stovall left the job uncompleted, and in doing so, breached. It had apparently realized -- given total costs of $103 million, and total payment of only $89 million -- that it was in Stovall's own best interests to make the efficient breach. Stovall may respond that Crabtree first breached the contract in performance, through delays in furnishing materials and completing the cutoff trench, and by supplying compressors which did not perform as promised. Crabtree would have to show that its delays were so insignificant that it had substantially performed its duties, though this would be difficult if the delays were slowing the project and increasing costs. With no written assurance of the adequacy of the compressors, there will be an argument about whether any was made; but since the owners of Stovall were experienced in construction, they should have thought to inspect them or to specify terms to cover any inadequacy. Still, since Crabtree was to furnish materials as needed, any failure to do so through delay might well be considered a breach; and since Stovall specifically warned Crabtree that the delays were causing problems, Crabtree should have known that it was breaching.
If Crabtree breached, Stovall would say that the violations were responsible for direct costs incurred on this job can be indirect loss of the referrals it had expected to receive. Since Stovall had expected to break even on this project, it can recover only the difference between the $68 million it has spent and the $58 million it has received so far. However, the reputational value of this project was expected to enable Stovall to line up future jobs. Stovall might have difficulty demonstrating just how many future jobs it has lost, and Crabtree would argue as well that the reputational value of the job was neither specifically contracted for nor reasonably foreseeable. But Stovall could counter by pointing out that it was clear, either explicitly during contract negotiations or by the lowness of its bid, that this job was important chiefly for its reputational value. If reputational value is to difficult to measure, it must have been worth at least $10 million, since Stovall was willing to forego the industry's average expected profit (most other bids had been near $100 million, based on $90 million cost estimates) in order to obtain the reputational value. Therefore Stovall's total claims would be $10 million for its costs on this project, plus at least $10 million for the future jobs lost.
If it was Stovall who breached, it should be liable to Crabtree for its extra costs to complete the project. Since Stovall had originally contracted for $89 million, and since Crabtree will end up paying a total of $96 million, Stovall must pay $7 million in expectation damages. Crabtree might also argue that the delay caused by Stovall's abandonment has caused additional consequential damages; the amount depends on the resolution of Crabtree's conflict with the other parties
Finally, there is the issue of the excavation by Crabtree of the cutoff trench. If Crabtree breached, the issue is moot; any work done by Crabtree was effectively part of its compensation to Stovall. But it Stovall breached, then Crabtree would be entitled to additional compensation for the work it had done, either by claiming a modification of the contract, or by quantum meruit.
Portsmouth's unilateral decision not to supply material passed 1994 is the source of any claims between Portsmouth and Crabtree. Crabtree will want argue that Portsmouth breached, and therefore must compensate Crabtree for the difference between the market price of material still needed for the project and the price originally contracted for those materials. Portsmouth would owe Crabtree 10 cents for every cubic yard of material purchased in the future a -- unless it agrees to supply the product at the original price. Portsmouth would argue that Crabtree breached first, through its delays in construction. If this were the case, then Portsmouth's demand for Crabtree to cover the difference between the original price and the resale price would be justified under UCC 2-706. With the contract breached, Portsmouth would be free to negotiate a new contract for any future sales, even at a higher price.
The outcome here turns on determining which party breached the contract. Crabtree has a stronger argument. Portsmouth must complain that delays caused construction to continue past the time limit implied in the original contract, the planned completion in October 1994. But the contract was not explicitly limited to any time period, and was simply an agreement that Portsmouth would supply Crabtree's requirements. As a construction supplier, Portsmouth should have known that projects often take longer than planned; and, if such occurrence were of concern, it should have explicitly limited the contract. In fact, Portsmouth was probably aware of the fluctuating market for cement and gravel, and reneged on its agreement out of fear that it would be stuck with lots of expensive Sotheby sold cheap packet further, Crabtree could point out that it had never rejected any materials, or failed to make a payment, or otherwise acted (as described in UCC 2-703 and as required to invoke UCC 2-706) to breach the contract. Thus it seems that the breach was actually Portsmouth's.
Skeletarch had a more well-defined contract than Portsmouth; it had specifically promised to set aside 40 percent of its capacity in 1993 and early 1994. Therefore it is better able than Portsmouth to claim a breach by Crabtree through delay. If such a claim were successful, then Skeletarch would be entitled to its lost profits. If the contracted had been a special deal, in which Skeletarch agreed to accept the lower profit in return for being offered such a large project, then Skeletarch might argue that it should collect its normally expected profit, which it had foregonein reliance of the contract which was not filled.
Crabtree might try to argue that unforeseen circumstances, such as the inappropriate air compressor, the fire, and Stovall's abandonment, constitute sufficiently changed circumstances to warrant a modification of the original contract. The time element should be extended into 1995. If Skeletarch still declined to comply, the extreme difficulty of finding another supplier could constitute "proper circumstances" under UCC 2-716, which would warrant holding Skeletarch to specific performance. However, Skeletarch might counter that the delays were due in large part to Crabtree's own delays in furnishing Stovall with the necessary materials. Thus the delays were Crabtree's responsibility and could not be a basis for modifying the contract. Also, since Skeletarch may be effectively the only supplier of the needed supports, it might not be wise to antagonize it by playing hardball, since a loss in court would be disastrous to Crabtree. It would be best to try and negotiate, even if this means acknowledging Skeletarch's claims for lost profits; given the supports' cost, the lost profits cannot be more than $5 million -- less than even one more month's penalty for delay.
These penalty payments are the subject of any claims between Crabtree and Yellowknife. The only breach of their contract is the delay in furnishing the project, and the contract itself defines the damages for this breach. Yellowknife would simply like to abide by the terms of the contract. However, Crabtree has a strong argument for its requested modification of the contract. Liquidated damages generally should not greatly exceed a party's expectation damages, at least as far as they can be determined. Here, even at the time of contracting, the damages clause was questionable: the $4 million dollars per month scheduled for the first six months included not just Yellowknife's fair estimate of costs, but also a seemingly arbitrary markup of 20 percent. Even if that markup was justified by uncertainty, the additional $3 million per month penalty, added from the seventh month forward, has no such justifications. It is plainly a penalty, and Yellowknife would be unjustly enriched for Crabtree's troubles, even if Yellowknife's estimated needs had been correct. Given that now the plant will not be needed until after November of 1995, Yellowknife is not actually suffering even its predicted damages. Finally, Yellowknife's justifications for holding onto the payments -- to insure low rates and stock dividends -- are inappropriate, since they do not reflect costs due to Crabtree's delay. A court would be unlikely to enforce the penalty clause beyond whatever smaller amount would be needed to cover Yellowknife's costs of running its generators over time and bringing in power from neighboring grids.
Question 2, Answer 1
Part A
I would advise Kellman to hold Agron to the original contract. Agron's request for recission or modification seems to be based on a position that the license arrangement was conditioned on reaching an agreement with Ferris-Burnham. However, no such condition was part of the contract and if Agron wanted the license to be conditioned on successful negotiations with Ferris-Burnham, it could have (and should have) insisted on making that condition a part of the license.
Agron may want to introduce evidence that Kellman and Agron orally agreed that making Creduline would be impractical without an agreement with Ferris-Burnham. The merger clause in the contract will provide Kellman with evidence that this understanding was not intended to be part of the integrated
contract, and therefore that Agron's evidence should be barred by the parol evidence rule. Of course, a court will probably look at the evidence itself to decide whether it should be admitted. The evidence may in fact be admitted if a court decides that it doesn't contradict the terms of the integrated writing and accurately reflects the intentions of the parties.
Even if the evidence is admitted, though, it seems unlikely to be interpreted as a condition of the contract. The parties agreed that making Creduline would be impractical in the absence of an agreement with Ferris-Burnham, but did not agree on who would bear the risk of failed negotiations. Agron may have intended that failure would mean recission, while Kellman may have insisted on the $2.5 million payment up-front as insurance against failed negotiations.
Agron may also claim that the change in circumstances from what was anticipated has made performance under the contract impractical. This position would find support in the parties' oral understanding if the parol evidence was admitted.
Agron's hints that it may share Kellman's trade secrets with Ferris Burnham unless Kellman agrees to rescind the contract or lower the royalties suggests that Agron is trying to take advantage of its enhanced bargaining position. Kellman has made relationship-specific investments in Agron by sharing proprietary information about Creduline. Agron's veiled threats to share Kellman's trade secrets with a commercial rival is a form of duress that the courts are unlikely to countenance. The Restatement, Second, § 89 states that a modification is binding only if it is fair and equitable in view of unanticipated circumstances. Here, the failure to reach an agreement with Ferris-Burnham could reasonably have been anticipated by Agron, which was a sophisticated commercial party and, in addition, knew of the prior interactions with Ferris-Burnham that had caused distrust. Thus, the lack of an agreement with Ferris-Burnham should not be considered an unanticipated circumstance.
Also, the changes requested by Agron are not a fair and equitable solution to the situation. Agron has requested that it be released from its obligations or, alternatively, that Kellman take over the negotiations and reduce the royalties due under the contract. Recission of the contract is an unfair solution because it would put too much of the cost of the failed negotiations on Kellman. Kellman would have to return the $2.5 million up-front fee and would lose the royalties it would have made over the course of the licensing deal, leaving Kellman to negotiate from its weak position for a new partner. At the same time, Agron would lose the profits it would have made on Creduline but would gain the opportunity to devote its energies to some other product.
Having Kellman take over negotiations and reduce the royalty rate is also not a fair and equitable solution. Although having Kellman participate in the negotiations might be desirable as a means of mediating the mistrust between Agron and Ferris-Burnham, having Kellman take over the negotiations would likely result in a deal that was worse for Kellman. The whole point of arranging a licensing agreement between Kellman and Agron before starting negotiations with Ferris-Burnham was to put Agron in a strong bargaining position. If Kellman has to take over negotiations, it will be negotiating from a much worse bargaining position than Agron has and therefore will likely end up with a deal that is much less favorable than the one that Agron could strike. In addition, regarding the reduction in royalty rates, the lack of an agreement is Agron's fault, in that it was their lack of negotiating skill that brought about the current impasse. If their performance in negotiating an agreement with Ferris-Burnham has resulted in a less profitable sales environment for Creduline, it is only fair that they bear the cost of that situation.
Part B
First, in regard to the indemnification issue, Kellman should point out that the settlement contract contains no mention of indemnification and does contain a merger clause, indicating that it is an integrated agreement, superseding the earlier contract that provided for indemnification. If the settlement agreement contains all the necessary terms of the licensing agreement between Kellman and Agron, a court may well consider it to embody the parties' understanding. The settlement contract reduces the royalty rate, which a court might take as consideration for Agron's loss of indemnification. In addition, the settlement contract reflects settlement of the patent dispute that indemnification was meant to cover, so arguably there was no further need for an indemnification clause.
However, our facts are unclear whether the settlement agreement contained all of the details on patent rights that were necessary for operation of the original license. If the settlement agreement did not contain all of the patent rights needed to make and sell Creduline, a court may consider that the merger clause in the later agreement was mere boilerplate, and interpret the settlement agreement as a modification of the earlier agreement, with the indemnification clause preserved.
If an indemnification clause is read into the settlement agreement, either because reference to the earlier agreement is necessary to provide patent rights needed to make an sell Creduline, or because the court allows parol evidence to be entered to show the context of the settlement agreement, the scope of indemnification under the original contract will be an issue for interpretation. The licensing contract provided that Kellman would indemnify Agron for costs associated with defending the validity of the Creduline patents in court. The scope of the indemnification seems clearly limited to defending the Creduline patents. The costs associated with defending against an antitrust suit do not appear to fall within the scope of indemnification. The antitrust suit is based on the anti-competitive behavior of the parties and never challenged the validity of the Creduline patents. The costs of defending against the antitrust suit therefore should not fall within the scope of the indemnification, even if a court gives effect to the indemnification clause.
If the provisions of the first contract are given effect, Kellman can also point to the force majeure clause, which says that Agron will not have a claim against Kellman for losses caused by agencies of the US government. Although the force majeure clause was originally intended to protect against adverse FDA action, it is broadly worded and seems to encompass as well the actions of the Justice Department in investigating antitrust complaints.
In regard to Agron's demand for lower royalty rates, Kellman should perhaps agree to negotiate a decrease in royalties. The Restatement, Second, § 89 states that a promise to modify a contract is binding when it is a fair and equitable response to unanticipated circumstances. Here, neither party anticipated the antitrust suit that forced Kellman and Ferris-Burnham to compete actively against each other, thereby driving down prices and profits. The original royalty rate was calculated based on thefat profits that could be obtained in a market without significant competition. In the new, post-antitrust suit world, profit levels are much lower than originally counted on. An equitable solution would appear to be sharing the pain between licensee and licensor, so that neither has to bear the entire burden of the unanticipated circumstances. In the absence of an adjustment in the royalty rate, Agron is paying the same fixed-cost royalty rate but is only able to obtain a much lower price for the product, so the burden falls entirely on them.
Allowing Agron a little more profit per unit may also be a good business decision for Kellman. Kellman and Agron are involved in a long-term relationship that got off to a rocky start, and a show of good faith may make the rest of the relationship much less contentious. In addition, Agron has the exclusive license on Creduline, and Kellman is dependent on Agron's best efforts to sell Creduline in order to obtain its royalties. If Agron is making only a razor-thin profit on Creduline, it is likely to devote less effort to selling Creduline than it otherwise would.
Question 2, Answer 2
Part A
Kellman (K) has several options. One is refusing to modify the agreement and demanding performance. Another is agreeing to the modification. A third is agreeing to the modification, and later suing to have the modification voided.
Refusing Modification
Should K demand performance on the original contract, A has hinted it would breach, and ally itself with Ferris-Burnham (F). K could forestall any F-A alliance by seeking an injunction, and then suing A for specific performance.
Specific performance is appropriate where substitute performance is unavailable. F and A were K' s two possible candidates for licensing Creduline. Were A to join with F, K apparently would have no way to market its product. Even were such an alliance not to materialize, a licensing agreement between K and F seems unlikely. F would be entrusting the success of Creduline to the competition. In addition, the unsuccessful initial negotiations conducted by A to reach a cross-licensing agreement with F has likely poisoned the atmosphere. Thus, A has no good substitute for A's performance, and specific performance is appropriate. Nonetheless, this course of action is not recommended. Courts are reluctant to grant specific performance, given the restraints it places on efficient breach. Even were specific performance granted, K would be left with the success of Creduline dependent upon the marketing efforts of A. Given the hard feelings which a suit for specific performance is likely to engender, A's motivation to advance Creduline would be questionable.
Modifying
Alternatively K could modify the agreement, as A has demanded. This would keep A happy, thus removing any impediments to its marketing of Creduline. K itself would have to handle negotiations with F for cross-licensing, but given the animosity between F and A, this seems to be in K' s best interest anyway.
Modifying (For Now)
Still, K need not resign itself to submitting to A's demands. K could agree to the modifications for now, and later sue for breach of the original contract, demanding the difference between the original royalties arrangement and the modified arrangement. K has a strong case for claiming the modification is unenforceable. According to the Restatements, any modification must be "fair and equitable," in that it must be due to unanticipated circumstances, and cannot be coerced. Here, neither of these requirements has been satisfied. The oral agreement between A and K shoed that both parties understood F's patent claims presented difficulties for the marketing of Creduline, and that a settlement would have to be reached with F before manufacture could go forward.
A could counter this argument in two ways. First, it could simply defend the modification. A can deny coercion, and claim it had been misinterpreted. Further, A could try to prevent admission of the oral agreement which K would rely on to show the circumstances in question were not unanticipated. Relying on the integration clause, A would claim the oral agreement was superseded by the written contract. K' s case for allowing admission of the oral agreement, however, is strong. According to the Restatement, consistent additional terms may be added to an agreement where those terms might naturally be omitted from the writing. That is the case here, since the oral agreement would have weakened A's bargaining position in its negotiations with F .
Second, and more likely, A could argue there was no modification. Rather, the original contract never came into existence, and the new royalties arrangement was part of an entirely new contract. Under this line of reasoning, the oral agreement was not an additional term to the original contract, but rather a condition precedent. This condition stated the written contract would only come into effect if A were able to reach an agreement with F on cross-licensing. Since A was not able to reach such an agreement, the condition was never satisfied, and the written contract never went into effect. Thus, the "modification" was really an entirely new agreement, with separate consideration, and K would be bound by its terms. K's response to such an argument should be that the oral agreement contained an implicit promise A would conduct negotiations in good faith. A's refusal to continue negotiations with F, and its failure to disclose the animosity which existed between A and F, should be interpreted as bad faith.
Part B
K appears to have a clear case for breach of contract. A has three possible defenses. The first is that Kfirst violated its duties under the agreement by refusing to indemnify A for costs incurred in the Deering antitrust suit. The second is that because the contract failed to consider the possibility of either antitrust litigation or an increasingly competitive market, this is a case of mutual mistake. Finally, A may argue the amended agreement is no longer enforceable, since performance has become impracticable.
Refusing to Indemnify
There is a presumption that mutual promises in a contract are dependent. A may argue K had a duty to indemnify A for expenses in the antitrust litigation. When it failed to do so, K breached the agreement, and A was no longer obligated to carry out its duties. In this case, however, the merger clause is likely to benefit K. The amended agreement does not include provisions for indemnification, so K has no such duty . A may argue that the amended agreement was only intended to alter the royalty percentages under the original agreement, and that the indemnification clause is still valid. But A would have to present a good reason why the indemnification provision was not in the writing. Since there is none, this argument is likely to fail.
Refusing to Modify
A more plausible argument for A to claim mutual mistake, in that neither A nor K anticipated "cut-throat" competition. Under the Restatements, an adversely affected party may avoid a contract on account of mutual mistake where the mistake concerns a basic assumption on which the contract was made, where it had a material affect on the "agreed exchange," and where the adversely affected party did not bear the risk of the mistake. A is likely to argue the continued lack of any aggressive competitors in the fat substitute market was a basic assumption on which the contract was made. Further this mistake had a material affect on the agreed royalty percentage established under the amended licensing agreement. Additionally, A will argue the risk of mistake was not allocated to A by the agreement.
K can respond that while the risk of mistake may not have been allocated to A by the agreement, it should be allocated to him by the court. K is a medium-sized chemical company which did not even have the resources to produce and market its own food additive. A is a large, diversified chemical company with technical know-how and marketing experience. Given A's experience, it should be more aware of the possibility of a non-competitive market suddenly becoming competitive. It is therefore the least cost avoider. Likewise, A presumably is engaged in the production of a wide variety of products. As such, it can most easily provide for the risk that a market will become less profitable by providing for a suitable profit margin in all its contracts. A is the least cost insurer. Additionally, by assigning the risk to A, the court would give other companies in A's situation the incentive to more thoroughly investigate the situation before entering into such an agreement.
Finally, A may argue that given the increasingly competitive market, performance on the amended agreement has become impracticable. This argument seems to be foreshadowed in A's statement that it "needs a lower royalty percentage to be able to compete successfully and to cover its costs with sufficient profit margin." This argument is equally unlikely to prevail. To be excused from performance due to impracticability , there must be a change in circumstances which renders performance infeasible from a commercial viewpoint. But if we rely on U.C.C. §2-615 for guidance, it becomes clear that increased cost alone does not excuse performance. Rather, the cost increase must be due to some unforeseen contingency which alters the essential nature of the performance. Examples of such contingencies provided in the U.C.C. include wars, embargoes, and crop failures. By contrast, increased competition should be foreseeable, especially to an experienced chemical company such as A.
Given the apparent weakness of A's case, K need not blindly submit to A's demands. This is especially the case, since an alliance between A and a competitor is unlikely, given the increased attention the U.S. Justice Department has given to the fat substitute market. Nonetheless, threatening A would not appear to be in K's best interests. K may wish to at least discuss the possibility of modification with A. After all, K may find it advantageous to request a modification itself in the future. Should K now refuse to even consider modifying the current arrangement, it would be unlikely A would be agree to such a request.
Question 2, Answer 3
Part AIt is probably in Kellman's best interest to modify the agreement with Argon at this point for several reasons. First, even though the a merger clause purports to integrate the writing, evidence of the oral agreement concerning negotiations with Ferris-Burnham would most likely be heard by the court. Second, the condition that a settlement be reached with Ferris-Burnham would most likely be found to be a condition precedent. Third, Kellman has made a substantial investment in the relationship with Argon and it makes more sense to repair that relationship than to start over with another candidate. Last, if it proves later to be an improvident modification, Kellman could later argue that it was not a proper modification because it was extorted by Argon.
Parol Evidence Rule:
There are several factors that would tend to make the merger clause less credible. First the contract was drawn up by Argon. Argon is a larger company with most likely a superior bargaining position. Given that, Kellman may not have had any choice in whether to accept or reject the clause. Second, the clause was not specifically negotiated. It was part of the "boilerplate" of Argon's standardized contract. Being that it was part of the fine print and not specifically negotiated, courts are less likely to give the clause much weight. Third, even if the clause is given weight, courts may still allow testimony concerning the parties evidence concerning negotiations with Ferris-Burnham. It can be argued the parties did not intend the agreement to embody completely the agreement. They have a very good business reason not to include the condition that Argon be able to negotiate successfully in the contract. The parties did not want Ferris-Burnham to know about their relationship. In addition, the additional information would not contradict the writing. It would explain it or supplement the writing.
Condition Precedent:
Once evidence of the agreement concerning negotiations with Ferris-Burnham is allowed, it will become apparent that the entire agreement was based on both parties intention to proceed only if Argon was able to negotiate the matter of the patents with Ferris-Burnham. As such, Argon's inability to successfully negotiate with Ferris-Burnham will be a bar to enforcing the contract because hypothetically, it never came into being. Therefore, this is a strong argument for modifying the current agreement with Agron to change the party who will negotiate with Ferris-Burnham.
Investment in Relationship with Argon:
Another reason to modify is because Kellman has already made an investment in the relationship with Argon. It would cost more to rescind the contract (have to give up $2.5 million for one thing) and would have to find and negotiate with another party . In addition Kellman is vulnerable because Argon does have trade secrets. Even though there is a clause in the contract that Argon must not compete and keep confidential any non-patentable trade secrets, these may be very difficult clauses to enforce or if they are enforced to obtain satisfactory damages for their breach. Damages for lost profits would be highly speculative and it can be argued a court would have a tendency to under compensate instead of overcompensate for any breach.
Modification:
Lastly, it can be argued that if Kellman did enter into a modification of the agreement with Argon to change the party who should negotiate with Ferris-Burnham and change the royalty structure, the modification is invalid. If the modification later proves to be too beneficial to Argon, Kellman can argue that it modified the contract due to Argon's extortionary tactics. By threatening to tell Ferris-Burnham Kellman's trade secrets, Kellman can argue that it was persuaded to enter into the modification to ensure a continuing relationship with Argon. The most obvious reason to modify the contract with regards to the royalty structure could be that Argon threatened Kellman if it did not modify . Argon would have to show that the modification was consistent with standards of fair dealing in the trade, that is the modification was motivated by factors which would also motivate an ordinary merchant in the trade to seek a similar modification. Second, Argon would have to show the modification was due to an honest desire to compensate for commercial exigencies. Roth Steel. Here, Kellman can argue at a later date that Kellman does not meet either condition and therefore the modification is invalid. Of course, Kellman would only want to bring this up in the future if sales of the product turn out much better than is presently anticipated and doesn't feel that the royalty structure is "fair. "
Part B:
There are several reasons Kellman should be counseled to proceed filing a complaint against Agron. First, the agreement with Agron has been fully integrated and the current agreement makes no mention of paying legal fees for fighting an anti-trust suit. Furthermore, Kellman can argue that the provision for legal fees has never been discussed. Second, Agron has an obligation to use their best efforts to promote the sale of Creduline. Third, Agron has acted in an extortionary manner in the past to extract a better royalty structure and if allowed to do so now, they could believe they could get away with such behavior in the future. They are using their superior bargaining power to extract more from Kellman. ("They can only stand so much, and they can't stands no more." - Popeye)
Merger Clause:
For the same reasons Kellman should not be held to the merger clause in Part A, Agron should be held to the merger clause here. First, in the original agreement, Agron was the party who drafted the original agreement. They had reason to know the agreement contained a merger clause - they were the ones who put it in. Second, Agron being the large diversified company probably is aware that the everything in life (including prices and costs) is temporary . There should be know reason to believe that prices and costs would stay the same. If they wanted flexibility in the royalty structure, they would have allowed for it in the contract. Kellman can argue Agron assumed the risk of additional price decreases and/or cost increases.
Best Efforts:
Agron has a duty to use their best efforts to promote the sales of Creduline. Not sure what this means, however, they could not sacrifice the sales of Creduline to develop other lines of products. In addition, a good faith effort has been defined to require a company to perform under a contract as long as the survival of their company was not at stake. Agron is large diversified chemical company so that the reduction in profit from one line would not jeopardize the entire company. As long as it is profitable for Agron to sell Creduline, they must do so.
Agron has already demanded a reduction in the royalty structure once because of unforeseen circumstances, if they wanted the flexibility to modify the agreement based on future unforeseen circumstances, they should have put an option to modify in the amended agreement.
Use of Superior Bargaining Power
Courts have a tendency to frown on the type of behavior Agron has exhibited currently and in the past. Therefore, Kellman has a little more leverage in a courtroom. Agron can be seen as the best cost spreader because they are a large diversified company, they can afford less of a product on this line because they have other products where they can reap a larger profit. Agron is smaller and has fewer customers to spread the costs around.
Alternatives :
Something Kellman may want to think about is developing a relationship with another company that could market Creduline in the event the relationship with Agron sours. It counter the dependant relationship Kellman has with Argon and even out the bargaining power some.
There are very good reasons for not filing suit against Agron. Kellman is in a vulnerable position (it happens in these types of relationships). Kellman is only asking for amounts due under the contract. It is not looking to discontinue the relationship. The parties still have to work together. A suit could antagonize Agron. They could shift some of their efforts away from Creduline - not enough to be seen as acting in bad faith, but just enough to perhaps reduce the volume of Creduline sold. This retaliatory behavior in the long run could do more harm to Kellman than a decrease in the royalties.
Another alternative for Kellman is to agree to enter into negotiations for a modification. Kellman should ask for concessions on Agron's part. Kellman could ask for a termination clause in the contract (say one for 30 days notice). This may have the effect of keeping Agron's behavior more in line. If Kellman did do this, however, they should develop a relationship with alternative companies that could provide the same services in case Agron is \ the one who decides to terminate. Sometimes the only way to deal with a bully is to be one.