MBE Contracts & Sales Outline - Formation of Contracts PDF

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Themis Bar Review    15  Home / Read: MBE Contracts & Sales Outline through Formation of Contracts (Enforceability) Quick jump menu Search  MARK AS COMPLETE  BACK TO TOP Editor’s Note This outline discusses testable areas of the common law of contracts and Articles 1 and 2 of the Uniform Commercial Code (UCC). Revisions to Article 1 are included to align with the Multistate Bar Exam (MBE) testing specifications released by the National Conference of Bar Examiners (NCBE). The common law applies to contracts for services or real estate. When analyzing a contracts question on the MBE, always apply common law, unless a UCC rule that differs from common law applies. In general, Article 2 of the UCC will apply whenever the transaction at issue is a sale of goods (generally, tangible personal property). When a transaction involves both the sale of goods and the rendering of services, the predominant-purpose test applies to determine which law applies. If the sale-of- goods aspects of the transaction predominate, the UCC applies to the entire transaction, but it does not preclude the application of other law in appropriate circumstances to aspects of the transaction that do not relate to the sale of goods. If the services aspects of the transaction predominate, only the provisions of the UCC that relate primarily to the sale-of-goods aspects of the transaction apply (e.g., warranties, risk of loss, and tender of nonconforming goods). I. FORMATION OF CONTRACTS A contract is a legally enforceable agreement. A legally enforceable contract is typically created through the process of mutual assent (i.e., offer and acceptance) and consideration, provided no valid defense to contract exists. A. Mutual Assent For a contract to be formed, there must be a manifestation of mutual assent to the exchange, which occurs upon acceptance of a valid offer to contract. 1. Objective Theory of Contracts In contract law, intent is determined by the “objective theory” of contracts and not by the subjective intent or belief of a party. The objective theory is key to determining whether an offer or acceptance is valid. Whether a party intends to enter into a contract is judged by outward objective facts, as interpreted by a reasonable person. The intent of a party is what a reasonable person in the position of the other party would believe as a result of that party’s objective manifestation of intent. Therefore, when the other party knew or should have known that the party lacked the intent to enter into a contract, a contract is not formed. By contrast, the party’s mere subjective lack of intent is not sufficient to prevent the formation of a contract. A contract may be formed in “any manner sufficient to show agreement, including conduct by both parties which recognizes the existence of such a contract.” UCC § 2-204(1). When words express the intent of the parties, the contract is an express contract. When conduct indicates assent or agreement, the agreement is considered implied in fact. Example: Without paying, Party B joins a tour group that is walking through a downtown area learning about landmark buildings. The tour guide can charge B a fee for the tour because B’s conduct of joining the group implied agreement with the contract. 2. Offer and Acceptance a. Offer Definition An offer is an objective manifestation of a willingness by the offeror to enter into an agreement that creates the power of acceptance in the offeree. In other words, it is a communication that gives power to the recipient to conclude a contract by acceptance. 1) Intent A statement is an offer only if the person to whom it is communicated could reasonably interpret it as an offer. It must express the present intent of a person to be legally bound to a contract. As noted above, the primary test of whether a communication is an offer is based on the objective theory of contracts. As applied, the test is whether an individual receiving the communication would believe that by assenting to the offer an enforceable deal was created. 2) Knowledge by the offeree To have power to accept an offer, the offeree must have knowledge of it. 3) Terms For a contract to exist, the terms of the contract must be certain and definite, or the contract fails for indefiniteness. a) Common law—terms Under common law, all essential terms (i.e., the parties, subject matter, price, and quantity) must be covered in the agreement. b) UCC approach—terms The UCC allows for a more liberal contract formation. Under the UCC, a contract is formed if both parties intend to contract and there is a reasonably certain basis for giving a remedy. Typically, in contracts for the sale of goods, quantity is the key term that must be specified. As long as the parties intend to create a contract, the UCC “fills the gap” if other terms, such as the time or place for delivery, or even the price of the goods, are missing. Requirements or output contracts satisfy UCC contract formation requirements even without naming specific quantities because the UCC implies good faith as a contract term. c) Duration term In most ongoing contracts, if a duration term is not specified in the agreement, courts will imply that the contract will last for a reasonable period of time. i) Employment contracts If an employment contract does not state duration, there is a rebuttable presumption that the employment is “at will.” In an at-will employment relationship, either party can terminate the relationship at any time, without the termination being considered a breach of the contract (unless the termination is against public policy, such as when an employee is discharged for filing a discrimination claim). If an employment contract provides for “permanent employment,” most courts hold that, in the absence of a proven contrary intention, the employment is “at will,” because the duration term in the contract is considered too vague. If the offer promises “lifetime employment,” some courts hold that the agreement is for at-will employment, while others take the term literally. Many employment agreements overcome the default rule of at-will employment by express terms of the contract, by rules published by the employer (such as those in an employee handbook) or by implication (by usage or conduct). EXAM NOTE: When presented with a question involving an employment agreement that is not at will, use a traditional breach?of?contract analysis. d) Missing terms A contract may still be formed when a term is missing, if it appears that the parties intended to create a contract. The court may supply the missing term because there is a presumption that the parties intended to include a reasonable term. The UCC “fills the gap” for missing terms other than subject matter and quantity, such as the time (reasonable) or place for delivery (the seller’s place of business), the time of payment (when the buyer is to receive the goods), the assortment of goods (reasonable choice of the buyer), and even the price for the goods. If the contract omits a price or if the parties agree to set the price in the future and then fail to agree, the UCC supplies a reasonable price at the time of delivery. The contract must have an objective standard for the court to reference. UCC § 2-305. The court may infer a term or the reasonableness of a party’s conduct based on the parties’ course of performance or course of dealing or on trade usage. See § VI.B.7. Trade Usage and Course of Dealing or Performance, infra. e) Vague terms When the terms of the contract are vague, the same presumption cannot be made, because the parties have manifested an intent that cannot be determined because of the vagueness of the terms. 4) Language The offer must contain words of promise, undertaking, or commitment (as distinguished from words that merely indicate intention to sell or interest in buying). The offer must also be targeted to a number of people who could actually accept. If a return promise is requested, then the contract is a bilateral contract. If an act is requested, then the contract is a unilateral contract. (See § I.A.2.c.1) Bilateral Versus Unilateral Offer, below.) 5) Invitation to deal Offers must be distinguished from invitations to deal. Compare, for example, the question, “what is your lowest price?” with the response to that question, “we can quote you $5 per gross for immediate acceptance.” The first question is merely an inquiry, whereas the second statement is an offer. (Note that for the offeree to accept the offer, the offeree must supply the quantity term in order for the contract to meet the definiteness requirement.) Advertisements generally are considered invitations to receive offers from the public, unless associated with a stated reward. An advertisement that is sufficiently specific and limiting as to who may accept may also qualify as an offer (e.g., “Used car for sale for $5,000. First come, first served.”). EXAM NOTE: Be careful not to mistake a true offer for language that sounds like an offer but is actually just an invitation to receive offers. The more definite the statement (e.g., “I will sell you X for…”), the more likely it is to be an offer. b. Termination of offers An offer can be accepted only when it is still outstanding (i.e., before the offer is terminated). Offers can be terminated in the following ways. 1) Lapse of time in offer If the offer specifies a date on which the offer terminates, then the time fixed by the offer controls. If the offer states that it will terminate after a specified number of days, the time generally starts to run from the time the offer is received, not sent, unless the offer indicates otherwise. If the offeree is aware (or should have been aware) that there is a delay in the transmittal of the offer, the offer expires when it would have expired had there been no delay. If the offer does not set a time limit for acceptance, the power of acceptance terminates at the end of a reasonable period of time. What is reasonable is a question of fact and depends on a variety of factors, including the nature of the contract, the purpose and course of dealing between the parties, and trade usage. For an offer received by mail, an acceptance that is sent by midnight of the day of receipt generally has been made within a reasonable period of time. Unless otherwise agreed, if the parties bargain in person or via telephone, the time for acceptance does not ordinarily extend beyond the end of the conversation. Restatement (Second) of Contracts § 41. 2) Death or mental incapacity An offer terminates upon the death or mental incapacity of the offeror or offeree, even if the offeree does not learn of the offeror’s death or mental incapacity until after the offeree has dispatched what is believed to be an acceptance. An exception exists for an offer that is an option, which does not terminate upon death or mental incapacity because consideration was paid to keep the offer open during the option period, and the offer is therefore made irrevocable during that period. Compare accepted offer: If an offer has been accepted, death of the offeror does not automatically terminate the contract. The contract may be enforceable unless there is some reason, such as impracticability, that justifies discharge of the contractual obligation. 3) Destruction or illegality An offer involving subject matter that is destroyed is terminated. Similarly, an offer that becomes illegal is terminated. Restatement (Second) of Contracts § 36, cmt. c. 4) Revocation Definition Revocation is the act of withdrawing an offer during contract negotiations. In general, an offer can be revoked by the offeror at any time prior to acceptance. An offer is revoked when the offeror makes a manifestation of an intent not to enter into the proposed contract. Restatement (Second) of Contracts § 42. A revocation may be made in any reasonable manner and by any reasonable means, and it is not effective until communicated. A revocation sent by mail is not effective until received. Example: On day 1, Party A mails an offer to B. On day 2, A mails a revocation to B. If B receives the offer and accepts before receiving the revocation, a contract is formed. At common law, a written revocation, rejection, or acceptance is received when it comes into the possession of the person addressed or the person authorized to receive it on his behalf, or when it is deposited in some place authorized by the recipient for deposit for this or similar communications. Restatement (Second) of Contracts § 68. Under the UCC, a person receives notice when the notice: i) Comes to that person’s attention; or ii) Is duly delivered in a reasonable form at the place of business or where held out as the place for receipt of such communications. Receipt by an organization occurs at the time it is brought to the attention of the individual conducting the transaction or at the time it would have been brought to that individual’s attention were due diligence exercised by the organization. UCC § 1-202. If the offeree acquires reliable information that the offeror has taken definite action inconsistent with the offer, the offer is automatically revoked (i.e., a constructive revocation occurs). The offeror’s power to revoke an offer is limited by the following items. a) Option—promise not to revoke Definition An option is an independent promise to keep an offer open for a specified period of time. Such a promise limits the offeror’s power to revoke the offer until after the period has expired, while also preserving the offeree’s power to accept. If the option is a promise not to revoke an offer to enter a new contract, the offeree must generally give separate consideration for the option to be enforceable. If the option is within an existing contract, no separate consideration is required. While the option contract is in effect, the offeree’s power of acceptance cannot be terminated by rejection, counteroffer, revocation, or by death or incapacity of the offeror, unless the requirements are met for the discharge of a contractual duty. Restatement (Second) of Contracts § 37. b) UCC firm-offer rule Under the UCC, an offer to buy or sell goods is irrevocable if: i) The offeror is a merchant; ii) There is an assurance that the offer is to remain open; and iii) The assurance is contained in a signed writing from the offeror. No consideration by the offeree is needed to keep the offer open under the UCC firm-offer rule. UCC § 2-205. i) Definition—merchant For purposes of this rule, a merchant includes not only a person who regularly deals in the type of goods involved in the transaction or otherwise by his occupation holds himself out as having knowledge or skill peculiar to the practices or goods involved in the transaction, but also any businessperson when the transaction is of a commercial nature. UCC § 2-104(1) cmt. 2. ii) Time period If the time period during which the option is to be held open is not stated, a reasonable term is implied. However, irrevocability cannot exceed three months, regardless of whether a time period is stated or implied, unless the offeree gives consideration to validate it beyond the three-month period. iii) Signed writing The primary purpose of the signed writing requirement is to ensure that the merchant deliberately makes a current firm offer binding. Therefore, a full handwritten signature is not always required, such as when merely initialing the relevant clause is appropriate under the circumstances, or when the offeror handwrites on letterhead “confirming” that a firm offer was already made. UCC § 2-205, cmt. 2. A firm offer in a form prepared by the offeree must be separately signed by the offeror to protect against inadvertent signing. UCC § 2-205, cmt. 4. EXAM NOTE: Provisions of the UCC requiring a signed writing may be satisfied by an electronic record and electronic signature. c) Promissory estoppel (detrimental reliance) When the offeree reasonably and detrimentally relies on the offeror’s promise prior to acceptance, the doctrine of promissory estoppel may make the offer irrevocable. It must have been reasonably foreseeable that such detrimental reliance would occur in order to imply the existence of an option contract. The offeror is liable to the extent necessary to avoid injustice, which may result in holding the offeror to the offer, reimbursement of the costs incurred by the offeree, or restitution of the benefits conferred. (See § I.C.4. Promissory Estoppel, infra.) d) Partial performance If the offer is for a unilateral contract, the offeror cannot revoke the offer once the offeree has begun performance. Once performance has begun, the offeree will have a reasonable amount of time to complete performance but cannot be required to complete the performance. A unilateral contract is not formed until performance is complete. Restatement (Second) of Contracts § 45. Commencement of performance of a bilateral contract operates as a promise to render complete performance. Restatement (Second) of Contracts § 62. Whether the contract is unilateral or bilateral, the offeree must have had knowledge of the offer when she began performance. 5) Revocation of general offers A “general offer” is an offer made to a large number of people, generally through an advertisement. A general offer can be revoked only by notice that is given at least the same level of publicity as the offer. So long as the appropriate level of publicity is met, the revocation will be effective even if a potential offeree does not learn of the revocation and acts in reliance on the offer. Restatement (Second) of Contracts § 46. Note that if a person has actual knowledge of the intent to revoke but did not see the notice, then the revocation will be effective as to such person. 6) Rejection by offeree An offer is terminated by rejection. In other words, the offeree clearly conveys to the offeror that the offeree no longer intends to accept the offer. A rejection is usually effective upon receipt. An offeree cannot accept an offer once it has been terminated. A counteroffer acts as a rejection of the original offer and creates a new offer. An exception exists for an option holder, who has the right to make counteroffers during the option period without terminating the original offer. EXAM NOTE: Remember that a counteroffer is both a rejection and a new offer. Examine the offeree’s statement closely. It may be a rejection, but it may also be only an inquiry (e.g., “Is that a 2005 model car?”) or merely indecision (e.g., “I’ll keep your offer under advisement.”). In either case, the offer remains open. 7) Revival of offer A terminated offer may be revived by the offeror. As with any open offer, the revived offer can be accepted by the offeree. Example: Party A offers to paint B’s house for $500. B rejects the offer. A states that the offer remains open. B can change B’s mind and accept the revived offer. c. Acceptance Definition An acceptance is an objective manifestation by the offeree to be bound by the terms of the offer. Only a party to whom an offer is extended may accept or, if the offer is extended to a class, a party who is a member of the class may accept. An offeree must know of the offer upon acceptance for it to be valid. In addition, the offeree must communicate the acceptance to the offeror. 1) Bilateral versus unilateral offer The offeror can detail the manner of proper acceptance. Definition A bilateral contract is one in which a promise by one party is exchanged for a promise by the other. The exchange of promises is enough to render both promises enforceable. An offer requiring a promise to accept can be accepted either with a return promise or by starting performance. Commencement of performance of a bilateral contract operates as a promise to render complete performance. Restatement (Second) of Contracts § 62. Definition A unilateral contract is one in which one party promises to do something in return for an act of the other party (e.g., a monetary reward for finding a lost dog). Unlike in a bilateral contract, in a unilateral contract, the offeree’s promise to perform is insufficient to constitute acceptance. Acceptance of an offer for a unilateral contract requires complete performance. Once performance has begun, the offer is irrevocable for a reasonable period of time to allow for complete performance unless there is a manifestation of a contrary intent. However, the offeree is not bound to complete performance. In addition, while the offeror may terminate the offer before the offeree begins to perform, expenses incurred by the offeree in preparing to perform may be recoverable as reliance damages. Restatement (Second) of Contracts § 45. EXAM NOTE: The offeree of a unilateral contract can accept only an offer that the offeree is aware of. In other words, if the offeree does not become aware of the offer until after acting, then the offeree’s acts do not constitute acceptance. When there is doubt as to whether an offer may be accepted by a promise to perform or by performance, the offeree may accept the offer by either. Restatement (Second) of Contracts § 32. 2) Means of acceptance The offeror is master of the offer and can dictate the manner and means by which an offer may be accepted. For example, the offeror can require the offeree to accept in writing or to accept by means of a phone call. Unless the offeror specifically requires the offeree to accept in a particular manner or by using a particular means, the offeree can accept in any reasonable manner and by any reasonable means. UCC § 2-206(1)(a). A means of acceptance is reasonable if it was used by the offeror, used customarily in the industry, or used between the parties in prior transactions. Restatement (Second) of Contracts § 65. Even if the acceptance is by unauthorized means, it may be effective if the offeror receives the acceptance while the offer is still open. Restatement (Second) of Contracts § 67. a) Silence Generally, silence does not operate as an acceptance of an offer, even if the offer states that silence qualifies as acceptance (or, more likely, implied acceptance), unless: i) The offeree has reason to believe that the offer could be accepted by silence, and the offeree was silent with the intent to accept the offer by silence; or ii) Because of previous dealings or patterns of behavior, it is reasonable to believe that the offeree must notify the offeror if the offeree intends not to accept. b) Shipment of goods If the buyer requests that the goods be shipped, then the buyer’s request will be construed as inviting acceptance by the seller either by a promise to ship or by prompt shipment of conforming or nonconforming goods. If the seller ships nonconforming goods, then the shipment is both an acceptance of the offer and a breach of the contract. The seller is then liable for any damage caused to the buyer as a result of the breach. If, however, the seller “seasonably” notifies the buyer that the nonconforming goods are tendered as an accommodation, then no acceptance has occurred, and no contract is formed. The accommodation is deemed a counteroffer, and the buyer may then either accept (thereby forming a contract) or reject (no contract formed). 3) Mailbox rule An acceptance that is mailed within the allotted response time is effective when sent (not upon receipt), unless the offer provides otherwise. The mailing must be properly addressed and include correct postage. EXAM NOTE: Keep in mind that the mailbox rule applies only to acceptance. Therefore, the rule almost exclusively applies to bilateral contracts (when there is one promise in exchange for another promise) because unilateral contracts require action as acceptance. a) Rejection following acceptance If the offeree sends an acceptance and later sends a communication rejecting the offer, then the acceptance will generally control even if the offeror receives the rejection first. If, however, the offeror receives the rejection first and detrimentally relies on the rejection, then the offeree will be estopped from enforcing the contract. b) Acceptance following rejection If a communication is sent rejecting the offer, and a later communication is sent accepting the contract, then the mailbox rule will not apply, and the first one to be received by the offeror will prevail. An acceptance or rejection is received when the writing comes into the possession of the offeror or the offeror’s agent, or when it is deposited in the offeror’s mailbox. The offeror need not actually read the communication that is received first for it to prevail. c) Revocations effective upon receipt Offers revoked by the offeror are effective upon receipt. d) Options and other irrevocable offers The mailbox rule does not apply to an option contract, which requires that the acceptance be received by the offeror before the offer expires, or to offers that specify that acceptance must be received by a certain date. Restatement (Second) of Contracts § 63(b) cmt. f. e) Medium If the acceptance is via an “instantaneous two-way communication,” such as telephone or traceable fax, it is treated as if the parties were in each other’s presence. Restatement (Second) of Contracts § 64. 4) Notice a) Unilateral contract In a unilateral contract, an offeree is not required to give notice after performance is complete, unless the offeree has reason to know that the offeror would not learn of performance within a reasonable time, or the offer requires notice. No notification is required for an effective acceptance when the offer invites the offeree to accept by rendering performance unless the offer requests such notification. Restatement (Second) of Contracts § 54(1). If an offeree renders performance and has reason to know that the offeror lacks adequate means of learning of such performance, the offeror’s duty is discharged unless: i) The offeree exercises reasonable diligence to notify the offeror of acceptance; ii) The offeror learns of performance within a reasonable time; or iii) The offer specifies that notification of acceptance is not required. Restatement (Second) of Contracts § 54(2). b) Bilateral contract An offeree of a bilateral contract must give notice of acceptance. Under the mailbox rule, because acceptance becomes valid when sent, a properly addressed letter sent by the offeree operates as an acceptance when mailed, even though the offeror has not yet received the notice. Under the UCC, notice is required within a reasonable time if acceptance is made by beginning performance and failure to do so will result in a lapse of the offer. UCC § 2-206(2). d. Effect of additional or different terms 1) Common law—mirror-image rule The acceptance must mirror the terms of the offer. Any change to the terms of the offer, or the addition of another term not found in the offer, acts as a rejection of the original offer and as a new counteroffer. Mere suggestions or inquiries, including requests for clarification or statements of intent, made in a response by the offeree do not constitute a counteroffer. A conditional acceptance terminates the offer and acts as a new offer from the original offeree. 2) UCC rule—acceptance contains additional or different terms The UCC does not follow the mirror-image rule. Additional or different terms included in an acceptance of an offer do not automatically constitute a rejection of the original offer. Generally, for a sale of goods, an acceptance that contains additional or different terms with respect to the terms in the offer is nevertheless treated as an acceptance rather than a rejection and a counteroffer. An exception exists when the acceptance is expressly conditioned on assent to the additional or different terms, in which case the acceptance is a counteroffer. UCC § 2-207(1). Whether the additional or different terms are treated as part of the contract depends on whether the parties are merchants. a) One or both parties are not merchants When the contract is for the sale of goods between nonmerchants or between a merchant and a nonmerchant, a definite and seasonable expression of acceptance or written confirmation that is sent within a reasonable time operates as an acceptance of the original offer. This is true even if it states terms that are additional to or different from the offer unless the acceptance is made expressly conditional on the offeror’s consent to the additional or different terms. The additional terms are treated as a proposal for addition to the contract that must be separately accepted by the offeror to become a part of the contract. UCC § 2-207(2). b) Both parties are merchants—battle of the forms EXAM NOTE: The MBE has consistently tested the situation in which both parties to the contract are merchants. In this situation, remember that a contract exists under the terms of the acceptance, unless: · The terms materially alter the agreement; · The offer expressly limits the terms; or · The offeror objects to the new terms within a reasonable time. When both parties are merchants, the parties often use sales forms that might not be designed for the particular sale in question. As a consequence, the acceptance often contains different and additional terms. In this “battle of the forms” over whose terms will form the basis of the contract, the rules may vary depending on whether the terms are additional terms or different terms. i) Acceptance includes additional terms An additional term in the acceptance is automatically included in the contract when both parties are merchants, unless: i) The term materially alters the original contract; ii) The offer expressly limits acceptance to the terms of the offer; or iii) The offeror has already objected to the additional terms, or objects within a reasonable time after notice of them was received. If any one of these three exceptions is met, the term will not become part of the contract, and the offeror’s original terms control. UCC § 2-207(2). Materially Alter: A term that results in surprise or hardship if incorporated without the express awareness by the other party “materially alters” the original contract. Examples of terms found to have materially altered the original contract include a warranty disclaimer, a clause that flies in the face of trade usage with regard to quality, a requirement that complaints be made in an unreasonably short time period, and other terms that surprise or create hardship without express awareness by the other party. Terms that usually do not materially alter the contract include fixing reasonable times for bringing a complaint, setting reasonable interest for overdue invoices, and reasonably limiting remedies. UCC § 2-207 cmts. 4,5. ii) Acceptance includes different terms The courts in different jurisdictions disagree as to the result when different terms are included in the merchant offeree’s acceptance. A few jurisdictions treat different terms the same as additional terms and apply the rule described above. However, most jurisdictions apply the “knock-out” rule, under which different terms in the offer and acceptance nullify each other and are “knocked out” of the contract. When gaps are created after applying the knock-out rule, the court uses Article 2’s gap-filling provisions to patch the holes. (See § I.A.2.a.3).d) Missing Terms, above.) c) UCC rule—acceptance based on conduct If the offer and purported acceptance differ to such a degree that there is no contract, but the parties have begun to perform anyway (i.e., demonstrated conduct that recognizes the existence of a contract), then Article 2 provides that there will be a contract, and its terms will consist of those terms on which the writings of the parties agree, together with any supplementary terms filled in by the provisions of the UCC. UCC § 2-207(3). e. Auction contracts The UCC has special rules for auction sales. 1) Goods auctioned in lots If goods in an auction sale are offered in lots, each lot represents a separate sale. 2) Completion of a sale An auction sale is complete when the auctioneer announces its end, such as by the fall of the auctioneer’s hammer or in any other customary way. When a bid is made contemporaneously with the falling of the hammer, the auctioneer has discretion to treat the bid as continuing the bidding process or declare the sale completed at the fall of the hammer. 3) Reserve and no-reserve auctions In a reserve auction, the auctioneer may withdraw the goods any time before she announces completion of the sale. An auction is with reserve unless specifically announced as a no-reserve auction. In a no-reserve auction, after the auctioneer calls for bids on the goods, the goods cannot be withdrawn unless no bid is received within a reasonable time. In either type of auction, a bidder may retract their bid until the auctioneer announces the completion of the sale. A retraction, however, does not revive any earlier bids. 4) When the seller bids When an auctioneer knowingly accepts a bid by the seller or on the seller’s behalf, or procures such a bid to drive up the price of the goods, the winning bidder may avoid the sale or has the option to take the goods at the price of the last good-faith bid prior to the end of the auction. There are two exceptions to this rule: i) A seller may bid at a forced sale; or ii) A seller may bid after specifically giving notice of reserving the right to bid. Debtors and foreclosing creditors are both treated as “sellers” under the forced-sale exception to auction sales. B. Consideration Rule If there is a valid offer and acceptance that creates an agreement, the agreement is legally enforceable so long as there is consideration. Consideration is a benefit (e.g., act, money, return promise) bargained for and received by the promisor from a promise. 1. Bargain and Exchange Valuable consideration is evidenced by a bargained-for change in the legal position between the parties. Most courts conclude that consideration exists if there is a detriment to the promisee, irrespective of the benefit to the promisor. A minority of courts look to either a detriment or a benefit, not requiring both. The Second Restatement asks only whether there was a bargained-for exchange. Restatement (Second) of Contracts § 71. a. Legal detriment and bargained-for exchange For the legal detriment to constitute sufficient consideration, it must be bargained for in exchange for the promise. The promise must induce the detriment, and the detriment must induce the promise (“mutuality of consideration”). Consideration can take the form of: i) A return promise to do something; ii) A return promise to refrain from doing something legally permitted; iii) The actual performance of some act; or iv) Refraining from doing some act. b. Gift distinguished A promise to make a gift does not involve bargained-for consideration and is therefore unenforceable. Example 1: A promise by Party A to give Party B $1,000 when B turns 21 years old is not enforceable because the act of attaining the age of 21 is not bargained for and is thus not sufficient consideration. There also can be no reliance on the promise (B will turn 21 years of age regardless of A’s promise), so promissory estoppel does not apply. Example 2: Alternatively, if A offers B $1,000 to quit smoking, it is assumed that A is bargaining for B’s act and that B would rely on the promise of the payment when B quit smoking. EXAM NOTE: The test to distinguish a gift from valid consideration is whether the offeree could have reasonably believed that the intent of the offeror was to induce the action. If yes, there is consideration, and the promise is enforceable. A party’s promise to make a gift is enforceable under the doctrine of promissory estoppel if the promisor/donor knows that the promise will induce substantial reliance by the promisee, and the failure to enforce the promise will cause substantial injustice. (See § I.C.4. Promissory Estoppel, infra.) 2. Adequacy of Consideration The basic concept of legal detriment is that there must be something of substance, either an act or a promise, which is given in exchange for the promise that is to be enforced. In general, a party cannot challenge a contract on the grounds that the consideration is inadequate. A difference in economic value between the items exchanged is not grounds for finding that a contract did not exist due to inadequate consideration. a. Subjective value The benefit to the promisor does not need to have an economic value. Regardless of the objective value of an item, if the promisor wants it, the giving of it will constitute adequate consideration. b. Preexisting-duty rule 1) Common law At common law, a promise to perform a preexisting legal duty does not qualify as consideration because the promisor is already bound to perform (i.e., there is no legal detriment). Note that if the promisor gives something in addition to what is already owed (however small) or varies the preexisting duty in some way (however slight), most courts find that consideration exists. Restatement (Second) of Contracts § 73. Example 1: A borrower knows that he owes a lender $1,000 today. The borrower promises to repay the loan if the lender promises to lend the borrower an additional $100. The borrower has not provided consideration for the lender’s promise. Example 2: A borrower knows that he owes a lender $1,000 tomorrow. The borrower offers to pay the lender $900 today if the lender agrees to forgo the additional $100. The lender accepts the offer. The borrower has provided the lender with consideration for the lender’s promise. 2) Exception for a third party There is an exception to the preexisting-duty rule when a third-party’s promise is exchanged for the promise to perform an act that the promisor is already contractually obligated to perform. Under the exception, the party’s promise to the third party is sufficient consideration. Restatement (Second) of Contracts § 73. Example: Party C contracts with P for P to install plumbing in a house being built by C for H. C subsequently becomes insolvent and walks away from the project. H contracts with P and promises to pay P the same amount P would have received from C if P installs the plumbing. P’s completion of the job constitutes consideration for the promise by H, even though P was already contractually obligated to C to do the work. c. Past consideration Under the common law, something given in the past is typically not adequate consideration because it could not have been bargained for, nor could it have been done in reliance upon a promise. Example: Party A is drowning, and B dives in and saves A. Grateful to have been saved, A promises B $500. Under the common-law approach, there is no consideration, and the promise is therefore unenforceable. It is based on a mere moral obligation arising out of past conduct. There is a modern trend, adopted by the Second Restatement, however, toward enforcing some such promises under material-benefit rule (see § I.C.3. Promise to Pay Benefits Received—Material-Benefit Rule, infra). d. Executory contract Definition An executory contract is a contract whose terms are to be performed by both parties at a later date or in an ongoing manner. For example, a rental agreement that calls for monthly payments over a period of time cannot be performed all at once. The renter is required to make monthly payments while the owner is required to allow possession each month. Similarly, a construction contract that requires payments upon reaching specified milestones cannot be performed all at once and is therefore considered “executory.” In such agreements, the exchange of promises is adequate consideration. Note, however, that an obligation to make a one-time payment in the future typically does not make a contract executory. e. Modification EXAM NOTE: The MBE frequently tests the different common-law and UCC rules regarding contract modification. At common law, modifications require consideration. Under the UCC, they require only good faith. 1) Common law At common law, modification of an existing contract must be supported by consideration. Agreements to modify a contract may still be enforced if: i) There is a rescission of the existing contract by tearing it up or by some other outward sign, and then the entering into of a new contract, whereby one of the parties must perform more than she was to perform under the original contract; ii) There are unanticipated difficulties, and one of the parties agrees to compensate the other when the difficulties arise if the modification is fair and equitable in light of those difficulties; or iii) There are new obligations on both sides. The modification must rest in circumstances not anticipated as part of the context in which the contract was made but need not have been completely unforeseeable. When such a reason is present, the relative financial strength of the parties, the formality with which the modification is made, the extent to which it is performed or relied on and other circumstances may be relevant. 2) UCC Unlike the common law, under Article 2, no consideration is necessary to modify a contract; however, good faith is required. Thus, if one party is attempting to extort a modification, it will be ineffective under the UCC. Good faith requires honesty in fact and fair dealing in accordance with reasonable commercial standards. UCC § 1-201(20). The definition of “good faith” no longer limits the fair dealing prong of the rule to merchants. The same definition of good faith applies to all parties, both merchants and nonmerchants alike. Example: If a party demands an increase in price because the other party has no choice but to agree, the courts will invalidate such a bad- faith modification. a) Installment contracts Generally, a party benefited by a condition under a contract may orally waive that condition without new consideration. However, in installment contracts, the waiver may be retracted by providing the other party with reasonable notice that strict performance is required. The retraction is allowed unless it would be unjust because of a material change of position by the other party in reliance on the waiver. f. Accord and satisfaction Definition An accord and satisfaction is the tender and acceptance of an alternate performance that discharges a contractual obligation. 1) Accord Under an accord agreement, a party to a contract agrees to accept a performance from the other party that differs from the performance that was promised in the existing contract, in satisfaction of the other party’s existing duty. Restatement (Second) of Contracts § 281. a) Dispute of a monetary claim When a party agrees to accept a lesser amount in full satisfaction of its monetary claim, there must be consideration or a consideration substitute for the party’s promise to accept the lesser amount. For example, consideration can exist if the other party honestly disputes the claim or agrees to forgo an asserted defense (see § j. Settlement of a Legal Claim, below), or if the payment is of a different type than called for under the original contract (see § b.1) Common Law, above). Restatement (Second) of Contracts § 281, cmt. d. Example 1: On Monday, a contractor completes construction of a garage for a homeowner. Under the terms of the contract, the homeowner owes the contractor $40,000 in cash. The homeowner offers to deliver a sports car worth $35,000 to the contractor on Friday in satisfaction of his contractual obligation. The contractor agrees. The contractor’s acceptance of the homeowner’s offer creates an accord. Because the homeowner is offering payment in a different form than that called for under the contract (i.e., a car instead of cash), it does not matter that the car is worth less than $40,000. 2) Satisfaction A “satisfaction” is the performance of the accord agreement; it will discharge both the original contract and the accord contract. However, there is no satisfaction until performance, and the original contract is not discharged until satisfaction is complete. Therefore, if an accord is breached by the party who has promised a different performance, the other party can sue either on the original contract or under the accord agreement. Example 2: Assume the same facts as those in Example 1, except that on Wednesday, the contractor changes his mind and seeks to collect the $40,000 from the homeowner. The contractor cannot enforce the original contract. Although the debt is not yet satisfied, because there was an accord regarding the sports car, the homeowner’s obligation under the original contract is suspended until Friday. Example 3: Assume the same facts as those in Example 1, except that on Friday, the homeowner delivers the sports car to the contractor. This constitutes satisfaction. The contractor cannot enforce the contractual obligation of the homeowner to pay $40,000 in cash. Example 4: Assume the same facts as those in Example 1, except that on Friday, the homeowner fails to deliver the sports car to the contractor. At that point, the contractor may seek to enforce the homeowner’s original promise to pay $40,000 in cash or the homeowner’s promise to deliver the sports car to the contractor. Note: Compare accord with a substituted contract, which is a second contract that is itself accepted by a party in satisfaction of the other party’s existing obligation, immediately discharging the original obligation and limiting the remedy for breach to the terms of the second contract. Whether an agreement is an accord or a substituted contract turns on how formal the agreement is; the less formal, the more likely it is an accord. 3) Use of a negotiable instrument If a claim is unliquidated or otherwise subject to dispute, it can be discharged if: i) The person against whom the claim is asserted in good faith tenders a negotiable instrument (e.g., a check) that is accompanied by a conspicuous statement indicating that the instrument was tendered as full satisfaction of the claim (e.g., “Payment in full”); and ii) The claimant obtains payment of the instrument. The addition of a restriction by the claimant to an endorsement of the check, such as “under protest,” does not operate to preserve the claimant’s right to seek additional compensation. UCC § 3-311(a), (b). When the claimant is an organization, the discharge is not effective if the instrument is not tendered to a person, place, or office designated by the organization. If no such designation is made, or if the claimant is not an organization, the discharge is not effective if the claimant returns the payment within 90 days. However, regardless of the type of claimant, these exceptions do not apply and the claim is discharged when the claimant, or the claimant’s agent who has direct responsibility with respect to the disputed obligation, knew, within a reasonable time before collection was initiated, that the instrument was tendered in full satisfaction of the claim. The burden to establish such knowledge is on party seeking discharge. UCC § 3- 311(c). g. Illusory promises An illusory promise is one that essentially pledges nothing because it is vague or because the promisor can choose whether to honor it. Such a promise is not legally binding. Example: Party B promises, “I will give you $100, at my option.” B’s promise is an illusory promise. A promise that is based on the occurrence of a condition within the control of the promisor may be illusory, but courts often find that the promisor has also promised to use best efforts to bring about the condition. Restatement (Second) of Contracts § 76 cmt. d. Similarly, a promise to purchase goods upon the promisor’s satisfaction with the goods is not illusory because the promisor is required to act in good faith. UCC § 1-304. h. Voidable and unenforceable promises A promise that is voidable or unenforceable by a rule of law (e.g., infancy) can nevertheless constitute consideration. Restatement (Second) of Contracts § 78. Example: A car dealer promises to sell a used car to a minor for $5,000. The car dealer may not escape selling the car to the minor for $5,000 on the grounds that, because the minor’s promise is voidable, the car dealer did not receive consideration for its promise. i. Requirements and output contracts Definitions A requirements contract is a contract under which a buyer agrees to buy all that the buyer will require of a product from the other party. An output contract is a contract under which a seller agrees to sell all that the seller manufactures of a product to the buyer. There is consideration in these agreements because the promisor suffers a legal detriment. The fact that the party may go out of business does not render the promise illusory. Because a covenant of good faith and fair dealing is implied in all contracts (common law and UCC), any quantities under such a contract may not be unreasonably disproportionate to any stated estimates, or if no estimate is stated, to any normal or otherwise comparable prior requirements or output. j. Settlement of a legal claim A promise not to assert or a release of a claim or defense that proves to be invalid does not constitute consideration, unless the claim or defense is in fact doubtful due to uncertainty of facts or law, or the party promising not to assert or releasing the claim or defense believes in good faith that it may be fairly determined to be valid. Restatement (Second) of Contracts § 74(a). Example 1: A borrower knows that she owes a lender $1,000. The borrower offers to pay the lender $900 in exchange for the lender’s promise not to seek the remaining $100. The lender accepts the offer and makes the promise. The borrower pays the lender $900. The lender may nevertheless seek the remaining $100 from the borrower because there was no uncertainty as to the validity of the debt or the amount owed. As such, there was no consideration for the lender’s promise. Example 2: Due to an ambiguity in the wording of a contract, an employee contends that she is owed a commission of $500. The employer contends that the employee is owed nothing. The employer promises to pay the employee $250 in exchange for the employee’s promise to forgo her claim of $500. The employee’s promise constitutes consideration for the employer’s promise to pay $250. If the employer fails to pay the employee $250, the employee can enforce the employer’s promise. C. Promises Binding Without Consideration There are a number of circumstances in which a promise will be enforceable despite the fact that it is not supported by consideration. 1. Promise to Pay a Debt Barred by the Statute of Limitations or Bankruptcy A new promise to pay a debt after the statute of limitations has run is enforceable without any new consideration. When the new promise is an express promise, most states require that the new promise be in writing and signed by the debtor. In addition, a new promise may be implied when the obligor: i) Voluntarily transfers of something of value (e.g., money, negotiable note) to the obligee as interest on, part payment of, or collateral security for the prior debt; ii) Voluntarily acknowledges to the obligee the present existence of the prior indebtedness; or iii) States to the obligee that the statute of limitations will not be pleaded as a defense. A new promise made to pay a debt discharged in bankruptcy is enforceable without any new consideration. While there must be an express promise to pay rather than a mere acknowledgment or partial payment of the discharged debt, the new promise need not be in writing. Because it is the new promise that is enforceable and not the prior debt obligation itself, the amount to which the obligee is entitled may be less than the prior debt obligation. 2. Promise to Perform a Voidable Duty A new promise to perform a duty that is voidable will be enforceable despite the absence of consideration, provided that the new promise does not suffer from an infirmity that would make it, in turn, voidable. Example: Party X, who is 15 years old, enters into a contract with Y that is voidable because of X’s infancy. Upon reaching the age of majority, X promises to perform the contract. Such promise will be enforceable without any new consideration. Note that if X reaffirmed the promise before reaching the age of majority, such promise would be voidable (because of X’s continued infancy). 3. Promise to Pay Benefits Received—Material-Benefit Rule Under the material-benefit rule, when a party performs an unrequested service for another party that constitutes a material benefit, the modern trend permits the performing party to enforce a promise of payment made by the other party after the service is rendered, even though, at common law, such a promise would be unenforceable due to lack of consideration. This rule is not enforced when the performing party rendered the services without the expectation of compensation (e.g., as a gift). In addition, the promise is enforced only to the extent necessary to prevent injustice, and it is not enforceable to the extent that the value of the promise is disproportionate to the benefit received, or the promisor has not been unjustly enriched. Example: P sees D’s horse running free and knows that D is out of town. While awaiting D’s return, P feeds and houses the horse for two weeks at a cost of $30. When D returns, D thanks P and promises to pay P $50 at the end of the month. At common law, this promise is unenforceable due to lack of consideration. Under the material-benefit rule, the promise is not enforceable to the extent that it is disproportionate to the benefit received. Thus, P’s promise can be enforced to the extent of $30. Note that, apart from a contract remedy, the provider of services may also be able to recover under a quasi-contract theory (see § I.G.2. Implied-in-Law Contracts (Quasi-Contracts), infra). Requested services distinguished: If one party requests another party to perform a service but does not indicate a price, and the service is performed, this generally creates an “implied-in-fact” contract. The party who performed the requested service is generally entitled to recover the reasonable value of that party’s services in a breach-of-contract action against the party who enjoyed the benefit of the services refused to pay. An exception applies, however, when the services were rendered without the expectation of payment. 4. Promissory Estoppel Promissory estoppel is referred to as a consideration “substitute.” The doctrine of promissory estoppel (detrimental reliance) can be used under certain circumstances to enforce a promise that is not supported by consideration. EXAM NOTE: Always consider whether there is a valid contract before considering promissory estoppel as the correct answer choice.  a. Requirements A promise is binding if: i) The promisor should reasonably expect it to induce action or forbearance on the part of the promisee or a third person; ii) The promise does induce such action or forbearance; and iii) Injustice can be avoided only by enforcement of the promise. In general, the promisee must actually rely on the promise, and such reliance must have been reasonably foreseeable to the promisor. See below, however, for an exception regarding charitable subscriptions. The remedy may be limited or adjusted as justice requires. Generally, this results in the award of reliance damages rather than expectation damages. Example: Party X, who is very wealthy, knows that her nephew Y is poor but wants to go to college. As a generous aunt, X promises to pay Y $100,000 when Y gets his diploma. Y chooses a college and takes out $50,000 in loans to cover all tuition and expenses. In April of his senior year, Y is told by X that she will not pay anything. In May, Y gets his degree and sues X. While there is no consideration for X’s promise, the promise is still enforceable under the doctrine of promissory estoppel. Party X reasonably should have expected that Y would rely on her promise. Given Y did in fact rely by going to college, it would seem unjust not to enforce the promise. Note, though, that Y’s remedy can be limited “as justice requires.” The proper amount would likely be $50,000 (the amount of Y’s out?of?pocket expenses in reliance), not the $100,000 that X originally promised. b. Exception to the reliance requirement for charitable subscriptions Courts often apply the doctrine of promissory estoppel to enforce promises to charitable institutions. A charitable subscription (i.e., a written promise) is enforceable under the doctrine of promissory estoppel without proof that the charity relied on the promise. Restatement (Second) of Contracts § 90(2). Example: B promises in writing to give a university a $10,000 donation. Under the Second Restatement, the university may enforce the promise under the doctrine of promissory estoppel, even though the university does not establish that it relied to its detriment on B’s promise. c. Construction contracts and promissory estoppel In the construction industry, it would be unjust to permit a subcontractor to revoke a bid after inducing justifiable and detrimental reliance in the general contractor. Thus, an agreement not to revoke a sub-bid offer can be enforceable under the theory of promissory estoppel. Because the sub-bid is only an outstanding offer, the general contractor is not bound to accept it upon becoming the successful bidder for the general contract. A general contractor can enter into a subcontract with another subcontractor for a lower price. D. Enforceability A contract may be unenforceable based upon a defense to formation or a defense to enforcement. Proof of the defense may render the contract void or voidable. 1. Void Contracts A void contract results in the entire transaction being regarded as a nullity, as if no contract existed between the parties. 2. Voidable Contracts A voidable contract operates as a valid contract, unless and until one of the parties takes steps to avoid it. 3. Unenforceable Contracts An unenforceable contract is a valid contract that cannot be enforced if one of the parties refuses to carry out its terms. EXAM NOTE: Remember that a void contract cannot be enforced, but a party may opt to avoid a voidable contract. E. Defenses to Formation Rule A person can defend a breach-of-contract action by showing that there was no “meeting of the minds” due to any of the following: Mistake Misunderstanding Misrepresentation, nondisclosure, or fraud Undue influence Duress Lack of capacity to contract 1. Mistake Definition A mistake is a belief that is not in accord with the facts as to a basic assumption on which the contract was made that materially affects performance. Note that the mistake must be with regard to a belief about an existing fact and not with regard to something that will happen in the future. Risks with regard to changing facts are governed by the doctrines of impracticability and frustration of purpose. a. Mutual mistake Mutual mistake occurs when both parties are mistaken as to an essential element of the contract. In such a situation, the contract may be voidable by the adversely affected party upon proof of the following: i) Mistake of fact existing at the time the contract was formed; ii) The mistake relates to a basic assumption of the contract; iii) The mistake has a material impact on the transaction; and iv) The adversely affected party did not assume the risk of the mistake. Example: Rescission of a contract to sell a cow was granted on grounds of mutual mistake when both parties completed the exchange of the cow on the mistaken understanding that the cow was barren. Sherwood v. Walker, 33 N.W. 919 (Mich. 1887). When reformation of the contract is available to cure a mistake, neither party can avoid the contract. 1) Conscious ignorance A party may bear the risk of a mistake when: i) The party is aware at the time of the contract of having only limited knowledge of the facts to which the mistake relates; and ii) The party accepts such limited knowledge as sufficient. Note that the risk created by conscious ignorance rests on the party’s awareness of having limited knowledge. Restatement (Second) of Contracts § 154. 2) Mistaken party’s negligence When the mistake is attributable to a party’s failure to know or discover facts before entering into the contract, the party may nonetheless assert the defense of mistake, unless the party failed to act in good faith and in accordance with the reasonable standards of fair dealing. The mistaken party’s negligence with regard to the mistake is not sufficient to prevent the mistaken party from avoiding the contract. Restatement (Second) of Contracts § 157. b. Unilateral mistake When only one of the parties was mistaken as to an essential element of the contract at the time the contract was formed, either party can generally enforce the contract on its terms. However, the mistaken party can void the contract if the elements for a mutual mistake exist and either: i) The mistake would make enforcement of the contract unconscionable; or ii) The nonmistaken party caused the mistake, had a duty to disclose or failed to disclose the mistake, or knew or should have known that the other party was mistaken. For a unilateral mistake to form the basis for rescission, there must be an absence of serious prejudice to the other party. Restatement (Second) of Contracts § 154. c. Reformation for mistake When a writing fails to express the agreement because of a mistake of both parties, the court may, at the request of a party, reform the writing to express the agreement, except to the extent that rights of third parties who have relied on the document, such as good-faith purchasers for value, will be unfairly affected. Restatement (Second) of Contracts § 155. Reformation of a writing for mistake is available if: i) There was a prior agreement (either oral or written) between the parties; ii) There was an agreement by the parties to put that prior agreement into writing; and iii) As a result of a mistake, there is a difference between the prior agreement and the writing. Note that if one party, without the consent of the other party, intentionally omits a term from the writing that had been agreed upon by the parties, reformation would be available on the grounds of misrepresentation. (See § I.E.3.g. Avoidance or Reformation for Misrepresentation, infra.) 2. Misunderstanding Definition A misunderstanding occurs when both parties believe that they are agreeing to the same material terms, but they in fact agree to different terms. Restatement (Second) of Contracts § 20. a. Neither party knows or should know of the misunderstanding If the misunderstanding involves a material term, and neither party knows or has reason to know that there is a misunderstanding, then there is no contract. b. One party knows or should know of the misunderstanding If a material term in the offer and acceptance is ambiguous, and only one party knows or has reason to know that the other party has a different understanding of the meaning of the ambiguous term, then there will be a contract formed based on the meaning of the term as understood by the unknowing party. While a contract exists, the contract may be voidable on grounds of mistake or misrepresentation due to the conduct of the party with the superior knowledge. c. Both parties know of the misunderstanding There is no contract if both parties at the time of contracting knew or had reason to know that a material terms was ambiguous, unless both parties intended the same meaning. d. Waiver of the misunderstanding Even if there is a misunderstanding, one party may waive the misunderstanding and choose to enforce the contract according to the other party’s understanding. e. Subjective determination of misunderstanding In determining the existence of a misunderstanding, it is each party’s knowledge or reason to know of the misunderstanding that governs, not what a reasonable person would know. In this regard, the objective theory of contracts does not apply. In addition, in determining what a party knows or has reason to know, the principles regarding conscious ignorance and negligence apply. See § E.1. Mutual Mistake, above. 3. Misrepresentation, Nondisclosure, and Fraud Definition A misrepresentation is an untrue assertion of fact. In order to constitute a fact, the assertion must be about a present event or past circumstance. An assertion of an opinion, such a belief or judgment as to the quality, value, or authenticity of an item or the occurrence of a future event, is generally not an assertion of a fact. However, an assertion of an opinion may, if reasonable, be interpreted by a party as an assertion that the person knows facts that are inconsistent with the opinion or that the person knows facts sufficient to justify the formation of the opinion. Use of an “as is” provision in a contract can shift the risk to a buyer in the absence of unconscionability. Misrepresentation can be innocent, negligent, or fraudulent. a. Fraudulent misrepresentation Fraudulent misrepresentation requires proof of the following: i) The misrepresentation is fraudulent; a) A false assertion of fact made knowingly, or recklessly without knowledge of its truth; and b) With intent to mislead the other party; ii) The misrepresentation induced assent to the contract; and iii) The adversely affected party justifiably relied on the misrepresentation. b. Nondisclosure Affirmative conduct to conceal a fact is equivalent to an assertion that the fact does not exist. In addition, mere nondisclosure of a known fact is tantamount to an assertion that the fact does not exist, if the party not disclosing the fact knows that: i) Disclosure is necessary to prevent a previous assertion from being a misrepresentation or fraudulent or material; ii) Disclosure would correct a mistake of the other party as to a basic assumption, and the failure to disclose would constitute lack of good faith and fair dealing; iii) Disclosure would correct a mistake of the other party as to the contents or effect of a writing evidencing their agreement; or iv) The other party is entitled to know the fact because of a confidential or fiduciary relationship. c. Effect 1) Fraud in the factum Definition Fraud in the factum (or fraud in the execution) occurs when the fraudulent misrepresentation prevents a party from knowing the character or essential terms of the transaction. In such a case, no contract is formed, and the apparent contract is void (i.e., not enforceable against either party), unless reasonable diligence would have revealed the true terms of the contract. 2) Fraud in the inducement Definition Fraud in the inducement occurs when a fraudulent misrepresentation is used to induce another to enter into a contract. Such a contract is voidable by the adversely affected party if she justifiably relied on the misrepresentation in entering into the agreement. d. Nonfraudulent misrepresentation Even if nonfraudulent, a misrepresentation (innocent or negligent) can still render a contract voidable by the adversely affected party if: i) The misrepresentation is material (i.e., information that would cause a reasonable person to agree or that the person making the misrepresentation knows would cause this particular person to agree); ii) The misrepresentation induced assent to the contract; and iii) The adversely affected party justifiably relied on the misrepresentation. e. Effect of party’s fault in not knowing or discovering facts A party’s fault in not knowing or discovering facts before entering into the contract does not prevent the party’s reliance on the misrepresentation from being justified unless it constitutes a failure to act in good faith and in accordance with the reasonable standards of fair dealing. The party’s negligence with regard to learning about the falsity of the misrepresentation is not sufficient to prevent the party from avoiding the contract.