Contracts Chapter 15 Legality and Statute of Frauds

The key points in this chapter include:

1. The enforceability of contracts that are contrary to public policy.

2. Covenants not to compete and exculpatory clauses.

3. The effect of an illegal contract and the severability of an illegal clause.

4. Contracts that must be in writing to be enforceable.

5. The parol evidence rule.

To be enforceable, a contract must not violate any statutes or public policy. Under the Statute of Frauds, certain types of contracts must be in writing to be enforceable. If there is no written evidence of a contract that falls under this statute, it is not void, but it may not be enforceable. This chapter covers illegal contracts, contracts that fall under the Statute of Frauds, and the parol evidence rule.

I. LEGALITY

A. CONTRACTS CONTRARY TO STATUTE

1. Usury
Every state sets rates of interest charged for loans (exceptions are made for certain business
deals). Charging a higher rate is usury—some states allow recovery of the principal plus
interest; other states allow recovery of the principal but no interest; a few states permit no
recovery.

2. Gambling
All states regulate gambling (any scheme that involves distribution of property by chance
among persons who pay for the chance to receive the property).

3. Sabbath Laws
In some states, contracts entered into on Sunday are illegal. Other states ban only sales
of goods (such as liquor) on Sunday. Exceptions include contracts for necessities
and works of charity, and executed contracts.

4. Licensing Statutes

a. Professional Licenses
Members of certain professions (such as doctors) must be licensed.

b. Business Licenses
Business licenses provide a means of regulating and taxing certain businesses, and
protecting the public. Lack of a business license can bar the enforcement of a work-
related contract.

1) Illegal Contracts
If the statute’s purpose is to protect the public, a contract with an unlicensed individual is illegal.

2) Enforceable Contracts
If the statute’s purpose is to raise revenue, a contract with an unlicensed individual is enforceable.

5. Contracts to Commit a Crime
A contract to commit a crime is illegal. If the contract is rendered illegal by statute after it
has been entered into, the contract is discharged.

B. CONTRACTS CONTRARY TO PUBLIC POLICY

1. Contracts in Restraint of Trade

a. Prohibited Contracts
Contracts that restrain trade, adversely affect the public, or violate an antitrust statute.

b. Covenant Not to Compete
Acceptable if reasonable, determined by the length of time and size of area in which the
party agrees not to compete. (In the sale of a business, it must also be a separate agreement.)

2. Unconscionable Contracts or Clauses
A bargain that is unfairly one-sided is unconscionable.

a. Procedural Unconscionability
Relates to a party’s lack of knowledge or understanding of contract terms because of
small print, etc. An adhesion contract may be held unconscionable.

b. Substantive Unconscionability
Relates to the parts of a contract that are so unfairly one-sided they “shock the conscience”
of the court.

3. Exculpatory Clauses

a. What an Exculpatory Clause Is
Contract attempting to absolve parties of negligence or other wrongs. Sometimes found
in rental agreements, and commercial and residential property leases.

b. Legality
Often held to be unconscionable. In most real property leases, held to be contrary to public
policy. Not enforced if the party seeking its enforcement is involved in a business important
to the public as a matter of practical necessity (airlines, public utilities).

4. Discriminatory Contracts
Contracts in which a party promises to discriminate in terms of color, race, religion, national origin, disability, or sex are contrary to statute and to public policy.

5. Contracts for the Commission of a Tort

6. Contracts Injuring Public Service
Contracts that interfere with a public officer’s duties or involve a conflict between duties and
private interests are contrary to public policy.

7. Agreements Obstructing the Legal Process

C. EFFECT OF ILLEGALITY

1. The General Rule
An illegal contract is void. No party can sue to enforce it and no party can recover for its
breach.

2. Exceptions

a. Justifiable Ignorance of the Facts
A party who is innocent may recover benefits conferred in a partially executed contract or
enforce a fully performed contract.

b. Members of Protected Classes
When a statute is designed to protect a certain class of people, a member of that class can
enforce a contract in violation of the statute (the other party cannot).

c. Withdrawal from an Illegal Agreement
If the illegal part of an agreement has not been performed, the party rendering performance
can withdraw and recover the performance or its value.

d. Contract Illegal through Fraud, Duress, or Undue Influence
A party induced to enter into an illegal bargain by fraud, duress, or undue influence can
recover for the performance or its value.

3. Severable, or Divisible, Contracts
A court may enforce the legal part of a contract, if the illegal part does not affect the essence of the bargain.

II. STATUTE OF FRAUDS

The Statute of Frauds stipulates what types of contracts must be in writing to be enforceable.
If one of these contracts is not in writing, the contract is not void but the Statute of Frauds is
a defense to its enforcement.

A. CONTRACTS INVOLVING INTERESTS IN LAND
Land includes all objects permanently attached, such as trees. Contracts for the transfer of
interests in land (such as leases) must be in writing (see Chapters 48 through 53).

B. THE ONE-YEAR RULE

1. Performance Objectively Impossible Must Be in Writing
A contract must be in writing if performance that is objectively impossible within a year of
the date of the contract’s formation.

2. Possibility of Performance Need Not Be in Writing
A contract need not be in writing if performance within one year is possible—even
if it is improbable, unlikely, or actually takes longer.

C. COLLATERAL PROMISES
A promise ancillary to a principal transaction and made by a third party to assume the debts
or obligations of the primary party (only if the primary party does not perform) must be in
writing to be enforceable.

1. Exception—“Main Purpose” Rule
An oral promise to answer for the debt of another is enforceable if the guarantor’s main
purpose is to secure a personal benefit.

2. Estate Debts
Promises made by the administrator or executor of an estate to pay personally the estate debts must be in writing to be enforceable.

D. PROMISES MADE IN CONSIDERATION OF MARRIAGE
Prenuptial agreements must be in writing to be enforceable.

E. CONTRACTS FOR SALE OF GOODS
The Uniform Commercial Code (UCC) requires a writing for a sale of goods priced at
$500 or more [UCC 2–201] (see Chapter 21).

F. EXCEPTIONS TO THE STATUTE OF FRAUDS

1. Partial Performance

a. Contracts for the Transfer of Interests in Land If a buyer pays part of the price, takes
possession, and makes permanent improvements and the parties cannot be returned to their pre-contract status quo, a court may grant specific performance.

b. Contracts Covered by the UCC Under the UCC, an oral contract is enforceable to the extent that a seller accepts payment or a buyer accepts delivery of the goods.

2. Admissions
In some states, if a party admits in pleadings, testimony, or in court that a contract was made, the contract will be enforceable.

3. Promissory Estoppel
An oral contract may be enforced if (1) a promisor makes a promise on which the promisee justifiably relies to his or her detriment, (2) the reliance was foreseeable to the promisor, and (3) injustice can be avoided only by enforcing the promise.

4. Special Exceptions under the UCC
Oral contracts that may be enforceable under the UCC include those for customized goods
and those between merchants that have been confirmed in writing (see Chapter 21).

G. SUFFICIENCY OF THE WRITING
No formal writing is required, but there must be at least a memo that includes the following.

1. Signature of the Party to Be Charged
The writing must be signed (initialed) by the party who refuses to perform. The signature
can be anywhere in the writing.

2. Essential Terms

a. Contracts Covered by the UCC
The writing must include a quantity term. Other terms need not be stated exactly, if they
adequately reflect the parties’ intentions.

b. Other Contracts
The writing must include the identity of the parties, subject matter, consideration, and
essential terms (in a sale of land these would include the price and a description of the property).

III. THE PAROL EVIDENCE RULE

A. THE RULE
If a written contract is the final expression of the parties’ agreement, evidence of prior negotiations, prior agreements, or contemporaneous oral agreements that contradicts or varies the terms is not admissible at trial.

B. EXCEPTIONS
Parol evidence is admissible to show—

1. Contract Subsequently Modified
Evidence of subsequent modification (oral or written) of a written contract is admissible (but
oral modifications may not be enforceable if they bring the contract under the Statute of
Frauds).

2. A Contract Is Voidable or Void

3. Meaning of Ambiguous Terms

4. Essential Term Lacking in an Incomplete Contract

5. Prior Dealing, Course of Performance, or Usage of Trade
Under the UCC, evidence can be introduced to explain or supplement a contract by showing a
prior dealing, course of performance, or usage of trade (see Chapter 20).

6. Orally Agreed-on Condition
Proof of such a condition does not modify the written terms but involves the enforceability of
the written contract.

7. An Obvious or Gross Clerical Error