CHAPTTR II

WMnW*s

.CONTRACTUAL CAPACITY

.LEGALITY

-THE EFFECT OF ILLEGALITY

CHAPTEN OUIt I l {E TEARII ING OBIECIIVES

AFTER READING THIS CHAPTER, YOU SHOULD BE ABLETO ANSWER THE FOLLOWING QUESTIONS:

What are some exceptions to the rule that a

minor can disaffinn (avoid) any contract?

Does an intoxicated person have the capacity to

enter into an enforceable contract?

Does the mental incompetence of one party

necessarily make a contract void?

Under what circumstances will a covenant not to

compete be enforceable? When will such

covenants not be enforced?

What is an exculpatory clause? In wl-rat circum-

stances might exculpatory clauses be enforced?

When will they not be enforced?

ourts generally want contracts to be enforceable, and much of the law is devoted to

aidini the enforceability of contracts. Noneiheless, as indicated in the chapter-

opening quo"tation, "liberty of contract" is not absolute. h'r other words, not all people can

-"t. tJgdty binding contracts ai all times. Contracts entered into by persons lacking the

c"pa.iry"to do ,o -"'y

be voidable. Similarly, contracts calling for the performance of an

illegal act are illegal and thus void-they are-not contracts at all. In this chapter, we exam-I

ine contractual capacity and some aspects of illegal bargains'

Contractual capacity is the legal ability to enter inio a contractual relationship' Courts

generally pr"r,rr11. the existence of contractual capacity, but in some situatiot-ts, capacity

i, lu.king'o, may be questior-rable. A person wl-ro has been determined by a court to_be

mentally"incompetent, for example, cannot form a legally binding contract with another

party. In other situations, a partlmay havethe capacity to enter into a valid contract but

i]]"i rlro have the right to ruoid iirbllity r-rnder it. For example, minors--or infants, as they

nr.'.o-*or1ly referied to in the law-usr-rally are not legally bound by contracts' In this

section, we look at the effect of youth, intoxication, and n'rental incompetence on con-

tractual capacity.

5 6libertv ofcontlactIS

not an absoluteconcePt. It isrelative to manyconditionsof time andplace andcircumstan ce,)'

Benjamin Cardozo, I 870-1938(Associate justice of the

tlnited Statcs Suprcne Court,I 932- l 93 8)

CONTRACTUAT CAPACIfiThe threshold mental caPacitYrequired by law for a PartY whoenters into a contract to be boundby that contract.

287 EtrfiHITCAPACITY AND LEGALITY

reThe Legal Informationlnstitute at Cornell LawSchool provides a table with linksto state statutes governing theemancipation of minors. Co to

288 llnilmllCONTRACTS

Table_Emancipation.htm.

EMANCIPATIONIn regard to minors, the act of beingfreed from parental control; occurswhen a child's parent or legalguardian rel inquishes the legal r ightto exercise control over the child.Normally, a minor who leaves hometo support himself or herself isconsidered emancipated.

DISAFFIRMAN€EThe legal avoidance, or setting aside,of a contractual obligation.

This minor is discussing the purchase

of a used car with o solesperson.When o minor disaffirms a controd,such os o contract to buy o car, moststotes require the minor ta returnwhotever he or she purchosed, if it iswithin his or her control. Why dosome sfofes require more?(Michael Newman/PhotoEdit)

MinorsToday, in virtually all states, Ihe age of maiority (when a person is no longer a minor) {or

contractual purposes is eighteen years-the so-called coming of age. (The age of major-ity may still be hventy-one for other purposes, however, such as the purchase and con-

sumption of alcohol.) In addition, some states provide for the termination of minority onmarriage. Minority status may also be terminated by a minor's emancipation, whichoccurs when a child's parent or legal guardian relinquishes the legal right to exercise con-trol over the child. Normally, minors who leave home to support themselves are consid-ered emancipated. Several jurisdictions permit minors to petit ion a court for

emancipation themselves. For business purposes, a minor may petit ion a court to betreated as an adult.

The general rule is that a minor can enter into any contract an adult can, provided thatthe contract is not one prohibited by law for minors (for example, the sale of aicoholicbeverages or tobacco). A contract entered into by a minot, however, is voidable at theoption of that minor, subject to certain exceptions (to be discussed shortly). To exercisethe option to avoid a conhact, a minor need only manifest an intention not to be boundby it. The minor "avoids" the contract by disaffirming it,

Disaffirmance The legal avoidance, or setting aside, of a contractual obligation is referredto as disaffirmance. To disaffirm, a minor must express, through words or conduct, his orher intent not to be bound to the contract. The minor must disaffirm the entire contract,not merely a portion of it. For instance, a minor cannot decide to keep part of the goods pur-chased under a contract and return the remaining goods. When a minor disaffirms a con-tract, the minor can recover any property that she or he transferred to the adult asconsideration for the contract, even if it is then in the possession of a third party.l

A contract can ordinarily be disaffirmed at any time during minorityl or for a reason-able time after the minor comes of age. What constitutes a "reasonable" time may vary.Two months would probably be considered reasonable, but except in unusual circum-stances, a court may not find it reasonable to wait a year or more after coming of age todisaffirm. If an individual fails to disaffirm an executed contract within a reasonabie timeafter reaching the age of majority, a court will likely hold that the contract has been rati-

fied (ratification will be discussed shortly).Note that an adult who enters into a contract with a minor cannot

avoid his or her contractual duties on the ground that the minor can doso. Unless the minor exercises the option to disaffirm the contract, theadult party normally is bound by it.

A Minor's Obligations on Disaffirmance Although all staies' lawspermit minors to disaffirm contracts (with certain exceptions), includ-ing executed contracts, state laws differ on the extent of a minor's obli-gations on disaffirmance.

Maioilty Rule. Courts in a majority of states hold that the minorneed only return the goods (or other consideration) subiect to the con-tract, provided the goods are in the minor's possession or conkol.tnExAMpTE ttfl Jim Garrison, a seventeen-year-old, purchases a com-

l. The Uniform Commercial Code (UCC), in Section 2 403(l), allows an exception if the third partl is a'good

faith purchaser for value." See Chapter 19.

2. In some states, however, a minor who enters into a contract for the sale ofland cannot disaffirm the contract until

she or he reaches the age ofmajorilv.

&tT * $'#lw fi T ittr $i i:;

puter ftom Radio Shack. While transporting the computer to histrome, Garrison, through

no fault of his own, is involved in a car accident. As a result of the accident, the plastic

casing of the computer is broken. The next day, he returns the computer to Radio Shack

and d--isaffirms the contract. Under the majority view, this return fulfills Garrison's duty

even though ihe computer is now damaged. Garrison is entitled to receive a refund of the

purchase price (ifpaid in cash) or to be relieved ofany further obligations under an agree-

ment to purchase the computer on credit. El

Minoity Rute. A growing number of states, either by statute or by court decision, place

an addiiional duty on the minor-the duty to restore the adult party to the position she or

he held before tire contract was made. tFExAIttPtE tttr Sixteen-year-old Joseph Dodson

bought a pickup truck for $4,900 from a used-car dealer. Although the truck developed

-eJh"rric"l proLl.*r nine months later, Dodson continued to drive it until the engine blew

up and it stopped running. Then Dodson disaffirmed the contract and attempted to rehrrn

the truck to lhe dealer for a refund of the full purchase price. The dealer refused to accept

the pickup or refund the money. Dodson filed suit. Ultimately, the Tennessee Supreme

Co.,tt "llo1y.d

Dodson to disaffirm the contract but required him to compensate the seller

for the depreciated value-not ihe purchase price-of ihe pickup.3 E fftis example illus-

trates the tend among today's courts to hold a minor responsible for damage, ordinary wear

and tear, and depreciation of goods that the minor used prior to disafiirmance.

Exceptions to the Minor's Right to Disaffirm State courts and legislatures have carved

out sJveral exceptions to the minor's right to disaffirm. Some contracts cannot be avoided

simply as a matter of law, on the ground of public policy. For example. marriage contracts

andcontracts to enlist in the armed services fall into this category. Other contracts may

not be disaffirmed for different reasons, including those discussed here,

Misrepresentation of Age. Suppose that a minor tells a seller she is hventy-one years old

when she is really seventeen. Ordinarily, the minor can disaffirm the contract even

though she has misrepresented her age. Moreover, in some iurisdictions the minor is not

liable for the tort of fraudulent misrepresentation, the rationale being that such a tort

judgment might indirectly force the minor to perform the contract.'

Ilr-, -"1ry

l,irisdictiot s, ho*"u.r, a minor who has misrepresented his or her age can be

bound by a contract under certain circumstances. First, several states have enacted

statutes flr precisely this purpose. In these states, misrepresentation of age is enough to

prohibit disaffirmance. Other statutes prohibit disaffirmance by a minor who has engaged

in business as an adult. Second, some courts refuse to allow minors to disaffirm executed

(fully performed) contracts unless they can teturn the consideration received. The com-

binrilin of the minors' misrepresentations and their uniust enrichment has persuaded

these courts Io estop (prevent) the minors from asserting contractual incapacity.

Contracts fot l,Jecessaries. A minor who enters into a contract for necessaries may disaf-

firm the contract but remains liable for the reasonable value of the goods used. Necessaries

are basic needs, sr,rch as food, clothing, shelter, and medical sewices, at a level of value

required to maintain the minor's standard of living or financial and social status. Thus, what

wili be considered a necessary for one person may be a luxury for another. Additionally,

what is considered a necessary depends on whether ihe minor is under the care or control

of his or her parents, who are required by law to provide necessaries for the minor. If a

t Drd*" r. Shr"drr1zl S.W.zd 545 (Tenn. 1992). See also Restatement Qhird) of Restitution, Sections 16 and

33 (2004).

289 EIEIMIICAPACITY AND LEGATITY

NECESSARIES

Necessities required for life, such asfood, shelter, clothing, and medicalattention; may include whatever isbelieved to be necessary to maintaina person's standard of living orfinancial and social status.

2e0 llEiluuCONTRACTS

fTnilllitlll,'tl':l A minor's station in life( including f inancial and socialstatus and lifestyle) is important indetermining whether an item is anecessary or a luxury. For examPle,clothing is a necessary but if aminor from a low-income familycontracts for the purchase of a$2,000 leather coat, a court maydeem the coat a luxury. ln thissituation, the contract would notbe for "necessaries."

was shot in the back of the head at point-blank range by aplaymate. Fountain required extensive life-saving medicalservices from a variety of providers, including Yale DiagnosticRadiology. Yale billed Fountain's mother, Vernetta Turner-Tucker, forthe cost of its services, $12694, but she did not pay.

Instead, in January 2001, Turner-Tucker fi led for bankruptcy(see Chapter 27), and all of her debts, including the amountowed to Yale, were discharged. Meanwhile, she fi led a suit in

f N THE WORDS 0F THE C0URT . . , BIRDEN, J. pusticel

minor's parents provide the minor with shelter, for example, then a contract to lease shelter

(such as an apaltment) normaliy will not be regarded as a contract for necessaries.

Generally, then, to qualify as a contract for necessaries, (l) the item contracted for

must be necessary to the minor's existence, (2) the value of the necessary item may be up

to a level required to maintain the minor's standard of living or financial and social sta-

tus, and (3) the minor must not be under the care of a parent or guardian who is required

to supply this item. Unless these three criteria are me! the minoi can normally disaffirm

the contract without being liable for the reasonable vaiue of the goods used.

The issue in the following case was whether a medical services provider could collect

from a minor, as a contract for necessaries, the cost of emergency services rendered to the

minor when his mother did not pav.

BACKGROUND AND FACTS a Connecticut state court against the boy who shot Fountain

and obtained payment for Fountain's medical care. Thesefunds were deposited in an account-sometimes referred to as

an "estate"-established on Fountain's behalf. Yale filed a suit

against Fountain's estate, asking the court to order the estateto pay Yale's bill, but the court refused to grant the order. Yale

appealed to a state intermediate appellate court, whichreversed this ruling and ordered the payment. The estateappealed to the state supreme court.

4......-...; ln March 1996. Harun Fountain

Connecticr,rt has long recognized the common-law rule that a minor child's contracts

are voidable. Under this rule, a minor may, upon reaching majority, choose either to ratify

or to ayoid contractual obligations entered into during his minority. The traditional reason-

ing behind this rule is based on the well established commonlaw principles that the law

should protect children from the detrimental consequences of their youthful and improv-

ident acts, and that children should be able to en'ierge into adulthood unencumbered by

financial obligations incurred during the course of their minority. The rule is further sup-

ported by a policy of protecting children from unscrupulous individuals seeking to profit

from their youth and inexperience. lEmphasis added.]The rule that a minor's contracts are voidable, howevet, is not absolute. An exception to

this rule, eponymously known as the doctrine of necessaries, is that a minor may not avoid

a contract for goods or services necessary for his health and sustenance. Such confracts are

binding even if entered into during minority, and a minor, upon reaching maiority, may not,

ot o*\oYr*of law, disaffirm them. lEmphasis added.l

We have not heretofore articulated the particular legal theory underlying the doctrine

of necessaries. We therefore take this occasion to do so, and we conclude that the most

apt theory is that of an implied in law contract, also sometimes referred to as a quasi-

contract. * * *

In distinction to an implied in fact contract, a quasi or implied in law contract is not a

contract, but an obligation which the law creates out of the circumstances present, even

Supreme Court of Connecticut,26T Conn.35l,838 A.2d 179 (2OO4).

CASE I l . l -Cont i f tued

though a pare did not assume the obligation t' t' {' It is based on equitable principles to

operate whenever justice requires compensation to be made * * {c . With no other test

than what, under a given set of circumstances, is just or unjust, equitable or inequitable,

conscionable or unconscionable, it becomes necessary * x * 1o examine the circum-

stances and the conduct of the parties and apply this standard. lEmphasis added.]

Thus, when a medical services provider renders necessary rnedical care to an injured

minor, two contracts arise: the primary contract between the provider and the minor's par-

ents; and an implied in law contract between the provider and the minor himself. The

primary contract between the provider and the parents is based on the parents' duty to pay

ior their children's necessary expenses * * * . Such contracts, where not express, may be

implied in fact and generally arise both from the parties' conduct and their reasonable

expectations. The primacy of this contract means that the provider of necessartes must

make all reasonable efforts to collect from the parents before resorting to the secondary,

implied in law contract with the minor'The secondary implied in law contract behveen the medical services provider and the

minor arises from equitable considerations, including the law's disfavor of uniust enrich-

ment. Therefore, where necessary medical services are rendered to a minor whose parents

do not pay for them, equity and justice demand that a secondary implied in law conhact

arise belween the medical services provider and the minor who has received the benefits

of those services. These principles compel the conclusion that, in the circumstances of

the present case, the fdefendant is] liable to the plaintiff, under the commonlaw doctrine

of 1e;eya;ies,

for tl-re services rendered by the plaintiff to Fountain.

The judgment is affirmed.

29r GlnmnCAPACITY AND LEGALITY

F0R CRITICAL ANALYSIS-SocialConsideration what might hove hoppened in

future coses if the court hod held thot there was no inplied-in-

low contract between Fountoin ond Yole?

DECISI0N AND REMEDY rtre connecticut SupremeCourt affirmed the judgment of the intermediate appellate

court. A party who provides emergency medical services to a

minor can collect for those services from the minor if his or

her parents do not pay. Thus, Yale could collect from

Fountain's estate for the cost of its services under the doctrine

of necessaries.

trInsurance and Loans. Traditionally, insurance has not been viewed as a necessary, so

minors can ordinarily disaffirm their insurance contracts and recover all premiums paid.

Nevertheless, some jurisdictions prohibit disaffirming insurance contracts-for example,

when minors contract for life insurance on their own lives. Financial loans are seldom

considered to be necessaries, even if the minor spends the borrowed funds on necessaries.

If, however, a lender makes a loan to a minor for the exPress purpose of enabling the

minor to purchase necessaries, and the lender personally makes sure the funds are so

spent, the minor normally is obligated to repay the loan.

Ratification In contract law, ratification is the act of accepting and giving legal force to

an obligation that previously was not enforceable. A minor who has reached the age of

maiority can ratify a contract expressly or impliedly. Express ratification occurs when the

individual, on reaching the age of majority, states orally or in writing that she or he

intends to be bound by the contra ct. Implied ratification takes place when the minor, on

reaching the age of majority, indicates an intent to abide by the contract.

RATIFICATIONThe act of accepting and giving legalforce to an obligation that previouslywas not enforceable.

292 sltrsilCONTRACTS

I -EIAMP_LE-I l3Linentersacontracttosel lher laptoptoArturo.a.minor. [ fArturodoesnot disaffirm th" .o'1t'"tii"a' ""

tt"t'i"g the age of maiority' writes a letter to Lin stat-

ing that he still ,r'"..-," 9ir-,1. 1;J;t'r* $;lf:*i,,L::iii:::*Xl"i;"ff:fl:Ar"t.tro takes possession of the laptop a-s

" -1:oting the age of maiortry,;;;;t't*o1iedly ratlfled the contract' E

If a minor fails to airriir- "

.Jntract within "

,.rro.,able time after reaching the age

of majority, then a ."J;;r,;.t"r^ir]. whether the conduct constitutes implied ratifi-

cation or disaffirmance. Generally, .onrt, pr.r,-ri'rr;'iil "

contract rharis executed (fti1y

performed by both sides) was ratiiied. e .""ni.iitt"i i' ttlll executory (not yet performed

bv both parties) t, "o"'l'lly

considered to be disaffirmed'

Parents,Liabi l i tyAsageneralrule 'parentsarenot] iab]eforthecontractsmadebyminor children acting or-th"i, own, exiept contracts for necessaries' which the parents

are legally required t" p-"ra" fr,rls ls why businesses ordinarily require parents to coslgn

anv contract *,de *ith ^

minor. The pare-nts tI'.,'' b..o-. personally obligated to per-

f"i*;ilili,i;", "rir-" .""i*..,

"u",r if their child avoids liabiliq''

Normally, minors J;;**li-iirUi. fo, ttreir own torts. The parents of the minor can

alsobeheld liable ir, ..rt"i., situations. I" ,o*" ,i;il, o"t*u -ry b. liable if they failed to

exercise proper parenr"i;;"1 *hen they t ,',"*or'r1to'"1d have known that this lack of con-

trol posed ",-r

rrnr.rro.";;;iJ of hrt,o t" "tt'ot

ftt*o-ryt---t-.@tAn eleven-year-old's par-

ents allow him to dri".;;'; f,tUti" .o"ar. fffitlf"ta at*"s negligently and causes

someone else to be iniured, the paients -ay

b" h"ld liable for the minor's tort (negligence)'

E other states have ."r.i.a ,tatut.s tt'rrt i-por" ti"uitity on p".l:lP for certain kinds of tor-

tious acts committed t, ,#;;i1.1*", ,u.h ^,

those thai are willful and malicious'

lntoxicated Persons

Contractual capacity also becomes an issue when a P'1Y'to a' con!11ct was intoxicated at

the time the contract was made' Intoxication i' '

to'lditio" in which''a P"T:j':::T'?l

capacity to act or tfr.l"i'i, i"f"iir.a Uy alcohol or some other drug. lf the person was sul-

ficiently intoxicated io t".t mental ."pr.ity,'til"".""1,"t' -1y. it

uoidatle even if the

intoxicat ionwaspurelyvoluntary'F": t l : to ' ' t t "" t tobevoidable'however ' thepersonmust prove that the t;;l;;;i;; i-pri..d t',"ior;;;;ff"" and iudgment so severelv that

she or he did not .";;;;.,.d ,frg i.g' .""r.q.r.,,.", of entering into the contract' In

addition, to avoid the contract i' the maiori,y oi rrra.t, the person claiming intoxication

must be able to return all consicleration received'

If, despite lr-,too.riio", an. n.::"" unclerstood the legal conseqxences of the ag(eement'

the contract i, "r-,io*.rU1". th" f".t t#l;; ,"?-t

"f ihe contract are foolish

or obviously t uo, t1,."oti"r;;;ay;;i, ""a -rl. ,r* contract voidable (r-rnless the other party

fraudulentlyinduceclthepersonto'becomeintoxicated).Asapracticalmatter,courtsrarelypermit contracts to be avorded on the grouni

"ii"a"i."tio", iecaus" it is difficult to deter-

mine whether a party was sufficiently i,rto*i."i.Jio avoid legal.duties' Rather than inquire

into the intoricaied person,s mental ,t"t", ;;;; .o.tri" i*tZtd focus on obiective indica-

tions of capacrty a" d#;;" *rr.,rr* ir.," contract is voidable owing to intoxication'-

MentallY lncomPetent Persons

Contractsmadebymentai ly incompetentPelsonscanbevoid,voidable,orval id.Welookhere at the circumstances that deteimine when these classifications apply'

q. -. s"", tor """-pl"Jh"

court's decision itLucy t zehmer' presenled as case 9 1 in chapter a

295 EIEHtrCAPACITY AND LECALITY

Poyday loons ore populor with

individuols who do not have regulor

banking relationships. A client writes

o check for some relotively smoll

amount to be coshed at "PoY daY,"

usually in two weeks. About 10

million IJ.S. residents apply for these

loons in ony given yeor. The implicit

interest rates ore extremelY high,

sometimes more thon I OO Percenton on onnuolized bosis. lIVhy luouldanyone ogree to poy so much for

such a short-term loon?(Seth Anderson/Creative Commons)

rli i

:i

:i

When the Contract Will Be Void If a court has previously determined that a person is

mentally incompetent and has appointed a guardian to represent the person, any contract

made by that mentally incompetent person is void-no contract exists. Only the guardian

can enter into a binding conkact on behalf of the mentally incompetent Person.

When the Contract Will Be Voidable If a court has not previously judged a person to

be mentally incompetent but in Fact the person was incompetent at ihe time, the contract

may be voidable. A contract is voidable if the person did not know he or she was entering

into the contract or lacked the mental capacity to comprehend its nature, purpose, and

consequences. In such situations, the contract is voidable at the option of the mentally

incompetent person but not the other party. The contract may then be disaffirmed or rat-

ified (if the person regains mental competence). Like intoxicated persons, mentally

incompetent persons must return any consideration and pay for the reasonable value of

any necessaries they recelve.hEXAMFLE uE Milo. a mentally incompetent man who had not been previously

declared incompetent by a fudge, agrees to sell hventy lots in a prime residential neigh-

borhood to Anastof. At the time of entering the contract, Milo is confused over which lots

he is selling and how much they are worth. As a result, he contracts to sell the properties

for substantially less than their market value. If the court finds ihat Milo was unable to

understand the nature and consequences of the contract, the contract is voidable. Milo

can avoid the sale, provided that he returns any consideration he received. E

When the Contract Will Be Valid A contract entered into by a rnentally incompetent

person (whom a court has not previously declared incornpetent) rnay also be valid lf Ihe

p.trotl had capacity at the time the contract was formed. For instance, a Person may be

,bl. to understand the nature and effect of entering into a certain contract yet simultane-

ously lack capacity to engage in other activities. In such cases, the contract ordinarily will

b. u"hd bec",rr. ti-r. p.rrlotiir not legally mentally incompetent for contractual purposes.5

Similarly, an otherwise mentally incompetent person may have a lucid intewal-a tem-

porary restoration of sufficient intelligence, jr-rdgment, and will to enter into contracts-

during which she or he will be considered to have full legal capacity'

To this point, we have discussed three of the requirements for a valid contract to exist-

agreement, consideration, and contractual capacity. Now we examine the fourth-legaliqt

For a contract to be valid and enforceable, it must be formed for a legal purPose.

A contract to do something that is prohibited by federal or state staiutory law is ille-

gal and, as such, void from the outset and thus unenforceable. Additionally, a con-

tract to commit a tortious act or to commit an action that is contrary to public

policy is illegal and unenforceable.

€ontracts Contrary to StatuteStatutes often set forth rules specifying which terms and clauses may be

included in contracts and which are prohibited. We examine here several ways

in which contracts may be contrary to a statute and thus illegal.

5. Modern coufis no longer require a person to be completely irrational to disaffirm contracts on the

basis ofmental incompetence. A contract may be voidable if, by reason ofa mental illness or defect, an

individual was unable to act reasonably with respect to the transaction and the other party had reason to

know of the condition.

2e4 mlliECONTRACTS

USURYCharging an illegal rate of interest.

Contracts to Commit a Crime Any contract to commit a crime is a contract in viola-

tion of a statute. Th.rr, a .o,-rtract to sell an illegal drug (the sale of which is prohibited by

statute) is not enforcerUt.. tf tn. ob ject or p.rf[r*rr-r* of the contract is iendered iliegal

by statute after Ihe contract has been entered into, the contract is considered to be dis-

.i,"rg"a by ir*. (See the discussion of impossibility of performance in Chapter i4.)

Usury Virtually every state has a statute that sets the maximum rate of interest that can

be .iarged for different types of transactiors, including ordinary loans. A lender who

makes a loan at ,n inter.si rate above the lawful maximum commits usury' The maxi-

mum rate of interest varies from state to state, as do the consequences for lenders who

make usurious ]oans. Some states ailow the lender to recover only the principal of a loan

along with interest up to the legal maximum. In effect, the lender is denied recovery of

the excess interest. ln other state"s, the lender can recover the principal amount of the loan

but no interest.Although usury statutes place a ceiling on allowable rates of interest, exceptions are

made to f"".ilitrt. buriness tiansactions. For erample, many states exempt corporate loans

from the usury iaws. ln addition, almost all statis have special statutes allowing much

hisher interest rates on small loans to help those borrowers who need funds and could not

otherwise obtain loans.

Gambling All states have statutes that regulate gambling-defined as any scheme that

involves the distribution of property by ch"ance ,il]o,'tg p.ttont who_have paid valuable

consideration for the opport,]ni'g, (chance) to receive the property.6 Gambling is the cre-

ation of risk for th. p.rrpor. of "rru-ing

it. Traditionally, the states have deemed gam-

bling contracts illegai and thus void.

Ii seueral statef however, i 'rcluding Louisiana, Michigan, Nevada, and New Jersey,

"^rino gambling is legal. In other states, certain forms of gambling are legal. california,

fo, "*"i,rpl",

ha"s not iefined draw poker as a crime, although criminal statutes prohibit

,rrrr,r"ro.r, other types of gambling games. A nr,rmber of states allow gambling ojr horse

races, and the rnalority of"states ha'vI legalized state-operated lotteries. as well as lotteries

(such as bingo) conducted for charitable Pulposes. Many states also allow gambling on

Indian reservations'Sometimes, it is difficult to distinguish a gambling contract from the risk sharing inher-

ent in almost all contracts. mH"-t--r-#-ta Ii on" caie, five co-workers each received some

free lottery tickets from r frrto*.tl"d ,greed to split the winnings if one of the tickets

turned out to be the winner. At first glrrr.J, this may seem entirely legal. The court, how-

ever, noted that the orai contract ir-, Ihi, .rr. "was an exchange of promises to share win-

nings from the parties' individually owned lottery tickets upon the happening of the

uncertain event" that one of the ticklts would win. Cor.seq,]ently, concluded the court, the

agreement at tssue was "founded on a gambling consideraiio"" ttd therefore was void'7 E

Online Gambling A significant issue today is how gambling-1aws can be applied in the

Internet context. Because state laws pertaining to gambling differ' online gambling ra,ises

a number of unique issues. For ."r-p]., in th"ose states that do not allow casino gambling

o, offtrrck betting, what can a state government do if residents of the state place bets

online? Also, where does the actual a'ct of gambling occur? Suppose that a resident of

New York places bets via the Internet at a gambling iite located in Antigua' Is -the.

actual

,ci of "ga,obling" taking place in New Yorlior in AntiguaZ According to a New York court

6. See Wshing Well Club t. Akron, I12 N E 2d 41 (Ohio Com Pl l951)

7. Dickerson v. Deno,770 So.2d 6l (Ala 2000)'

295@trCAPACITY AND LECALITY

Adults gamble ot o casino. Would

this some odivity be illegol if it were

conducted online? If so, could it be

prevented? How?(Ma rc Levin/Creative Commons)

BLUE IAWSState or local laws that prohibit theperformance of certain tYPes ofcommercial activities on Sundav'

in one case, "if the person engaged ir-i gambling is located in New York, tl-ien New York

is the location where the gambling occurred."E Courts of other states may take a different

view, however.Another issue that is being debated is rvhether entering contracts that involve gambling

on sports teams that do not really exist-fantasy sports-is a form of gambling. For a discus-

sion of this issue, see this chapter's Adapting the Law to the Online Environment feature on

the following page.

Sabbath (Sunday) Laws Statutes referred to as Sabbath (Sunday) laws prohibit thefor-

mation or performance of certain contracts on a Sunday.'fhese laws, rvhich date back to

colonial t imes, are often called blue laws, as mentioned in Chapter 2. Blue laws get their

name from the blue paper on which New Haven, Connecticut, printed its town ordi-

nance in l7B1 that prohibited work and required businesses to close on Sunday.

Accorcling to a few statl and local larvs, ail contracts entered into on a Sunday are illegal.

Laws ir-r oiher states or municipalities prohibit only the sale of certain types of merchan-

dise, such as alcoholic beverages, on a Sunday.

In rnost states u,ith such statutes, contracts that were entered into on a Sunday can be

ratified cluring a weekday. Also, if a contract t1'rat u,as entered into on a Sunday has been

ful1y perfomed (executed), normally it cannot be rescinded (canceled). Exceptions to

S"tr,fuy laws permit contracts for necessities (sucl-r as food) and works of charity. Many

states do not enforce Sunday laws, and some state courts have held these larvs to be

unconstitutional because they interfere with the freedon-r of religion.

Licensing Statutes A11 states require that members of certain professions obtain

licenses illo*it-rg then to practice. Physicians, lawyers, real estate brokers, architects,

8, Llnited States v. Cohen, 260 F.3d. 68 (2d Cir. 200 I )

le6 llNIIUilCONTRACTS

s many as 20 millionadults in the Uniied

States play some form offantasy sports via theInternet. A fantasY sPort is a

game in which particiPants,often called owners, buildteams composed of real-life

.tr

Testing the Gambling Aspe(t in Court

Thus far, the courts have had the opporhrnity to rule only on

whether the pay-to-play fantasy sports sites that charge an

entrance fee and offer prizes to the winners are running gam-

bling operations. Charles Humphrey brought a-lawsuit against

Viac'om, ESPN, The SportingNews' and other hosts of such

fantasy sports sites under a New fersey statute that allows the

recoveryof gambling losses. Humphrey claimed that the fan-

tasy sports leagues *.r. g"-"t of chance, not games of skill,

b""",ts" eventi beyond the participants' control could deter-

mine the or.rtcome-for example, a star quarterback might be

injured. He also pointed out that in the ofiline world, federal

law prohibits any games of chance, such as sweepstakes or

drawings, that require entrants to submit consideration in

order tJ play. Coisiderationhas been defined as the purchase

of , prod.tci or the payment of money. For these teasons, he

"rgrr.d, the entrance fees constituted gambling losses that

could be recovered.The federal district court that heard the case ruled against

Humphrey, mostly on procedural grounds, but the court did

conclude thrt "t

, matter of law the entrance fees did not

constitute "bets" or "wagers" because the fees are paid

unconditionally, the prizes offered are for a fixed amount and

certain to be awarded, and the defendants do not compete

for the prizes.b The court also observed that if a combination

of entrance fees and prizes constituted gambling, a host of

contests ranging from golf tournaments to track meets to

spelling bees and beauty contests would be gambling opera-

tions-a conclusion that the court deemed "patently

absurd."c Note, however, that the case involved only pay-to-

olav sites. The court did not have to address the question of

whether fantasy sporis sites that enable participants to con-

tibute to a pot in the hopes of winning it at the end of the

season constitute gau-ibling sites.

F0R CRf TICAL ANAtYSIS What arguments canbe used to suPport the idea thot playing fantasy

sports requires skill?

b. Humphrey v. Viocom, lnc., - F'Supp'2d -,2oo7 WL1797644

(D.N.J. 2oo7).

c. ln reaching this conclusion, the federal district court cited portions

of an Arizona Supreme Court ruling, Stote v. American Holidoy

Association, tnc., 151 AtiZ.3"12,727 P.zd 8o7 ('l986).

olarers from different real-iif"t"r-t. Each fantasy team competes against the fantasy

teams beionging to other ownels. At the end of each week, the

statistical p.ifot*rtt."t of all the real-life players are translated

into points, and the points of all the players on an owner's fan-

tasy team are totaled. Nthough a wide variety of fantasy games

are available, most participants play fantasy football' On many

fantasy sports sites, participants pay a fee in order to play and

use tlre site's facilities, such as staiistical tracking and message

boards. At the end of the season, prizes ranging from T:shirts to

flat-screen televisions are awarded to the winners.

In otl-rer instances, the participants in fantasy sports gam-

ble directly on the outcome. In a fantasy football league, for

example, each participant-owner adds a given amount to the

pot and then "drafts" his or her fantasy team from actual-l,trational

Football League players. At the end of ihe football

season, each owner's points are totaled, and tl-re owner with

the most points wir-rs the Pot.

Congress Weighs In

As online gambling l-ras expanded, Congress has attempted to

regulate it- In iate 2006, a federal law went into effect that

makes it illegal for credit-card companies and banks to engage

in transactioirs witl-r Internet gambling companies.a Although

the law does not prohibit individuals from placing online bets,

in effect it makes ii almost irnpossible for them to do so by pre-

venting them from obtaining financing for online gamlling'

At firsiglance, the legislation apPears comprehensive, but it

specifically eiempts Internet wagers on horse racing, state

Iotteries, and fantasy sports. Hence, one could argue ihat

Congress l-ras determined that fantasy sports do not constitute

a prohibited Internet gambling activity.

a. Security and Accountability for Every Port Act, Public L' No' 1 09-342

Sections 5361-5367,120 Stat. I884 (2006). (A version of the Unlawful

lnternet Gambling Enforcement Act of 2006 was incorporated into this

statute as Title Vlll.)

electricians, and stockbrokers are but a few of the people who must be licensed. Somelicenses are obtained only after extensive schooling and examinations, which indicate tothe pr-rblic that a special skill has been acquired. Others require only that the particularperson be ofgood moral character and pay a fee.

The Purpose of Licensing Statutes. Generally, business licenses provide a means ofregulating and taxing certain businesses and protecting the public against actions thatcould threaten the general welfare. For example, in nearly all states, a stockbroker mustbe licensed and must file a bond with the state to protect the public from fraudulent trans-actions in stocks. Similarly, a plumber must be licensed and bonded to protect the pub-lic against incompetent plumbers and to protect ihe public health. Only persons orbusinesses possessing the quaiifications and complying with the conditions required bystatr-rte are entitled to licenses. For instance, the owner of a bar can be required to sell foodas a condition of obtaining a license to serve liquor.

Contracts with Unlicensed Practitioners. A contract with an unlicensed oractitionermay still be enforceable, depending on the nature of the licensing statute. Some statesexpressly provide that the lack of a license in certain occupations bars the enforcement ofwork-related contracts. If the statute does not expressly state this, one must look to theunderlying purpose of the licensing requirements for a particular occupation. If the pur-pose is to protect the public from unauthorized practitioners, a contract involving an unli-censed individual is illegal and unenforceable. If, however, the underlying purpose ofthestatute is to raise government revenues, a contract with an unlicensed practitioner isenforceable-although the unlicensed person is usually f ined.

Contracts Contrary to Publ ic Pol icyAlthough contracts involve private parties, some are not enforceable because of the neg-ative impact they would have on society. These contracts are said Io l:e contrary to publicpolicy. Examples include a contract to commit an immoral act, such as selling a child,and a contract that prohibits marriage. lEExAMprE lfl Everett offers a young man$10,000 if he refrains from marrying Everett's daugl-rter. If the young man accepts, no con-tract is formed (the contract is void) because it is contrary to public policy. Thus, if theman marries Everett's daughter, Everett cannot sue him for breach of contract. EBusiness contracts that may be contrary to pr-rblic policy include contracts in restraint oftrade and unconscionable contracts or clauses.

Contracts in Restraint of Trade Contracts in restraint of trade (anticompetitive agree-ments) usually adversely affect the public policy that favors competition inlhe ecotro-y.Typicaliy, such contracts also violate one or more federal or state statutes.e An exceptionis recognized when the restraint is reasonable and is part of, or supplemental to, a con-tract for the sale of a business or an employment contract (a contract stating the termsand conditions of employment). Many such exceptions involve a type of restraint calleda covenant not to compete, or a restrictive covenant.

Covenants Not fo Compete and the SaIe of an OngoingBusiness. Covenants (prornises)not to compete are often contained as ancillary (secondary, or subordinate) clauses in con-tracts concerning the sale of an ongoing business. A covenant not to compete is created

297 GlEEtrCAPACITY AND LECALITY

EMPTOYMENT CONTRACTA contract between an employer andan employee in which the terms andconditions of employment are stated,

€OVENANT NOT TO COMPETE

A contractual promise of one partyto refrain from conducting businesssimilar to that of another party fora certain period of time and withina specified geographic area. Courtscommonly enforce such covenantsif they are reasonable in terms oft ime and geographic area and arepart of, or supplemental to, acontract for the sale of a businessor an employment contract.

9. Federal statutes prohibiting anticompetitive agreements include the Sherman Antitrust Act, the Clayton Act, andthe Federal Trade Commission Act. See Chapter 37.

2e8 IINIIUUCONTRACIS

REFORMATIONA court-ordered conection of awritten contract so that it reflectsthe true intentions of the parties.

UNCONSCIONABTE CONTRACT(on uHcorrrscroNABrE crAusE)

A contract or clause that is voidon the basis of public policybecause one party, as a result ofdisproportionate bargaining power,is forced to accept terms that areunfair ly burdensome and thatunfairly benefit the dominating party"

when a seller agrees not to open a new store in a certain geographic area surrounding theold store . Such agreements enable the seller to sell, and the purchaser to buy, the goodwilland reputation of an ongoing business. If, for example, a well-known merchant sells his orher store and opens a competing business a block away, many of the merchant's customerswill likely do business at the new store. This renders less valuable the good name and rep-utation sold to the other merchant for a price. If a covenant not to compete is not ancillaryto a sales agreement, however, it wili be void because it unreasonably restrains trade and iscontrary to public policy.

Covenants Nof to Compete in Employment Contracts. Agreements not to compete(sometimes referred to as noncompete agreemenfs) can also be contained in employmentcontracts. People in middle- or upperJevel management positions commonly agree notto work for competitors or not to start competing businesses for a specified period of timeafter termination of employment. Such agreements are legal in most states so long as thespecified period of tirne (of restraint) is not ercessive in duration and the geographicrestriction is reasonable. To be reasonable, a restriction on competition must protect alegitimate business interest and must not be any greater than necessary to protect thatinterest.l0 (For a discussion of what is reasonable in the online environment, see thisclrapter's Management Perspective feature.)

Enforcement Problems. The iaws governing the enforceability of covenants not to com-pete vary significantiy from state to state. In some states, such as Texas, such a covenantwill not be enforced ur-rless the employee has received some benefit in return for signingthe noncompete agreement. This is true even if the covenant is reasonable as to time andarea. If the employee receives no benefit, the covenant will be deemed void. Californiaprohibits the enforcement of covenants not to compete altogether.

Occasionally, depending on the jurisdiction, courts will reform covenants not to com-pete. If a covenant is found to be unreasonable in time or geographic area, the court mayconvert the terms into reasonable ones and then enforce the reformed covenant. Thispresents a problem, however, in that the judge has implicitly become a party to the con-tract. Consequently, courts usually resort to contract reformation oniy when necessary toprevent undue burdens or hardships.

Unconscionable Contracts or Clauses Ordinarily, a court does not look at the fairness orequity of a contract; for example, a court normally will not inquire into the adequacy of con-sideration. Persons are assumed to be reasonably intelligent, and the court does not come totheir aid iust because they have made unwise or foolish bargains. In certain circumstances,however, bargains are so oppressive that the courts relieve innocent parties of part or all oftheir duties. Such a bargain is called an unconscionable contract (or unconscionableclause). Both the Uniform Commercial Code (UCC) and the Uniform Consumer CreditCode (UCCC) embody the unconscionabiliq, concept-the former with regard to the saleof goods and the latter with regard to consumer loans and the waiver of rights.rr A contractcan be unconscionable on either procedural or substantive grounds, as discussed in ihe fol-lowing subsections and illustrated graphically in Exhibit 1l-l on page 300.

Procedural LJnconscionability. Procedural unconscionability has to do with how a termbecomes part of a contract and relates to factors bearing on a party's lack of knowledge or

10. See, for erample, Could & Lamb, LLC r. D'Alusio, 949 So.2d 12 12 (F la.App. 2007). See also Moore v. MidwestDistibution,Inc., 76 Ark.App. 197, 65 S.W3d 190 (2002).l l . See,forexample,UCC2-302and2-719, andUCCC 5 l08and I 107.

ManagementFaces a legal lssue

For some companies,particularly those in high-tech industries, trade secretsare their most valuableassets. Often, to preventdeparting employees fromdisclosing trade secrets to competing employers, a comPanyasks its key employees to sign covenqnts not to compete, in

which they agree not to set up a competing business or workfor a competitor in a specified geographic area for a certainperiod of time. Generally, the time and geographic restrictionsmust be reasonable. A serious issue facing management todayis whether time and space restrictions that have been deemed

reasonable in the past will be considered reasonable in today'schanging legal landscape, which includes the Internetenvironment.

What the Courts Say

There is little case law to guide manaSement on this issue.

One case involved Mark Schlach who worked as a Web site

manager for EarthWeb, Inc., in New York. Schlack signed acovenant stating tha! on termination of his employment hewould not work for any competing comPany for one year.

When he resigned and accepted an offer from a company inMassachusetts to design a Web site, EarthWeb sued to enforcethe covenant not to compete. The court refused to enforce the

covenant, in part because there was no evidence that Schlackhad misappropriated any of EarthWeb's trade secrets or clients.

The court also stated that because the lnternet lacks physical

borders, a covenant prohibiting an employee from working for

a competitor anywhere in the world for one year is excessive in

duration.a

a. EarthWeb, tnc. v. Schlock, Tl F.SuPP.2d 299 (S.D.N.Y. 1999).

2gg r*rEffi8CAPACITY AND LECALITY

In a later case, a federal district court enforceda one-year noncompete agreement against the founder of alaw-related Web site business even though no geographicrestriction was included in the agreement. According to thecour! ?lthough there is no geographic limitation on theprovision, this is nonetheless reasonable in light of the national,and indeed international, nature of Internet business."b

The sale of an Internet-only business involves literally thefull worldwide scope of the lnternet itself. In a recent case, acompany selling vitamins over the lnternet was sold for morethan $2 million, The purchase agreement contained anoncompete clause that prohibited the seller from engaging inthe sale of nutritional and health products via the Internet forfour years. Despite the noncompete agreement after the sale,the seller created at least two lnternet sites from which he soldhealth products and vitamins. When the buyer sued to enforcethe noncompete agreement, the court held for the buyer andenjoined (prevented) the seller from violating the agreement.cThe court pointed out that the seller could still engage in hisformer business by using non-lnternet markets. The seller alsoremained free to sell other types of products on the Internet.

lmplications for Managers

Management in high-tech companies should avoidoverreaching in terms of t ime and geographic restrictionsin noncompete agreements. Additionally, when consideringthe reasonability of time and place restrictions, the courtstend to balance time restrictions against other factors, suchas geographic restrictions. Because for Web-based workthe geographic restriction can be worldwide, the timerestriction should be narrowed considerably to comPensatefor the extensive geographic restriction.

b. West Publishing Corp. v. Stanley,2004 WL 73s90 (D.N.D. 2004).c. MyVitoNet.com v. Kowolski, - F.Supp.2d

- 2008 WL 203008 (5.D.

Ohio 2008).

understanding of the contract terms because of inconspicuous print, unintelligible lan-

guage ("legalese"), lack of opportunity to read the contract, lack of opportunity to ask

questions about the contract's meaning, and other factors. Procedural unconscionability

sometimes relates to purported lack of voluntariness because of a disparity in bargaining

power between the hvo parties. Contracts entered into because of one party's vastly supe-

rior bargaining power may be deemed unconscionable. Such contracts are often referred

to as adhesion contracts. An adhesion contract is written exclusivell, by one partv (the

dominant party, r-rsually the seller or creditor) and presented to the other (the adhering

ADHESION CONTRACTA "standard-form" contract, such asthat between a large retailer and aconsumer, in which the strongerparty dictates the terms.

300TWIIilEICONTRACTS

party, usually the buyer or borrower) on a take-it-or-leave-it basis.12 In other words, the

adhering party has no opportunity to negotiate the terms of the contract.

Substantiye Unconscionabikty. Substantiye unconscionability characterizes those con-

tracts, or portions of contracts, that are oppressive or overly harsh. Courts generally focus

on provisions that deprive one party of the benefits of the agreement or leave that party

without remedy for nonperformance by the other. lEExIilFLe Tr.Ci A person with little

income and only a fourth-grade education agrees to purchase a refrigerator for $4,000 and

signs a two-year installment contract. The same type of refrigerator usually sells for $900on the market. Some courts have held that this type of contract is unconscionable because

the contract terms are so oppressive as to "shock the conscience" of the court.l3 ESubstantive unconscionability can arise in a wide variety of business contexts. For

example, a contract clause that gives the business entity free access to the courts but

requiies the other party to arbitrate any dispute with the firm may be unconscionable.laSimilarly, an arbitration clause in a credit-card agreement that prevents credit cardhold-

ers from obtaining relief for abusive debt-collection practices under consumer law may beunconscionable.l5 Contracts drafted by insurance companies and cell phone providershave been struck down as substantively unconscionable when they included provisions

that were overlv harsh or one sided.rb

12. See,forexample,HenningsenvBloomfieldMotors, Inc. ,S2N.J.35B, l6 lA.2d69(1960).

f5. See,forexample, lonest.StarCredi tCorp. ,59Misc.2d189,298N.YS.2d264(1969).Thiscasewi l lbepresentedin Chapter l8 as Case 18.3.14. See,forexample, WisconsinAutoLoans, lnc.v. lones,290 Wis.2d 5l4,7l4N.W2d 155 (2006).

15. See, for example, Coarly v. Cross County Bank,2007 WI App 26, 299 Wis.Zd 420,729 N.W.Zd 732 (2007).

16. See, for example, Cattonv.T-Mobile USA, Inc., 152 Cal,App.4th 571,61 Cal.Rptr.3d344 (2007);Kinkelv

CingularWireless, LLC,223lll.Zd 1, 857 N.E.2d 250, 306 lll.Dec. 1.57 (2006); and Aul v. Colden Rule Insurance

Co.,2007 WI App 165, 737 N.W.2d 24 (.2007).

Exculpatory Clauses Closely related to the concept of unconscionability are exculpatoryclauses-clauses that release a party from liability in the event of monetary or physicalinjury no matter who is at fault. Indeed, courts sometimes refuse to enforce such clauses onthe ground that they are unconscionable. lnrxnrvrpr-r r r.5l An employer reqgires its employ-ees to sign a contract containing a provision that shields dre employer from liabiiity for anyinjuries to those employees. In that situation, a court would usually hold the erculpatoryclause to be contrary to public policy.i7 p Exculpatory clauses found in rental agreementsfor cominercial property are frequently held to be contrary to public policy, and suchclauses are almost always unenforceable in residential property leases.

Although courts view exculpatory clauses with disfavor, they do enforce such clauseswhen they do not contravene public policy, are not ambiguous, and do not claim to pro-tect parties from liability for intentior-ral misconduct. Businesses such as health clubs,racetracks, amusement parks, skiing facilities, horse-rental operations, golf-cart conces-sions, and skydiving organizations frequently use exculpatory clauses to limit their iiabil-ity for patrons' injuries. Because these services are not essential, the firms offering themare sometimes cor-rsidered to have no relative advantage in bargaining strength, and any-one contracting for their services is considered to do so voluntarily.

Sometimes, a company includes an indemnification provision in its contracts withindependent contractors (see Chapter 2B). Such a provision, or clause, removes anyresponsibil i ty on the company's part for accidents that happen to the independent con-tractor while working for the company. When is such a provision against public policy?This was the main question in the following case.

l7 Foracasewithsimi lar facts,seeLi t t leRock&FortSmithRaiLwayCo.v.Eubanks,,18Ark.460,3S.W.808(1887)Today, this type ofexculpatory clause may also be illegal because it violates a state workers'compensation law.

Court of Appeals of Kentucky, 250 S.W.3d 339 (2008).

BACKGROUND AND FACTSSpeedway SuperAmerica, LLC,

5OI EIEEtrCAPACITY AND LECALITY

EXCUTPATORY CLAUSEA clause that releases a contractualparty from liability in the event ofmonetary or physical injury nomatter who is at fault.

lil':Ifl':ffiTl:ffl Nearly everyone isliable for hei or his own torts,and this responsibility cannotbe contracted awav.

When he was helping load it on a truck, he fell and wasinjured. Erwin sued Speedway for damages resulting from theinjury he suffered. Speedway counterclaimed, seekingen{orcement of the contract's indemnification clause. Enruinmoved to dismiss the counterclaim on the grounds that theindemnification clause was invalid and unenforceable becauseit was against public policy. The trial court held for Erur'rin.Speedway appealed.

hired Sebert Enruin to provide "General Contracting" for fiveyears, but reserved the right to end the contract at any time.The contract contained an indemnificofion clause. Under thatclause, Enruin promised to "hold harmless" Speedway foranything that happened to him while working for thecompany. One day, Erwin was told to report to a Speedwaygas station in another city and help remove a walk-in freezer.

f N THE W0RDS 0F THE C0URT . . . ACREE, tudge.

First, wl-iere a party uses an indemnification provision to defend against its own negli-gence, any distinction between a preinjury release and an indemnification provision canbecome, as it has in this case, analytically negligible. When an indemnitee fhere,Speedway] uses an indemnification provision in such a manner, the provision becomes,n._"ti

"_rt_.Ouivalent of an exculpatory, preinjury release.

A key factor, perhaps Ihe key factor, in the analysis of both preinjury releases and indemni-

fication protisions used to defend the indemnitee's own negligence, is the relative bargainingpower of the parties who enter into them. lF,nphasis added.] CASE l l .2-Cont inues next page

502 IINII@CONTRACTS

CASE I1.2-Cont inued

DECISI0N AND REMEDY rtre appeals court aff irmed thetr ial court's ruling, holding that the indemnification provision

was contrary to public policy and would not be enforced. Suchprovisions are not always against public policy, but they are

when there is no bargaining between parties of similar

strength. They are especially disfavored in the employmentrelationship.

The predominant fact of fhis case is the disparity in bargaining power existing behveen

these hvo parties. Not only did Erwin have only an eighth grade education, the one-sided

contract terms themseives are strong indication of the superior bargaining position

Speedway enjoyed. Other than the gross compensation for his work, it is difficult to see any

benefit Erwin received under this contract. Speedway's ability to cancel the five-year con-

tract "at any time, for any reason" made even the term iilusory. Erwin appears to have been

burdened with the requirements and restrictions of at-will employment by Speedway, but

with no employee-type benefits. While his annual compensation ranged roughly behveen

$38,000 and $55,000, he was responsible for paying his own taxes and health insurance, as

well as incurring the cost of any additional "personnel, materials, and equipment necessary

to complete" the Work. His obligation to provide liability insurance, which he did main-

tain, was as much for Speedway's benefit as his own. That obligation, as well as the require-

ment that he maintain worker's compensation and auto insurance, further reduced the

vaiue of his compensation. Without the abiliry, absent Speedway's consent. to assign the

contract or subcontract the Work, the contract itself had little independent value as intan-

gible property. Even if he could obtain Speedway's consent to assign or subcontract, we

doubt Erwin could find a party willing to undertake the responsibilities of this contract at

a price that would yield Erwin any profit at all. We are not in doubt that there was a signif-

icant*disparity in the bargaining positions of the parties to this contract.

The IKentucky] Supreme Court recognized that "exculpatory clauses have been inval-

idated more frequently in the context of personal injury cases where an individual is often

forced to sign a release to obtain a necessity such as * x x employment from a party in a

superior bargaining position." We believe the case before us presents such circumstances

that wernust find the provision invalid.

Such prot'isions, whether preiniury releases or indemnification provisions applied to

defend against the indemnitee's own negligence, are not against public policy generally, but

they are when agreed to by a party in a clearly inferior bargaining position. * x * It was

improbable that Erwin intended to undertake sr,rch an indemnification of Speedway, and

we wor-rld, and do, declare the provision contrary to public policy. IEmphasis added.]

WHAT IF THE FACTS WERE DIFFERENT?Suppose thot Erwin worked for onother compony as a

mover ond his employer had sent him to help Speedwoy move

the freezer. Suppose further thot the indemnificotion clause

was in o controct signed between Speedwoy and Erwin's

employer. Would thot clause be valid? Exploin your answer.

@

Should exculpgtory clauses allow the signer on opportunity to bdrgainT Before you may

engage in a variety of activit ies, such as joining a gym or taking a lap around a miniature car

racecourse, you may be asked to sign an agreement containing a clause releasing the owner

of the operation from liability for any injury that you may suffer. Such exculpatory clauses are

common. Nevertheless, courts frequently refuse to enforce them'The Wisconsin Supreme Court, for example, has invalidated every exculpatory clause

brought before it in the last twenty-five years. A recent case involved the death of a woman

50JETIEEIIilCAPACITY AND LECALITY

who drowned in a private swimming and fitness facility after signing a general waiver releasestatement.ls The Wisconsin Supreme Court ruled that the exculpatory agreement was invalidbecause, among other things, the signer did not have "any opportunity to bargain." Indeed,waiver-of-liability agreements are almost always presented on a take-it-or-leave-it basis. Thus,if all courts were to make "an opportunity to bargain" a requirement for a-valid agreement,virtually all exculpatory clauses would be deemed invalid. That would mean that under no cir-cumstances could the creator of the waiver-otl iabil i ty agreement avoid l iabil i ty-even if thesigner of the agreement was loo percent at fault and negligent. The result would be higherIiabil ity insurance rates for all businesses dealing with the public. Such higher insurance rateswould be ultimately passed on to consumers in the form of higher prices for those whoengage in downhil l skiing, go to gyms, and do bungee jumping. ls this a fair outcome?

In general, an illegai contract is void: the contract is deemed never to have existed, andthe courts will not aid either party. In most illegal contracts, both parties are consideredto be equally at farlt-in pari delicto. If the contract is executory (not yet fulfiiled), nei-ther party can enforce it. If it has been executed, there can be neither contractual norquasi-contractual recovery.

. That one wrongdoer in an illegal contract is unjustly enriched at the expense of theother is of no concern to tl-re law-except under certain circumstances (to te discussedshortly). The rnaior iustification for this hands-off attitude is that it is improper to placethe machinery of iustice at the disposal of a plaintiff who has broken the iaw by enteringinto an iliegal bargain. Another justification is the l-ioped-for deterrent effect of this gen-eral rule. A plaintiff who suffers a loss because of an illegal bargain will presumably bedeterred from entering into similar illegal bargains in the future.

- There are exceptions to the general rule that neither party to an iliegal bargain can slre

for breacl-r and neither party can recover for performance rendered. We look at theseexceptions here.

f ust i f iable lgnorance of the FactsWhen one of the parties to a contract is relatively innocent (has no reason to know thatthe contract is illegal), that party can often recover any benefits conferred in a partiallyexecuted contract. In this situation, the courts will not enforce the contract but will allowthe parties to return to their originai positions.

A court may sometimes permit an innocent party who has fully performed under acontract to enforce the contract against the guilty party. lEEFArvrprEr r.rol A trucking com-pany contracts with Gillespie to carry crated goods to a specific destination for a normalfee of $5,000. The trucker delivers the crates and later finds out that thev containecl ille-gal goods. Although the shipment, use, and sale of the goods are illegal under the law, thetrucker, berng an innocent party, normally can still legally collect the $5,000 fromGillespie. E

Members of Protected ClassesWhen a statute protects a certain class of people, a member of that class can enforce an ille-

lgal conlracf even lhough the other party cannot. lEExAMpLiltrrl Statutes prohibit cerlainemployees (such as flight attendants) from working more than a specified number of hours

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18. Atftins y. Swimwest Family Fitness Center,2005 Wl1,277 Wis.2d 303, 691 N.W.2d 134 (2005)

504 IIEIIUEICONTRACTS

BLUE SKY I.AWSState laws that regulate the offeringand sale of securities for theprotection of the public.

per month. These employees thus constitute a class protected by statute. An employee whois recruired to work more than the maximum can recover for those extra hours of service. E

Other examples of statutes designed to prote ct a particular class of people are blue skylaws-state laws that regulate the offering and saie of securities for the protection of thepublic (see Chapter 35)-and state statutes regulating the saie of insurance. If an insur-ance company violates a statute when selling insurance, the purchaser can neverthelessenforce the policy and recover from the insurer

Withdrawal from an l l legal AgreementIf the illegal part of a bargain has not ),et been performed, the party rendering performancecan withdraw from the contract and recover the performance or its value. lEexftvtFtr-tt.tilMarta and Amil decide to wager (il1ega1iy) on the outcome of a boxing match. Each depositsfunds with a stakel-rolder, who agrees to pay the winner of the bel At this point, each partyhas perforrned part of the agreement, but the illegal part of the agreement will not occur untilthe funds are paid to the winner. Before such payment occurs, either party is entitled to with-draw from the agreement by givir-rg notice to the stakeholder of his or her withdrawal. E

Severahle, or Divis ihle, ContractsA contract that is severable, or divisible, consists of distinct parts that can be performedseparately, with separate consideration provided for eacl-r part. With an indivisible con-tract, in contrast, the parties intended that complete performance by each party would beessential, even if the contract contains a number of seemingly separate provisions.

If a contract is divisible into legal and illegal portions, a court may enforce the legalportion but not tl-re illegal one, so long as the illegal portion does not affect the essence ofthe bargain. This approach is consistent with the basic policy of enforcing the legal inten-tions of tl-re contracting parties whenever possible. trEXAMpLE It=l Cole signs an employ-ment contract that includes an overly broad and thus iliegal covenant not to compete. Inthis situation, tl're court may ailow the employment contract to be enforceable but reformthe unreasonably broad covenant by converting its terms into reasonable ones.Alternatively, the court could declare the covenant illegal (and thus void) and enforce theremaining employment terms. E

How do courts decide when o controct is severoble? Severability frequently arises in casesinvolving arbitration clauses. Should a court strike out illegal portions of an arbitration clauseand en{orce the remaining provisions? That is the fairest solution, according to the U.S. Court ofAppeals for the Third Circuit in Spinetti v. Service Corp. Internotionol.le ln that case, a womansued her former employer for age and gender discrimination (see Chapter al ). The woman hadsigned a contract in which she agreed to arbitrate any disputes with the employer. Part of thearbitration clause required the employee to pay a substantial amount in fees for the arbitration($500 plus 93,750 in filing fees, $l5O per day, and half of the arbitrator's hourly fee of $250).Because these provisions would make arbitration prohibitively expensive for employees, thecourt held that they were unenforceable and illegal. The court noted that two competing pub-lic policies were involved here: first, the policy of protecting employees' ability to enforce theirstatutory rights against workplace discrimination; and second, the strong policy favoring arbitra-tion agreements. By striking out the illegal portions of the arbitration clause but still requiringthe dispute to be arbitrated, the court reasoned that it could further both goals.

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ls. 324 F.3d 212 (3d Cir. 2003)

races required her to sign an exculpatory clause to participate,which she or her parents regularly signed. In 2008, rightbefore her birthday, she participated in the annual ElkhartCrand Prix, a series of races in Elkhart, Indiana. During theevent in which she drove, a piece of foam padding used as acourse barrier was torn from its base and ended up on thetrack. A portion of the padding struck Beaver in the head, andanother portion was thrown into oncoming traffic, causing amultikart coll ision during which she sustained severe injuries.Beaver fi led an action against the race organizers fornegligence. The organizers could not locate the exculpatoryclause that Beaver was supposed to have signed. Race

tnnnrf;fflCAPACITY AND LEGALITY

organizers argued that she must have signed one to enter therace, but even if she had not signed one, her actions showedher intent to be bound by its terms. Using the informationpresented in the chapter, answer the following questions.

I Did Beaver have the contractual capacity to enter a contractwith an exculpatory clause? Why or why not?

2 Assuming that Beaver did, in fact, sign the exculpatoryclause, did she later disaffirm or ratify the contract? Explain.

5 Now assume that Beaver had stated that she was eighteenyears old at the time that she signed the exculpatory clause.How might this affect Beaver's ability to disaffirm or ratifythe contract?

4 lf Beaver did not actually sign the exculpatory clause, coulda court conclude that she impliedly accepted its terms byparticipating in the race? Why or why not?

I05

Contracts l l legal through Fraud, Duress, or Undue Inf luenceOften, one party to an illegal contract is more at fault than the other. When a party hasbeen induced to enter into an illegal bargain through fraud, duress, or undu€ influenceon the part of the other party to the agreement, the first party will be allowed to recoverfor the performance or its value.

Renee Beaver startedracing go-kartscompetitively in 2005,when she wasfourteen. Many of the

iltirl:+iit:='i ffi

I q l a les personnel . part icu-I r I larly those who are paidon a cornmission basis, areoften eager to make con-tracts. Sometimes, hou ever,these salespersons must dealwith minors and intoxicatedpersons, both of whom have limited contractual capacity.Therefore, if you are a retailer, you should make sure thatyour employees are acquainted with the law governingcontracts with minors and intoxicated persons.

Contracts with MinorsIf your business involves selling consumer durables, such asIarge-screen televisions, entertainment centers, appliances,* This Application is not meant to substitute {or the services of an attorney who is licensed to practice law in your state.

furniture, or automobiles, your sales personnel must be care-ful in forming contracts with minors and should heed theadage, "When in doubt, check." Remember that a contractsigned by a minor (unless it is for necessaries) normally isvoidable, and the minor may exercise the option to disaffirmthe contract. Employees should demand proof of legal agewhen they have any doubt about whether a customer is aminor. If the customer is a minor, the employees should insistthat an adult (such as a parent) be the purchaser or at leastcosign an1 sales contract.

In addition, because the law governing minors' rights variessubstantially from state to state, you should check with yourattorney concerning the laws governing disaffirmance in yourstate. You and those you hire to sell your products shouldknow, for example, what the consequences will be if a minor

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106 llNilurCONTRACTS

disaffirms the sale or has misrepresented l-ris or her age whenforming a sales contract. Similarly, you need to find outwhether and in what circumstances a minor, on disaffirming acontract, can be required to pay for damage to goods soidunder the contract.

Dealing with Intoxicated PersonsLittle need be said about a salesperson's dealings with obvi-ously intoxicated persons. If the customer, despite intoxica-tion, understands the legal consequences ofthe contractbeing signed, the contract is enforceable. Nonetheless, it maybe extremely difficult to establish that the intoxicated cus-tomer understood the consequences of entering into the con-tract if the customer claims that she or he did not understand.Therefore, the best advice is, "When in doubt, don't." In

other words, if you suspect a customer may be intoxicated, donot sign a contract wilh that customer.

CHECKLIST FOR THE RETAITERl When in doubt about the age of a customer to

whom you are about to sell major consumer durablegoods or anything other than necessaries, requireproof of legal age.

2 lf such proof is not forthcoming, require that a parentor guardian sign the contract.

5 Check with an attorney about the laws governingminors' contracts in your state.

4 Do not sign contracts with intoxicated customers.

adhesion contract 299blue laws 295blue sky laws 504contractual capacity 287covenant not to compete 297

disaffirmance 288emancipation 288employment contract 297exculpatory clause 501necessaries 289

ratification 291reformation 298unconscionable contract

or clause 298usury 294

Minors(See pages 288-292.)

CONTRACTUAT CAPACITY

A minor is a person who has not yet reached the age of majority. ln most stateg the age ofmajority is eighteen for contract purposes. Contracts with minors are voidable at the optionof the minor.

1. Disoffirmance-The legal avoidance of a contractual obligation.

a. Disaffirmance can take place (in most states) at any time during minority and within areasonable time after the minor has reached the age of majority.

b. lf a minor disaffirms part of a contract, the entire contract must be disaffirmed.

c. When disaffirming executed contracts, the minor has a duty to return received goods if theyare still in the minor/s control or (in some states) to pay their reasonable value.

d. A minor who has committed an act of fraud (such as misrepresentation of age) will bedenied the right to disaffirm by some courts.

e. A minor may disaffirm a contract for necessaries but remains liable for the reasonable valueof the goods.

2. Ratificotion-The acceptance, or affirmation, of a legal obligation; may be express or implied.

a. Express ratification-Exists when the minor, through a writing or an oral agreement, explicitlyassumes the obligations imposed by the contract.

IO7 GINEENCAPACITY AND LEGALITY

Minors-Continued b. lmplied ratification-Exists when the conduct of the minor is inconsistent with disaffirmanceor when the minor fails to disaffirm an executed contract within a reasonable time afterreaching the age of majority.

3. Porents' liability-Generally, except for contracts for necessariet parents are not liable for thecontracts made by minor children acting on their own, nor are parents liable for minors'tortsexcept in certain circumstances.

4. Emancipotion-Occurs when a child's parent or legal guardian relinquishes the legal right toexercise control over the child. Normally, a minor who leaves home to supportiimself orherself is considered emancipated. In some jurisdictions, minors themselves are permitted topetition for emancipation for limited purposes.

l. A contract entered into by an intoxicated person is voidable at the option of the intoxicatedPerson if the person was sufficiently intoxicated to lack mental capacity, even if the intoxicationwas voluntary.

2. A contract with an intoxicated person is enforceable if, despite being intoxicated, the personunderstood the legal consequences of entering into the contract.

l. A contract made by a person previously judged by a court to be mentally incompetent is void.2. A contract made by a mentally incompetent person whom a court has not previously declared

to be mentally incompetent is voidable at the option of the mentally incompetent person.

LEGATITY'l. Usury-Usury occurs when a lender makes a loan at an interest rate above the lawful

maximum. The maximum rate of interest varies from state to state.2. Oambling-Cambling contracts that contravene (go against) state statutes are deemed illegal

and thus void.

3. Sobboth (Sunday) /ours-These laws prohibit the formation or performance of certain contractson Sunday. Such laws vary widely from state to state, and many states do not enforce them.

4. Licensing sfotufes-Contracts entered into by persons who do not have a license, when one isrequired by statute, will not be enforceable unless the underlying purpose of the statute is toraise government revenues (and not to protect the public from unauthorized practitioners).

'l. Contracts in restroint of trade-Contracts to reduce or restrain free competition are illegal andprohibited by statutes. An exception is a covenant not to compefe. lt is usually enforced by thecourts if the terms are secondary to a contract (such as a contract for the sale of a business oran employment contract) and are reasonable as to time and area of restraint. Courts tend toscrutinize covenants not to compete closely and, at times, may reform them if they areoverbroad rather than declaring the entire covenant unenforceable.

2. Unconscionoble contracts ond clouses-When a contract or contract clause is so unfair that it isoppressive to one party, it may be deemed unconscionable; as such, it is illegal and cannot beenforced.

3. Exculpotory c/auses-An exculpatory clause is a clause that releases a party from liability in theevent of monetary or physical injury no matter who is at fault In certain situations, exculpatoryclauses may be contrary to public policy and thus unenforceable.

EFFECT OF IttEGAtITY

In general, an illegal contract is void, and the courts will not aid either party when both partiesare considered to be equally at fault (n pori delido).lf the contract is executory neither party can

lntoxicated Persons(See page 292.)

MentallyIncompetent Persons(See pbges 292-293)

ContractsContrary to Statute(See pages 293-297.)

Contracts Contraryto Public Policy(See pages 297-303.)

General Rule(See page 303.)

(Continued)

308 IMCONTRACTS

General Rule-Continued

Exceptions(See'pages 303-305.)

enforce it. lf the contract is executed, there can be neither contractual nor quasi-contractualrecovery.

Several exceptions exist to the general rule that neither party to an i l legal bargain wil l be able torecover. In the following situations, the court may grant recovery:

1. Justifioble ignoronce of the focts-When one pafi to the contract is relatively innocent.

2. Members of proteded c/osses-When one party to the contract is a member of a group ofpersons protected by statute, such as employees.

3. Withdrawol from an illegol ogreemenf-When either party seeks to recover consideration givenfor an illegal contract before the illegal act is performed.

4. Severable, or divisible, contracts-When the court can divide the contract into illegal and legalportions and the illegal portion is not essential to the bargain.

5. Fraud, durest or undue influence-When one party was induced to enter into an illegalbargain through fraud, durest or undue influence.

Answers for the even-nambered questions in this tot Review section can be found on this text's accompanying Web site otSelect "Chopter II" ond click on "For Review."

I What are some exceptions to the rule that a rninor can disaffirm (avoidl any contract?

2 Does an intoricated person have the capacity to enter into an enforceable contract?

5 Does the mental incompetence of one party necessarily make a contract void?

4 Under what circumstances will a covenant not to compete be enforceable? When will such covenants not be enforced?

5 What is an exculpatory clause? In what circumstances rnight exculpatory clauses be enforced? When will they not beenforced?

E

ffi HypoTHETrcAr scENARros AND cAsE pRoBtEMs

n ?.tr Contracts by, Minors. Kalen is a seventeen-year-old minor u'hohas just gracluated from high school. He is attending a univer-sity trvo hundred rniles from home and has contracted to rentan apartment near the university for one year at $500 permonth. He is working at a convenience store to earn enoughincome to be self-supporting. After living in the apartment andpaying monthly rent for four n-ronths, he becomes involvecl in adispute with his landlord. Kalen, still a minor, moves out andrehrrns the key to the landlord. The landlord wants to holdKalen liable for the balance of the payments due under thelease. Discuss fully Kalen's liabiliq, ir-r this situation.

I l,? Hypothetical Question with Sample Answer. A famous NervYork City hotel, Hotel Lux, is noted for its food as well as its

luxury accornrnodations. Hotel Lux contracts with a famouschef, Chef Perlee, to become its head chef at $6,000 pernonth. The contract states that should Perlee leave thee nployment of Hotel Lur for any reason, he rvill not work asa chef for any hotel or restaurant in New York, New Je rsey, orPennsylvania for a period of one year. During the first sirrnonths of the contract, Hotel Lur extensively advertisesPerlee as its head chef, and business at the hotel is excellent.Then a dispute arises between the hotel l-ranagement andPerlee, and Periee terminates his employment. One monthlater, he is hired by a farnous New )ersey restaurant just

across the New York state line. Hotel Lux learns of Perlee'semployn.rer.rt througl-r a large advertisement in a New YorkCity newspaper. It seeks to enjoin (prevent) Perlee fron.r