Contracts Quiz 2nd Semester 1995

Contracts II Quiz

1. Under what circumstances would fraud be a valid defense to a contract action?

Fraud is a deliberate inducement of a mistake on the other contracting party. However, the consideration doctrine, in its purest form, is indifferent as to mistakes by either party.

It is the certainty of mistakes that causes parties to redistribute their risks contractually in the first place. In fact, one of the risks that a contracting party distributes to himself is that the other side may have deceived him. However, since fraud involves bad faith, it may interrupt the flow of information severely enough to disturb the consideration and distort the risk distribution. Only at that point may it become a valid defense, and then only to the extent that an objective reading of the contract (under the reliance principle) would disallow the portions of the contract that the fraud distorted. Even where fraud is present, some portion of the consideration may be salvageable. And where the consideration is salvageable, the consideration doctrine requires that it be salvaged.

2. Why must we reject the notion of “legal detriment” as a requirement for contract modification? As a matter of sound regulatory policy what should we substitute in its place?

The old classical theory of contract required a “new consideration” to be present in order to modify a contract. This required a party who was under a pre-existing contractual obligation to incur some further increment of “legal detriment” in order to secure any greater promise from the party to whom he was already obligated to perform. The rigidity of this requirement has given way to the new standard of “good faith”. Under the good faith standard, parties who desire to renegotiate their pre-existing contract to modify the risk distribution in view of changing market conditions may do so without stumbling over doctrinal baggage like “legal detriment”. As sound regulatory policy, the good faith requirement protects the reliance of the parties by allowing modifications so long as they are not brought about by economic duress, as in the case where one party has already performed and the other is using his resulting power monopoly as a tool of extortion. Thus, the same principle that regulates balance of power in contractual formation in the original case, is equally operative in a modification of that contract. The fact that a pre-existing contract is present may alter the balance of power, but it does not prevent good faith redistribution of the exact same risks that have already been distributed.

3. How does modification differ from waiver? Why is it important to commercial dealings that both means of risk redistribution be allowable?

Modification is a “permanent” change in the risk distribution which requires some manifested assent by both parties. Once a modification to the contract has been successfully made, it can not be permanently retracted by one of the parties acting unilaterally. Waivers, on the other hand, may be unilaterally introduced into the contract, as well as unilaterally retracted by that same party. They are both necessary to commercial dealings because they allow contracting parties the freedom or latitude they need to do business effectively. Changing market conditions happen so quickly that parties are often looking for a means of escape from the restriction of pre-existing obligations. Allowing both modifications and waivers provides the parties with more options to subtly reallocate risks.

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