Thursday, February 13, 2014
This is the third in a series of posts commenting on the cases cited in Jennifer Martin's summary of developments in Sales law published in The Businss Lawyer.
Professor Martin discusses two Statute of Frauds (SoF) cases. The first, Atlas Corp. v. H & W Corrugated Parts, Inc. does not cover any new territory. The second, E. Mishan & Sons, Inc., v. Homeland Housewares, LLC, raises more interesting issues and is a nice illustration of the status of e-mails as "writings" for the purposes of the SoF. The latter does not seem to be available on the web, but here's the cite: No. 10 Civ. 4931(DAB), 2012 WL 2952901 (S.D.N.Y. July 16, 2012).
In the first case, Atlas Corp. (Atlas) sold corrugated sheets and packaging products to H & W Corrugated Parts, Inc. (H&W). Atlas invoiced H&W for $133,405.24, but H&W never paid. Eventually, Atlas sued for breach of contract. H&W never answered the complaint, and Atlas moved for summary judgment. Although the motion was unopposed, the court considered whether the agreement was within the SoF, as the only writings in evidence were the invoices, which were not signed by the parties against whom enforcement was sought. Having had a reasonable opportunity to inspect the goods and not having rejected them, H&W is deemed to have received and accepted the goods, bringing the agreement within one of the exceptions to the SoF, 2-201(3)(c). The contract is thus enforceable notwithstanding the SoF, and H&W, not having paid for the goods, is liable for breach.
Homeland Housewares LLC (Homeland) manufactures the Magic Bullet blender. Homeland entered into an agreement with E. Mishan & Sons, which the Court refers to as "Emson," granting Emson the exclusive right to sell Magic Bullet blenders (not pictured at left) in the U.S. and Canada. Between March 2004 and March 2009, Emson ordered well over 1 million blenders from Household. Although the price fluctuated, it was generally about $21/blender, and Emson paid a 25% up-front deposit. After 2006, the parties operated without a written agreement.
In 2008-2009, the parties agreed to change their arrangement. Household sold directly to Bed, Bath & Beyond, Costco and Amazon, but Emson sought to remain as exclusive distributor to all other retailers. Emson alleges that the parties reached an oral agreement for a three year deal, the details of which were included in an e-mail confirmation that Emson sent on April 2, 2009. Homeland's principal responded the same day in an e-mail stating that Homeland "will need to add some provisions to this. We will [g]et back to you .” Although further discussions ensued, the parties dispute whether the disputed terms were material.
In any case, the parties continued to perform. Emson sought a per unit price reduction as called for in the e-mail confirmation. Homeland refused, citing increased costs. Emson did not push the point. That fact might suggest awareness that there was no binding agreement, or it might just suggest a modification of the existing agreement, which is permissible without consideration under UCC 2-209 so long as the parties agree to it. In March 2010, Emson learned that Homeland was soliciting direct sales to retailers. The parties tried to hammer out a new deal but the negotiations failed. By June 2010, Homeland had taken over all sales of the Magic Bullet in the U.S. and Canada.
Emson sued, and Homeland moved for summary judgment, claiming that the parties had no contract because the SoF bars enforcement of any alleged oral agreement for the sale of goods in excess of $500.
As I have remarked before, I find it curious that courts automatically apply the UCC to distributorship agreements. In this case, if I understand how the transaction worked, Emson may have operated as a bailee for goods that it passed on to retailers. Since it was dealing with large merchants, it likely would only order blenders that it already intended to pass on to merchants. It was basically just a broker. The court might well find that, because of assumption of risk and perhaps other matters, this agreement was in fact one in which goods were sold from Homeland to Emson and then again from Emson to retailers. But it is also possible that the goods passed through Emson and went straight to the retailers, in which case, I'm not sure the UCC should apply. But the parties agreed that the UCC applies to distributorship agreements and the court went along with that. Whatever.
Relying on the merchant exception to the SOF in UCC 2-201(2), Emson characterizes its April 2, 2009 e-mail as a written confirmation sent to a merchant, recieved and not objected to within 10 days. If that exception applies, the parties had a binding agreement. But Homeland argues that its response, referencing additional provisions, was a sufficient objection to take it outside of the ambit of the exception. The court did not resolve that issue but found that material questions of fact remained. The court denied Homeland's motion for summary judgment.
Monday, February 10, 2014
Vonage America, part of Vonage Holdings with operations in the United States, Canada, and the United Kingdom, has encountered judicial hostility to the rather ungenerous arbitration provisions in its Terms of Service (“TOS”) agreement. See Merkin v. Vonage America Inc. A class action suit filed in California state court in September 2013 (and later removed to federal district court for the Central District of California) charges that Vonage, a voice over Internet company, billed its customers for a monthly “Government Mandated” charge of $4.75 for a “County 911 Fee,” despite the fact that no government agency mandated such a fee. The suit claims violations of the California Unfair Competition Law, Cal Bus. & Prof.Code §§ 17200, et seq., obtaining money under false pretenses contrary to Cal.Penal Code § 496, violations of the Consumer Legal Remedies Act, Cal. Civ.Code §§ 1750 et seq., fraud, unjust enrichment, and money had and received.
In December 2013, Vonage moved to compel arbitration under the mandatory arbitration provision in the TOS, and to dismiss or stay the case. Vonage contended that every customer who signs up for Vonage services is required to agree to the TOS as part of the subscription process, whether that process is performed online at Vonage's website, or by phone with Vonage sales personnel. The court considered it to be “of particular importance” that the TOS changed repeatedly since the two named plaintiffs signed up in 2004 and 2006. The April 2004 version provided
. . . Vonage may change the terms and conditions of this Agreement from time to time. Notices [of changes in the TOS] will be considered given and effective on the date posted on to the “Service Announcements” section of Vonage's website. . . . Such changes will become binding on Customer, on the date posted to the Vonage website and no further notice by Vonage is required. This Agreement as posted supersedes all previously agreed to electronic and written terms of service, including without limitation any terms included with the packaging of the Device and also supersedes any written terms provided to Retail Customers in connection with retail distribution, including without limitation any written terms enclosed within the packaging of the Device.
The court noted that Vonage modified the TOS 36 times between April 2004 and October 2013 without providing notice to its customers other than posting changes to the TOS on its website. And how it grew! The court estimated that the 2004 version consisted of some 7,500 words organized into 6 sections, while the current 2013 version consists of 13,000 words organized in 18 sections. Still, Vonage insisted that each version contained a mandatory agreement to arbitrate and a mutual waiver of the right to bring or participate in a class action. For example, the current version of the TOS contains a provision that states:
Vonage and you agree to arbitrate any and all disputes and claims between you and Vonage. Arbitration means that all disputes and claims will be resolved by a neutral arbitrator instead of by a judge or jury in a court. This agreement to arbitrate is intended to be given the broadest possible meaning under the law.
The current version of the TOS also contained language restricting the consumer from bringing claims “as a plaintiff or class member in any purported class or representative proceeding.” (The provision purported to restrict both the consumer and Vonage, but the operative language of the restriction clearly applied lopsidedly to the consumer.) Naturally, Vonage took the position that the TOS arbitration provisions covered the individual plaintiffs' claims and barred them from proceeding in a representative capacity.
In response, the plaintiffs argued that they never agreed to the TOS, but the court could not countenance this. Vonage had shown that service sign-up could not be completed, nor could a customer use the service, without accepting the TOS. The best the Plaintiffs could do was to say that they did not “recall ever clicking on an ‘I agree to the Terms of Service’ button, or something similar to that.” Clearly, this was insufficient in the face of clear design information. Further, if the argument is simply about never reading the clickwrap language, the court made it clear that “failure to read a contract is no defense to [a] claim that [a] contract was formed. Moreover, courts routinely enforce similar “clickwrap” contracts where the terms are made available to the party assenting to the contract,” citing Guadagno v. E*Trade Bank and Inter–Mark USA, Inc. v. Intuit, Inc.
The plaintiffs’ ultimate position, however, was that in any event the TOS was unconscionable, and therefore unenforceable under California law, relying on the Ninth Circuit’s 2013 decision in Kilgore v. KeyBank, Nat. Ass'n, which in turn relied upon the Supreme Court’s 1996 decision in Doctor's Assocs., Inc. v. Casarotto. The import of these cases was that generally applicable contract defenses – including fraud, duress, or unconscionability – were available to invalidate an arbitration agreement without contravening the mandate of the Federal Arbitration Act to counteract “widespread judicial hostility to arbitration agreements” and to reflect “a liberal federal policy favoring arbitration,” as the Supreme Court noted in its 2011 decision in AT&T Mobility LLC v. Concepcion.
On the issue of unconscionability, the parties launched into an extended debate as to which version of the TOS was relevant to the argument – the version as of the date of sign-up, or the current version, which was arguably more “consumer friendly.” The court swept all of this aside, declaring that it was “not necessary to resolve which version of the TOS controls for purposes of the unconscionability analysis. Even assuming that Vonage is correct and the current (allegedly more consumer-friendly) TOS is the salient version of the TOS, the Court finds that . . . the arbitration agreement contained in the current TOS is unconscionable.” Hence, the court assumed for purposes of its analysis and explanation that the current TOS governed.
Unlike the situation in Rent–A–Center, West, Inc. v. Jackson, the TOS did not include any provision “delegating” the issue of unconscionability to the arbitrator, despite the language giving the arbitration agreement “the broadest possible meaning under the law.” The court therefore proceeded with its own analysis. It began with the basic proposition that, per Kilgore, to be considered invalid under California law a contract must be both procedurally and substantively unconscionable. As to procedural unconscionability, the court found that the TOS evinced “a substantial degree of both oppression and surprise.” There was no dispute that the TOS was a contract of adhesion, which was the threshold inquiry. The consumer was confronted with the TOS during sign-up, and there was no real choice or possibility of negotiation. The consumer “must either accept the TOS in the entirety, or else reject it and forego Vonage services.” While there is support in older California case law for the proposition that adhesion and oppression are not identical (see, e.g., Dean Witter Reynolds, Inc. v. Superior Court), recent Ninth Circuit case law on the subject argues that contracts of adhesion are per se oppressive. See Newton v. Am. Debt Servs., Inc. Beyond this, the court found other clear features of oppression – the company’s unilateral ability to modify the TOS, “the largely unfettered power to control the terms of its relationship with its subscribers,” the lack of any “balance of bargaining power” – and concluded that the TOS involved a high degree of oppression.
The second factor in procedural unconscionability analysis is the question of surprise. The court was quick to emphasize that “surprise is not a necessary prerequisite for procedural unconscionability where, as here, there are indicia of oppressiveness,” citing the 2004 California case Nyulassy v. Lockheed Martin Corp. However, the court did find that there were significant features of surprise – arbitration terms buried within a lengthy contract, no separately provided arbitration agreement, no requirement that consumers separately agree to the agreement – although there was a TOS table of contents and a bolded, cautionary instruction introducing the provision. On balance, however, the court considered the finding of surprise to be “augmented by Vonage's repeated modification of the TOS” in 36 versions updated without any prior notice to the consumers. This led to a strong showing of surprise, and the court concluded that “[b]ecause the arbitration provision involves high levels of both oppression and surprise, the Court finds a high degree of procedural unconscionability.”
As to substantive unconscionability, the court’s view of the pertinent case law was that an arbitration provision was substantively unconscionable if it was “overly harsh“ or generated “one-sided results.” The court found that the TOS lacked mutuality – while purporting to require arbitration of “any and all disputes between [the consumer] and Vonage,” the TOS actually carved out exceptions for any type of claim likely to be brought by Vonage, for example, small claims, debt collection, disputes over intellectual property rights, claims concerning fraudulent or unauthorized use, theft, or piracy of services. Accordingly, the court concluded that the arbitration provision lacked even a “modicum of bilaterality,” and was therefore substantively unconscionable. Given the high degree of procedural unconscionability as well, the court found that the arbitration provision was unconscionable.
For several reasons, severance of the offending features was not appropriate. The high degree of procedural unconscionability tainted “not just the specific carve-out provision, but also the TOS and arbitration provision more generally.” Furthermore, previous versions of the TOS as well contained a variety of provisions that were likely to operate in an unconscionable way – a forum selection provision likely to be extremely inconvenient for consumers, restrictions on the ability of arbitrators to award relief to consumers, a shortened limitations period. Finally, the repeated modifications of the TOS made it difficult for the court to determine “what the TOS would look like in the absence of the offending provision.” In light of the repeated modification of the contract, it was unclear what contractual relationship could or should be conserved.
Two final points of general application are worth noting. First, the implications of the case suggest a broader impact on the telecommunications sector generally. Vonage had tried to argue that the contract was not oppressive because the plaintiffs had the option to procure telecommunications services from other providers, and thus had meaningful alternatives to contracting with Vonage. The court found this argument unpersuasive, and observed, somewhat ominously,
Vonage presents no evidence that plaintiffs in fact had meaningful alternatives to agreeing to arbitrate their claims. At most, Vonage presents evidence that the telecommunications market is competitive. . . . But Vonage does not demonstrate that plaintiffs could have procured equivalent telecommunications services from these competitors without being required to sign a similarly restrictive arbitration agreement. Indeed, as Vonage itself points out, “a ‘sizable percentage’ of [telecommunications and financial services companies] use arbitration clauses in [their] consumer contracts.” . . .
One might well wonder who among Vonage’s competitors will be next up for a class action challenge. Will they be “vonaged” as well?
Second, the Merkin decision may raise questions about the effectiveness of ostensible “opt-out” provisions that on-line providers tout in anticipation of criticism of their subscription practices. Vonage tried to argue that the TOS was not oppressive because a provision gave subscribers the possibility of opting out of any substantive change to the arbitration provision, through the transmittal of an “opt-out notice” within thirty days of the time the TOS was modified. The Court found this claim to be unpersuasive in the absence of prior notice. As the court explained,
Vonage did not provide separate notice to its subscribers when modifying the TOS; modifications were instead effective at the time they were posted to the Vonage website. As such, opting out would require a subscriber to constantly monitor the Vonage website for modifications to the TOS in order to ensure that the brief thirty-day window did not elapse. Indeed, Vonage itself appears to admit that no Vonage subscriber has ever availed himself of the thirty-day opt-out. . . . In such circumstances, the right to opt-out does not act as a meaningful check on Vonage's power to unilaterally impose modifications on its subscribers and provide subscribers with a meaningful opportunity to avoid the impact of those modifications.
Should the Merkin court’s view of the linkage between prior notice, opt-out, and validity become widely endorsed, online merchants might well find themselves in the shocking position of being required to provide meaningful notice to their consumers if they wish to continue to oppress them. Would this be crazy . . . or crazy generous to consumers?
Thursday, February 6, 2014
This is the fifth in a series of posts that draw on Michael Dorelli and Kimberly Cohen's recent article in the Indiana Law Review on developments in contracts law in Indiana.
Defendant Dean V. Kruse Foundation (Kruse) operates a World War II and automobile museum in Auburn, IN. It owned a property, but it could not generate sufficient income on the property to meet expenses, and so it sought to sell the property. Plaintiff Jerry Gates (Gates) eventually purchased the property at auction for $4.2 million.
The Purchase Agreement required a deposit of $100,000 in earnest money. After voicing concerns about the property's condition and title, Gates terminated the Purchase Agreement. Kruse threatened that it would seek specific performance. Eventually, it sold the property to a third party for $2.35 million.
Gates eventually sued Kruse and its realtor for breach of contract, fraud and conversion. Kruse counterclaimed for breach of contract and slander of title. The trial court granted summary judgment to Gates and ordered Kruse to return the earnest money with interest. The Indiana Court of Appeals reversed and remanded with instructions to enter summary judgment in favor of Kruse and to hold a hearing on damages. At that hearing, Kruse sought damages of about $2.5 million plus prejudgment interest. The damages represented the difference between the contract price and the price on resale. Kruse also sought a $200,000 buyer's premium that was part of the Purchase Agreement, but was willing to set off the $100,000 earnest money against the amount owed.
The trial court determined that the provision for $100,000 in earnest money was a liquidated damages clause. Kruse had the additional option of suing for specific performance, but it did not do so. The trial court therefore held that its dmaages were limited to the $100,000. Kruse appealed. In Dean V. Kruse Foundation v. Gates, the Court of Appeals once again reversed the trial court and remanded with instructions.
Kruse argued that the liquidated damages clause was in fact an impermissible penalty clause, among other reasons because the Purchase Agreement provided for specific performance. Under Indiana Law, "liquidated damages clauses are generally enforceable where the nature of the agreement is such that damages for breach would be uncertain, difficult, or impossible to ascertain." After reviewing relevant precedents, the Court of Appeals concluded that the clause at issueindicated an intent "to penalize the purchaser for a breach rather than an intent to compensate the seller in the event of breach." The first prong of the test thus suggested a penalty clause.
The Court next considered whether the alleged penalty was disproportionate in relation to the amount to be lost in case of breach. The Court could not determine whether it was at the time Gates bid on the property. Liquidated damages clauses are used where the potential harm is uncertain. So, the question was whether or not damages were uncertain. Incredibly, the Court of Appeals found that they were not, because there was expert testimony presented that the market value of the property at the time of the breach was $3.5 million.
Huh? The property sold once for $4.2 million and then again for $2.35 million. Since the parties could not know in advance when a breach would occur, and factual record reveals that the value of the property fluctuated considerably, to say that the parties could have known in advance the harm that would result from a breach seems quite fanciful. Nevertheless, the Court of Appeals struck down the earnest money provision as a penalty clause.
Kruse also argued on appeal that its remedies were not limited to the liquidated damages provision and specific performance. The Court agreed, since the parties had not expressly limited their remedies.
The outcome of the case is that Kruse retained all of its contractual remedies except for the two clearly provided for in the Purchase Agreement: the earnest money, which was struck down as a penalty, and the right of specific performance, which Kruse chose not to exercise. This all seems quite backwards. If it was a penalty clasue, it was a penalty clause that protected Kruse's interest in forcing Gates to stick with the deal. If the penalty proved inaccurate, it seems quite odd that Kruse should have standing to argue that the penalty it imposed was inappropriate. I have never heard of a penalty clause being struck in favor of a claim for damages 25 times higher than the alleged penalty.
The case was remanded back to the trial court again for a calculation of damages.
Monday, February 3, 2014
We learn more about public policy limits on enforcement of arbitration clauses in a January 2014 ruling of the SDNY in National Credit Union Admin. Bd. v. Goldman, Sachs & Co. The case is a $40 million suit filed in September 2013 by the National Credit Union Adminsitration as Liquidating Agent of failed credit unions Southwest Corporate Federal Credit Union and Members United Corporate Federal Credit Union. A spinoff from the capital markets collapse of 2008, the complaint alleges that Goldman, Sachs – through GS Mortgage Securities Corp. – misrepresented the quality of securities sold in 2006 and 2007 to the two credit unions, in violation of sections 11 and 12(a)(2) of the Securities Act of 1933, 15 U.S.C. §§ 77k, 77l(a)(2), and the Texas Securities Act, Tex.Rev.Civ. Stat. Ann. art. 581, § 33 (2013).
Goldman’s immediate response was to move for an order to compel arbitration, based on arbitration provisions in a 1992 cash account contract between Goldman and Southwest that appeared to govern “any controversy” between the parties. Citing 12 U.S.C. § 1787(c), the NCUA had repudiated the Cash Account Agreement between Southwest and Goldman Sachs. The court found that the NCUA had met the requirements of the statutory provision, and therefore the agency had broad authority to repudiate contracts that might burden its administration of a troubled credit union. Accordingly, the court denied Goldman’s motion.
While this ruling is certainly consistent with growing policy skepticism about arbitration clauses discussed in an earlier Global K post, we need to keep in mind what the ruling does and does not represent. First, it is by no means the final word in this litigation. As the court noted in passing, Goldman had expressly reserved the right to file a motion to dismiss in the event that the court rejected the motion to compel arbitration. There is no reason to doubt that such a motion will be forthcoming.
Second, we should not over-read the ruling as a repudiation of arbitration clauses. In the course of its discussion, the court was careful to note the strong policy of the Federal Arbitration Act (FAA) “to counteract ‘widespread judicial hostility to arbitration agreements’ and [to] reflect ‘a liberal federal policy favoring arbitration,’ ” quoting AT&T Mobility LLC v. Concepcion.
Nevertheless, the ruling does accord considerable credibility to the position that, despite the strong and longstanding FAA policy in favor of arbitration, a broad arbitration clause frustrates supervisory efforts to resolve institutional failures and should not be enforced in a financial institutions receivership. This observation leads to the third point to be noted – that in a regulated industry, contract law expectations skew in favor of overarching supervisory policy. Like the corresponding policy that applies to failed banks in FDIC receivership under 12 U.S.C. § 1821(d) and § 1823(e), § 1787(c) allows the NCUA as conservator or liquidating agent to “disaffirm or repudiate” any contract or lease of which the failed credit union is a party, if the conservator or liquidating agent determines in its discretion that the performance would be “burdensome” to it, and the disaffirmance or repudiation would “promote the orderly administration of the credit union's affairs.” Significantly, the Second Circuit has long taken the same position as National Credit Union Administration in cases dealing with bank receiverships. See, e.g., Resolution Trust Corp. (“RTC”) v. Diamond, 45 F.3d 665, 670 (2d Cir.1995); Westport Bank & Trust Co. v. Geraghty, 90 F.3d 661, 668 (2d Cir.1996). While the credit union statute allows for claims for damages for the contract repudiation, such claims are “limited to actual direct compensatory damages,” and expressly exclude claims for “lost profits or opportunity.” We must await further developments in this litigation to assess how far contracts principles skew in favor of supervisory intervention.
Tuesday, January 28, 2014
Last week, Myanna Dellinger posted about tipping and Uber. One piece of information she provided in that post that was new to me was that servers were tipped only about 10% on the West Coast until about ten years ago. It seemed odd to me that there should be a more stingy tipping culture in the West. After all, one does not imagine Hollywood players threatening one another with "You'll never tip 10% in this town again."
Yesterday's New York Times provides a timely explanation of this anomaly. It turns out, tips may be lower on the West Coast because wages are higher. While the federal minimum wage for waiters who earn tips is only $2.13, states are free to mandate higher miniumum wages, and states in the West are most likely to do so. In Washington State, a waiter's base pay is $9.32/hour.
Myanna has lived in Europe so she knows that the real solution to the problem is to pay servers a living wage. If restaurant patrons want to reward them for especially fine service, they are welcome to do so, but with many servers living below the poverty line, they should be protected against economic surges and depressions that are beyond their control.
The restaurant industry protests against any rise in the minimum wage and is fighting legislation supported by the Obama administration that would incrementally increase the minimum wage for tip-earners to $7.25/hour. But restaurants can learn from cabbies. Pass increased costs onto customers by increasing menu prices, but then recommend that patrons tip only 10%. Across the nation, people with math phobia will delight in the ease of calculation.
Myanna's post about Uber got me thinking about a recent trip to New York City. New York City was the first city in which I took the occasional cab. I went to college and to law school there. When I was in college, some kindly relative told me that cabbies should get a 10% tip, and I have lived by that ever since. Turns out my kindly relative was a cheapskate.
As this article from The New York Times from about a year ago indicates, as early as 1947, cabbies expected at least 12½%, and until recently average tips exceeded 20%. Tips have come down as fares have gone up, and as of a year ago they averaged just over 15%.
New York City cabs are now equipped with credit card readers that offer riders the option to leave a tip. The reader will automatically add a tip, and it gives riders the option of tipping 15%, 20% or 25%. Behavioral economics suggests that most people will choose the middle one, and so it seems that the aim of the screen is to get cabbies' tips back up to where they were before the fares increased. When I saw these three options, I felt oppressed and manipulated, since I was still operating on the assumption that 10% is what is expected. Now I feel guilty that I did not tip more reasonably. In my own defense, I didn't save myself any money, since the my law school reimbursed me for my travel expenses on that trip. So you see, I wasn't being cheap; I was being a responsible steward of my law school's resources. But no more stingy tips for me.
I am a work in progress. I was as astonished as was Jerry Seinfeld (the character) to learn that chambermaids expect $5 a night (see the scene below, starting about 1:40 in).
Ann Landers is an even bigger cheapsake than my relative. Before we saw this, I would tip $2 a night, and I still think $5 a night is rather high. After all, Jerry Seinfeld (the character) is an experienced traveler, and he seems pretty free with his money. If he gives $1, $2 seems okay. But my wife and daughter agree with the suspected serial killer. Five dollars it is. It would have been interesting to see if chambermaids noticed an increase in generosity following the airing of this episode. And I wonder if they now wish that cable channels would stop showing Seinfeld reruns. The episode is now at least fifteen years old, so if $5 a night was a good tip then, one should expect $10 /a night now.
Monday, January 27, 2014
Offshore friends and colleagues are often confused or frustrated by the U.S. approach to resolving financial exploitation or manipulation of consumers. Why is it assumed that private remedies are the appropriate response to such pervasive problems, they ask. How is it that U.S. consumer protection law is so often merely a matter of perfunctory disclosures that noone reads, they complain. Certainly, much of the run-up to the capital markets collapse of 2008 involved rather blatant abuse of consumers, but when the Great Reccession emerged, only the high end of the economy received massive government support, while affected mortgagors were left largely to whatever remedies or defenses they could fashion from applicable transactional law. One might legitimately wonder at these official responses.
A recent decision, In re Late Fee and Over–Limit Fee Litigation, issued by the Ninth Circuit on January 21, 2014, offers an interesting variation on this problem. The case also highlights the limits of ordinary principles of contract law in addressing contemporary issues of consumer protection.
A group of credit cardholders, who had allegedly paid excessive late fees and over-limit fees to issuing banks, brought a class action against the issuers, claiming on a flurry of legal grounds that the fees should not be enforceable. Some of these grounds were regulatory. Others sought to align the judicial treatment of torts remedies with that of contracts remedies. Among other things, the plaintiffs argued that the fees violated usury limits under the National Bank Act, 12 U.S.C. §§ 85–86, or were otherwise excessive under the corresponding provisions of the Depository Institutions Deregulation and Monetary Control Act (“DIDMCA”), 12 U.S.C. § 1831d(a), which applied to state-chartered, FDIC-insured banks. Even if seemingly in compliance with these regulatory statutes, plaintiffs asserted, the fees were so excessive as to be unconstitutionally punitive. They also made a try at arguing that the issuing banks had conspired to fix prices and maintain a price floor for late fees in violation of the Sherman Act, 15 U.S.C. § 1 et seq. Furthermore, the plaintiffs alleged, the fees violated the California Unfair Competition Law, Cal. Bus. & Prof.Code § 17200 et seq.
The district court found it hard to accept these challenges given the routine practices of the issuers. In accordance with federal law, the fees had been disclosed in the contracts between the issuers and the cardholders, and were fairly uniform and typically between $15 and $39 – amounts that the plaintiffs argued still vastly exceeded the harm the issuers actually suffered when their customers charged beyond their credit limits or made late payments. The Northern District of California dismissed the action for failure to state a claim.
On appeal, the cardholders argued that the fees should be treated like the punitive damages that were subjected to substantive due process limits in the Supreme Court’s 1996 decision in BMW of North America, Inc. v. Gore and its 2003 decision in State Farm Mut. Auto. Ins. Co. v. Campbell. Hence, even if permitted by federal regulatory law, the fees should be refused enforcement on constitutional grounds. Nevertheless, the Ninth Circuit affirmed, holding that substantive due process principles – developed in the context of jury-awarded punitive damages in tort cases – did not apply to liquidated damages clauses in contracts cases. As the court explained, “[t]he jurisprudence developed to limit punitive damages in the tort context does not apply to contractual penalties, such as the credit card fees at issue in this case.” It also held that the banks could not be liable for excessive charges under the state unfair competition law, since the late fees and over-limit fees were charged by banks in conformity with federal law. As Judge Nelson observed in her opinion for the court, “[b]ecause we conclude that the issuers' conduct did not violate the National Bank Act or the DIDMCA, there is no derivative liability under the Unfair Competition Law.”
Judge Nelson recognized that the case turned on the relative similarities and differences between liquidated damages and punitive damages. It is a commonplace of contracts remedies that “liquidated damages” are enforceable if the damages are likely to be difficult to determine at the time of agreement and the liquidated sum represents a good faith effort by the parties to quantify. See, e.g., UCC § 2–718(1). However, if the liquidated damages provision were “unreasonably large,” it would be treated as an unenforceable penalty.
Judge Nelson also acknowledged that “[l]ike the common-law rule against contractual penalty clauses, punitive damages have an ancient provenance.” The key to the case was the plaintffs’ attempt to meld these two historical traditions to invalidate otherwise enforceable contractual fees, on a constitutional basis. This the court refused to do. “[C]onsidering that the penalty clauses at issue originate from the parties' private – albeit adhesive – contracts, they are distinct from the jury-determined punitive damages awards,” Judge Nelson concluded. “Adhesive” though the contracts may be, the court was not prepared to invalidate fees ostensibly permitted by federal law.
Ironically, the problem seems to be that contracts law had already long assimilated excessiveness as a ground for unenforceability of a penalty clause without the invocation of due process notions. Hence, if a regulatory statute interevened – as the National Bank Act and DIDAMCA provisions arguably had – to permit a standardized fee that might otherwise be argued to be excessive, the question was whether a litigant could resuscitate the excessiveness argument with a jolt of due process. The basic reason for not exploring this possibility is that this had only been done in tort remedies theory, not contracts.
I am not sure that that is a very compelling reason. Apparently, neither did the Ninth Circuit. Judge Reinhardt concurred in the judgment “reluctantly.” In his view, the Supreme Court would be “well advised” to apply the prinicples of BMW of North America, Inc. and State Farm Mut. Auto. Ins. Co. “to prevent disproportionate penalties from being imposed on consumers when they breach contracts of adhesion.” He reluctantly admitted that the opinion of the court was correct in recognizing that due process constraints in the Constitution had not yet been interpreted so widely, but he gave a stirring and persuasive analysis of why it should be.
Judge Reinhardt’s separate opinion deserves the serious attention of contracts scholars and practitioners, as a possible map of future developments. Apparently, Judge Nelson, the author of the court’s opinion, agrees with me, because – in an extraordinary gesture – Judge Nelson also wrote separately to join Judge Reinhardt's concurrence, “although [she] agree[s] that the district court reached the correct result under currently applicable law and should be affirmed.” Are they suggesting the need for further judicial review?
Last week, we noted Michael Dorelli and Kimberly Cohen's recent article in the Indiana Law Review on developments in contracts law in Indiana. This week, we will be summarizing some of the important cases discussed in that article.
East Porter County School Corporation v. Gough, Inc. is a pretty typical bid case. Gough, Inc. (Gough) submitted a bid of around $3 million to the East Porter County School Coporation (the County) on some additions, presumably to school buildings. Just after the deadline for the submission of bids, but likely before the bids were unsealed, Gough tried to withdraw its bid, claiming that its bid was the result of an inadvertent clerical error. One month later, the County awarded the contract to Gough. Gough's president notified the County that the bid was incorrect and stated that Gough would not accept the contract. Gough returned the contract to the County unsigned.
When the County tried to enforce the contract, Gough brought suit, seeking a declaration that its bid be rescinded and its bid bond released. The County counterclaimed, alleging breach of contract by both Gough and its bid bonding agency, Travelers Casualty and Surety Company of America (Travelers). The trial court granted the Gough and Travelers summary judgment, citing a 1904 case that permitted excuse of a contractor's bid based on mistake.
The law in Indiana excuses bids based on mistakes in calculation or clerical errors but not based on errors in judgment. Gough's presidnet submitted an affidavit in which he stated that on the day that Gough submitted its bid, its total of the bids of its subcontractors and its own cost estimates came to just over $3.3 million. "For psychological reasons," Gough wanted to get the bid below $3.3 million, but they spoke of trying to get to 299 or 2998. They thus mistakenly wrote down a bid of $2.998 million, which they then arbitrarily cut down to $2,997,900, when they apparently intended $3,299,700. Gough then quickly realized that the error would result in a $200,000 loss on the project, so Gough attempted to pull the bid.
The Court of Appeals found that, as a result of the error, the minds of the parties never met and the County "would obtain an unconscionable advantage" as a result of Gough's mistake. Because Gough timely notified the County of the mistake, the County was not in any way harmed by its withdrawal of its bid. As a result, the Court ruled that the County had no right to enforce Gough's erroneous bid, nor did Traveler's have any obligation to pay its bid bond.
I have no problem with this result, but the "meeting of the minds" language strikes me as misplaced in this context. Many contracts professors dislike the phrase "meeting of the minds" because it suggests that subjective agreement on terms is what is required when the test for whether or not a contract formation is objective. Twenty bishops could attest to Gough's president's veracity and still he would be bound if a contract had actually been formed. But here no contract was formed because the bid was withdrawn before it was accepted. In this circumstance, courts should really only ask two questions. First, was the bid irrevocable? If so, Gough should bear the burden of its own mistake -- and the existence of the bond suggests that the parties have allocated the burden. If not, the second question is whether the bid was relied upon, and it was not. So really the case should turn on whether or not the bid was irrevocable and not on whether the parties "minds" met or on how the court categorizes Gough's mistake.
This is not to find fault with the Court in this case, which simply followed Indiana precedent. But the case nicely illustrates the difficulties in distinguishing between clerical or calculation errors and errors of judgment. Sure, Gough's principals made a clerical mistake reducing their bid by $330,000 when they meant to reduce it by only $30,000, but one could also argue that the decision to reduce the bid is a judgment, especially when one does so for "psychological reasons." Once they made the decision to reduce their bid, the fact that they committed a clerical error in carrying out that judgment is epiphenomenal.
Monday, January 20, 2014
In the mid-1990s, the Walt Disney Company hired Michael Ovitz to be its #2 executive. After slightly over a year in the position, Disney's Board of Directors fired Ovitz, having determined that he was an ineffective executive for the company. He received over $100 million in severance pay. After years of litigation, the Delaware courts found that Disney's Board of Directors did not breach its duty of care in approving an excecutive compensation scheme that made Ovitz better off for having been terminated than he would have been had he stayed on the job. The Delaware Supreme Court noted that Disney's corporate governanace was far from optimal and should not pass muster in a post-Enron/WorldCom etc., world. I have written about the case here.
According to this article in The New York Times, Yahoo! was not paying attention. In 2012, Yahoo! hired Henrique de Castro to be its #2 executive. He lasted a little over a year and is now walking away with at least $88 million. The Times quotes Charles M. Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, who says that such hiring decisions are usually made by the corporation's CEO and that the Board can't tell the CEO whom to hire. However, Professor Elson also notes that Boards have an obligation to "ask hard questions," especially when executive compensation seems "out of whack." Mr. de Castro was the eighth highest paid executive in the region, earning more than Yahoo!'s CEO.
I suppose it is usually true that a Board cannot tell a CEO whom to hire, but the Board and its Compensation Committee do set executive pay. And nobody at that level can be hired without Board approval. In order to lure an executive of de Castro's experience, a corporation must offer "downside protection." That is, a business person of de Castro's experience is not going to leave a secure, well-compensated position without a guarantee that he will be well-compensated at the new position, even if the relationship sours. However, as the Times points out, de Castro's record at Google was mixed. He had been demoted and then promoted again, which suggests his position was not that secure. In any case, his compensation seems to have been well in excess of what was necessary to protect his potential downside.
Board capture apparently is still a major problem in U.S. public companies, and the Times suggests that the problem is especially bad in Silicon Valley. The real problem is that executive pay remains absurdly, stratospherically high in this country. No pay package should be structured to guarantee millions in dollars of severance even in cases of abject failure.
Friday, January 17, 2014
The main character of James Joyce's short story, "A Mother" (beginning on p, 103 of the link), is a naturally pale woman with an unbending manner who made few friends at school. She became Mrs. Kearney out of spite, Joyce tells us, when her friends began to loosen their tongues regarding her impending spinsterhood. Hoppy Holohan had been attempting for nearly a month to arrange a series of concerts for the Eire Abu Society, but he had no success until he came across Mrs. Kearney, who then "arranged everything."
She did so because she desired that her daughter, Kathleen, perform as accompanist at the Society's concerts. Once Mr. Holohan approached her, Mrs. Kearney "entered heart and soul into the details of the enterprise, advised and dissuaded: and finally a contract was drawn up by which Kathleen was to receive eight guineas for her services as accompanist at the four grand concerts."
The relationship sours as soon as the concerts begin. Wednesday's concert is poorly attended. Thursday's concert is better attended, but the audience "behaved indecorously, as if the concert were an informal dress rehearsal." Moreover, as Mrs. Kearney noted, and Mr. Holohan conceded, "the artistes" were not good. But the real conflict arose over a decision by the "Cometty" of the Society to reduce the number of concerts from four to three. Mrs. Kearney attempted to protest to Mr. Holohan that any such decision did not alter the contract, and her daughter would be paid for all four concerts.
We none of us can help our natures, and Mrs. Kearney's frosty and haughty disposition, coupled with Mr. Holohan's well-intentioned ineptitude combine to form the equivalent of Chekhov's gun introduced in Act I which must be fired in Act III. When Mrs. Kearney threatens that her daughter be paid in advance or she will not perform in the final contract, Mr. Holohan attempts to disclaim all authority and refers her to the elusive Mr. Fitzpatrick.
One Mr. O 'Madden Burke was to write a notice of the concert for The Freeman. Joyce describes him as "a suave, elderly man who balanced his imposing body, when at rest, upon a large silk umbrella. His magniloquent western name was the moral umbrella upon which he balanced the fine problem of his finances. He was widely respected." After a few rounds of haggling over Ms. Kearney's pay, Mr. O 'Madden Burke declared that "Ms. Kathleen Kearney's musical career was ended in Dublin."
There are dangers in insisting that contractual promises are irrevocable.
Tuesday, January 14, 2014
$350,000. That’s the value an anonymous American big game hunter is willing to pay to shoot one of the world’s last 5,000 black rhinoceroses. 1,700 of these live in Namibia, which recently auctioned off a permit to kill an old bull through the Dallas Safari Club.
Contracts are meant to assign market values to various items and services in order to facilitate commercial exchanges of these. But does this make sense with critically endangered species?
Namibia and the Safari Club tout the sustainability of the sale claiming that the bull is an “old, geriatric male that is no longer contributing to the herd.” All $350,000 will allegedly go to conservation measures. That is, of course, unless some of the funds disappear to corruptness, not unheard of in the USA and perhaps not in Namibia either. Although the male may no longer be contributing to his herd, he does contribute to the enjoyment of, just as one example, people potentially able to see him and his likes on safari trips as well as to a much greater number of people around the world who simply enjoy the rich diversity of nature as it still is even if unable to personally see the animals.
Conservationists thus decry the sale, claiming that it is “perverse” to kill even one of a species that is so rapidly becoming extinct. The argument has been made that critically endangered species should not be valued more dead than alive. If humans cull the aging, natural predators will have to go one step “down the ladder” for the next one; a healthier one. Who are we to continually mess with nature in these ways? Counterarguments are made that poachers are the real problem, not a “single sale.” And so it goes.
At bottom, the irony in killing such an animal to “increase” the population is, indeed, great. This particular contract was not.
Monday, January 13, 2014
Over the past year, there has been an explosion of interest – and a frenzied up-swing in trading – in bitcoins. Writing in The New York Times in late December 2013, in an article called Into the Bitcoin Mines, Nathaniel Popper noted that “The scarcity — along with a speculative mania that has grown up around digital money — has made each new Bitcoin worth as much as $1,100 in recent weeks.” From a socio-economic perspective, this offers an unusual opportunity to observe the emergence and development of an entirely new, and so far unregulated, kind of market. Scholars like Wallace C. Turbeville interested in the law and policy of financial services regulation are now presented with an important opportunity to test assumptions we often blithely make about the ways in which regulation interacts with business and commercial activity.
Policymakers may confront a moment of truth – to regulate or not to regulate, and when, and how. Earlier this month, National Taxpayer Advocate Nina Olson argued that the IRS should give taxpayers clear rules on how it will handle transactions involving bitcoin and other digital currencies accepted as payment by vendors. The Senate Homeland Security and Governmental Affairs Committee held hearings on bitcoins and other “cryptocurrencies” several weeks ago, and may have a report on the situation early next year after further consideration, but Committee Chair Sen. Thomas Carper (D-Del.) seems to be taking a “wait and see” attitude. Meanwhile, the People’s Republic of China has already banned banks from using bitcoins as a currency, while U.S. regulators have not addressed the use of virtual currencies, even as an increasing number of vendors – including Overstock.com – have announced that they will accept them in payment for transactions.
One basic problem is the difficulty in determining what is involved in bitcoin creation and trading. Unfortunately, we are as yet at the mercy of metaphors. For example, within the first six paragraphs of his NYT piece, Popper refers to bitcoins as “virtual currency,” “invisible money,” “a speculative investment,” “online currency,” and “a largely speculative commodity.” In point of fact, bitcoins are book-entry tokens awarded for successfully solving highly complex algorithms generated by an open-source program, The program is disseminated by a mysterious, anonymous sponsor or group known only as Satoshi Nakamoto – the digital world’s version of Keyser Söze.
Determination of the proper legal characterization of bitcoins is essential if we are to choose appropriate transactional and regulatory approaches. For example, if bitcoins really are a “virtual currency” – a meaningless phrase, a glib metaphor – then fiscal supervision by the Federal Reserve might be the most appropriate approach to regulating bitcoin activity. Further, if they are in any significant sense “currency,” then treatment under the U.S. securities regulation framework would be problematic, since “currency” is excluded from the statutory definition of “security” in section 3(a)(10) of the Securities Exchange Act. Similarly, if bitcoins are viewed as some sort of currency, they would then likely be an “excluded commodity” under section 1a(19)(i) of the Commodity Exchange Act. On the other hand, if bitcoins are viewed as derivatives of currency or futures contracts in currency, then they may be subject to securities regulation, or possibly commodities regulation, depending upon the basic characteristics and rights of the financial product itself. The exact delimitation between treatment as a security and treatment as a commodity is currently the subject of study and proposed rulemakings by the SEC and the CFTC.
Recent news reports have noted that bitcoins are beginning to be accepted by more and more vendors as a form of payment. If in fact it becomes a commonplace that bitcoins operate as a payment mechanism, then we must deal with the possibility that they should be subject to transactional rules of the UCC and the procedures of payment clearance centers. It is at this point that the contractual aspects of bitcoins become critical features of our analysis.
Conceivably, we might go further and argue that bitcoins are functionally a type of note – relatively short-term promises to pay the holder – in which case, they would be subject to UCC article 3, exempt or excluded from securities registration requirements, but possibly still subject to securities antifraud rules. This is an attractive alternative, since it would give us some definite transactional rules to work with, plus antifraud protection against market manipulation – if we could figure out what “manipulation” should mean in the strange new world of cryptocurrencies.
Sunday, January 5, 2014
The recent discussion of the December 2013 decision by the Ninth Circuit in In re Wal-Mart Wage & calls to mind the contrast in attitudes between international and domestic practice. Mention “arbitration” among international practitioners and profs, and you are likely to get a bit of a swoon from most – arbitration, properly structured, rescues us from the risks and uncertainties of unfamiliar legal systems and provides a comfort level in terms of predictability of process if not outcome. Mention "arbitration" in domestic circles, particularly with respect to consumer protection issues, and you encounter a growing skepticism if not outright hostility about the imposition of arbitration as an exclusive contract remedy.
There are delicate ironies in these contrasting attitudes. Many would say that the contrast – to the extent it actually exists – simply reflects the difference between complex disputes at the “wholesale” level, between commercial actors with more or less equal bargaining power, and consumer disputes in which arbitration is imposed by the dominant party on the “retail” party. However, In re Wal-Mart itself undermines that neat dichotomy, since it involves parties with, presumably, more or less equal bargaining power. In any event, there is certainly nothing in principle or in text that suggests a wholesale-retail split in the approach to deciding arbitration challenges. (Consider, for example, the Supremes’ 2011 AT & T Mobility LLC v. Concepcion, upholding an arbitration provision in a class-action consumer suit, and the Ninth Circuit’s own 2003 en banc decision in Kyocera Corp. v. Prudential–Bache Trade Servs., Inc., upholding arbitration in what was ostensibly a “wholesale” transaction between commercial parties.) It is nevertheless clear that there is a growing conception – or preconception – that arbitration clauses may be hostile to, or at least incompatible with, consumer interests.
This conception does have textual support in the 2010 enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 1414(a) of the Act added a provision to the Truth in Lending Act, 15 U.S.C. § 1639c(e)(1), that prohibits the inclusion in any home mortgage or home equity loan of “terms which require arbitration or any other nonjudicial procedure as the method for resolving any controversy or settling any claims arising out of the transaction.” However, as with so many of the provisions of the Dodd-Frank Act, § 1639c contained a special delayed effective date, namely, the date on which final regulations implementing the prohibition took effect, or a date 18 months after the transfer of authority to the new Consumer Financial Protection Bureau, whichever is earlier. Nevertheless, in the November 2013 case State ex rel. Ocwen Loan Servicing, LLC v. Webster, the Supreme Court of Appeal of West Virginia found that the delayed effective date “only applies to those portions of Title XIV that require administrative regulations to be implemented.” Accordingly, the effective date of this prohibition was the general effective date of the act, July 22, 2010. Good for us, not so good for the consumer plaintiffs suing the mortgage servicer, since their mortgage agreement containing an arbitration clause was entered into several years prior to the enactment of the Dodd-Frank Act. The West Virginia court refused to apply the Dodd-Frank Act retroactively, and proceeded to decide that it was compelled to enforce the arbitration clause in light of the mandate of the Federal Arbitration Act, which generally favors the application and enforcement of such clauses, despite the plaintiffs’ claims that the arbitration clause was procedurally and substantively unconscionable. Ocwen Loan Servicing is worth a careful read, particularly in light of its consideration of the interplay among emerging statutory policy with respect to consumer protection, general federal policy in favor of arbitration, and the contract doctrine of unconscionability.
Monday, December 30, 2013
I have been thinking a lot about Peggy Radin's book Boilerplate and her arguments about how boilerplate contacts threaten a democratic degradation (discussed elsewhere on the blog by Brian Bix, with Peggy Radin responding here, and by David Horton) because they permit private parties, powerful companies, to negate statutory or common law rights. The Ninth Circuit has put its foot down and refused to permit a potential innovation in the direction of democratic degradation, but the odd thing about the case is that the arbitration agreement at issue here seems to have been among parties with fairly even bargaining power.
On December 17, 2013, the Ninth Circuit issued its opinion in In re Wal-Mart Wage & Hour Employment Practices Litigation, affirming the District Court's confirmation of an arbitration award and rejecting appellee's argument that the Court was without jurisdiction because the parties agreed to binding, non-appealable arbitration.
The dispute at issue arose in the aftermath of an $85 million settlement agreement between Wal-Mart and a class of employee-plaintiffs. As part of that settlement, the parties agreed to have all disputes as to fees decided by an arbitrator. The District Court awarded $28 million in attorneys' fees, but plaintiffs' counsel quarreled over the proper allocation of that fee award. That dispute was submitted to "binding, non-appealable arbitration."
The arbitrator divided the fee among three law firms, and one of them brought suit in District Court challenging the allocation. The District Court found no grounds to vacate the arbitrator's award, and the law firm that challenged the award appealed. The firm that got the lion's share of the fee award argued that there could be no appeal due to the "non-appealable" language in the arbitration agreement.
The Ninth Circuit found the language of the agreement ambiguous. "Non-appealable" could just preclude courts from reviewing the merits of the arbitrator's decision, or it could mean that no federal court could exercise jurisdiction in the case. The Ninth Circuit concluded that the second meaning would be unenforceable in any case, as inconsistent with the provision for judicial review of arbitration awards under Section 10 of the Federal Arbitration Act (FAA). Citing Hall Street Associates, L.L.C. v. Mattel, Inc., 552 U.S. 576 (2008), in which the Supreme Court rejected an arbitration agreement that expanded the grounds for judicial review of an arbitration award, the Ninth Circuit reasoned that "[j]ust as the text of the FAA compels the conclusion that the grounds for vacatur of an arbitration award may not be supplemented, it also compels the conclusion that these grounds are not waivable, or subject to elimination by contract." As if the Court had the concept of democratic degradation in mind, the opinion continues:
Permitting parties to contractually eliminate all judicial review of arbitration awards would not only run counter to the text of the FAA, but would also frustrate Congress’s attempt to ensure a minimum level of due process for parties to an arbitration. . . . If parties could contract around this section of the FAA, the balance Congress intended would be disrupted, and parties would be left without any safeguards against arbitral abuse.
In a separate memorandum disposition, the panel affirmed the District Court's confirmation of the aribral award.
Tuesday, December 17, 2013
Sunday, December 15, 2013
London, UK: Current events smiled on GLOBAL K last week and offered an example of how contemporary economic sanctions programs interact with transnational contract activity. (See last week’s Global K.) While I was lecturing at the Centre for Commercial Law Studies in London, the news broke about possible sanctions violations by a British bank in its payment transfer practices.
On December 11, 2013, the British press was full of the news that Royal Bank of Scotland plc (RBS) had agreed to pay £62 million ($100 million) to settle charges by U.S. state and federal banking authorities that it had violated U.S. sanctions against Iran, Burma, Libya and Sudan, and possibly Cuba according to some news accounts. The three agencies involved – the Office of Foreign Assets Control (OFAC) in the Treasury, the Federal Reserve Board, and the New York State Department of Financial Services – coordinated their investigation with the UK Financial Conduct Authority. According to OFAC, from 2005 to 2009 (the Daily Mail asserted it was 2002-2011), RBS payment practices impeded U.S. economic sanctions. References to critical information about certain payment transfers that would have triggered a blocking of funds and payments – such as the fact that an Iranian party might be interested in one end or the other of the transfer – were excluded from documentation covering payments sent to or through U.S. financial institutions. By some accounts, these payment transfer practices involved more than 3,500 US dollar transactions worth £320 million ($523 million) routed through US banks. Two aspects of this situation are worthy of specific comment.
First, the nature of the claimed violations varies somewhat as you look from one sanctions program to the next, even if the payment activities were essentially the same. For example, under the Iran sanctions, foreign financial institutions such as RBS are quite specifically targeted by prohibitions in the sanctions program. A foreign financial institution would be prohibited from knowingly “[f]acilitat[ing] the activities of ... a person subject to financial sanctions” under U.N. sanctions against Iran,” engaging in “money laundering to carry out” such an activity, or facilitating “efforts by the Central Bank of Iran or any other Iranian financial institution to carry out” such an activity. 31 C.F.R. 561.201 (2013). Under the Burmese Sanctions Regulations, the focus would be on transactions and transfers involving “property and interests in property” of the direct targets of the sanctions, which would be prohibited where the property or interest was “in the United States, ... hereafter [came] within the United States, or … [came] within the possession or control of U.S. persons.” 31 C.F.R. 537.201 (2013). The Sudanese Sanctions Regulations contain a similar prohibition on transactions and transfers (31 C.F.R. 538.201 (2013)), but its facilitation prohibition applies on its face only to “U.S. persons.” 31 C.F.R. 538.206 (2013). Likewise, the Cuban Assets Control Regulations would prohibit transactions and transfers involving “property and interests in property” of any Cuban national. (31 C.F.R. 515.201 (2013).) However, beyond this basic sanction, if RBS were considered to be acting on behalf of a blocked Cuban national in these transfers, then it might be deemed to be a “specially designated national” of Cuba and as such it would itself be a direct target of the Cuban sanctions, See 31 C.F.R. 515.302,515.306 (2013) (defining “national,” “specially designated national”). Hence, given the incidence of significant variation as one moves from one sanctions program to the next, it becomes more difficult in managing risk in transnational contract activity to generalize as to the risks and appropriate risk management strategies.
Second, the likely implications of transnational contract activity on domestic contract activity may also vary significantly as our attention shifts from program to program. Take, for example, the situation of a U.S. citizen who is a holder of a credit card issued by RBS NA, a national bank subsidiary of RBS. In many of the sanctions situations identified above, the impact of the RBS violations on her contractual relationship would be adventitious. The substantial fine might marginally raise the cost of doing business with the card issuer, assuming that the bank chose to pass some portion of this indirect cost of doing business throughout the enterprise. Even at $100 million, it is unlikely that the credit card holder would even feel the effects of the event. However, if aggressive action were taken against RBS under the Cuban sanctions – a contingency that is essentially eliminated by the bank’s settlement, one would imagine – the effect on the credit card holder would be quite dramatic. As an ongoing contract party of a specially designated national, she herself would be potentially committing a direct violation of the Cuban Assets Control Regulations, because U.S. persons are prohibited from entering into contracts with Cuban nationals – even with specially designated nationals – in the absence of a license. So unless you are a great humanitarian like Beyoncé and hence above the law, avoid entering into contracts and other transactions with specially designated nationals of Cuba.
Thursday, December 12, 2013
I happen to agree with the recent New York Times article on the usefulness of legal research. As many will recall, the basic idea was that a great deal of what is published is only that -- it exists in print and is largely unread or impractical. Part of the problem is that writing is a bit like hazing. Young people must do it to join the fraternity even if they have little new to say. Another problem is the actor and audience problem. Law professors appear are both. As writers they are the actors and as readers they are the audience -- the only audience. So they play their part and then rush back to the audience to applaud the "acts" of others. In these instances the work may be so theoretical that it is only of interest to very few, if any, and perhaps useful to no one at all. This is related to or the same as the skyhook problem as described by Monroe Freedman. As I understand it, work that is too theoretical and too burdened by assumptions is comparable to engineers talking about the impossible. Monroe H. Freedman, A Critique of Philosophizing About Lawyers' Ethics," 25 Geo. J. Legal Ethics 91 (2012).
That was how an Article by Daniel Markovits and Alan Schwartz, "The Myth of the Efficient Breach: New Defenses of the Expectancy Interest," 97 Va. L. Rev. 1939 (2011), struck me. Why write anything further about the efficient breach? Of course, as always the joke was on me. I immediately set out to write yet another article about efficient breach which essentially says it does not exist, and Markovits and Schwartz are covering ground that is in large part both old and irrelevant. And with that I became the actor, the audience, and an actor acting out the roles of the actor an audience. I think this means my article, "A Nihilistic View of the Efficient Breach" 2013 Mich St.L. Rev. 167 , was a skyhook for skyhooks. If any of this interest to you and I hope not. Here is the link.
I realized why we do much of our writing. It's fun and we are addicted to ideas. It's a pretty good job! But are we at times too self indulgent?
Tuesday, December 10, 2013
In late November 2013, negotiators reached agreement on a temporary accord under which Iran would halt much of its nuclear program and roll back some existing elements of it, and the United States agreed to $6 billion to $7 billion in sanctions relief, including releasing approximately $4.2 billion in oil revenue “frozen” in banks outside the United States. (The United States would continue to enforce other substantial sanctions that remain in place.) Recent coverage and commentary about the six-month U.S.-Iran deal calls to mind the fact that economic sanctions have become a pervasive feature of the transnational contract environment. (See this Table)
Source: M. P. Malloy (ed.), Economic Sanctions (Cheltenham, UK: Edward Elgar Publishing, forthcoming).
Two things are noteworthy about this situation. First, there is such a considerable array of sanctions in place – unilateral and multilateral, trade and financial, direct and indirect – that a state negotiating with Iran has an extensive menu from which to choose when it starts horse-trading. Second, it is probably not safe, as many casual observers still do, to view economic sanctions as unusual or “exigent,” rather than a commonplace feature of contracting in the transnational market.
It could be a year or more before we know the outcome of the ongoing maneuvering between Iran and the “P5-plus-1 countries” – the permanent members of the U.N. Security Council plus Germany – but contracts practitioners and commentators should learn one thing right now. The immediate lesson to be drawn is that the potential impact of sanctions is an increasingly pervasive risk factor in transnational contracting. The risk factor arises from three distinct circumstances in contemporary transnational practice.
First, the resurgence of U.N. mandatory sanctions practice under Chapter VII of the U.N. Charter. Prior to 1990, U.N. sanctions practice was limited and ineffective – the classic example being the curiously stunted trade sanctions against the break-away Southern Rhodesian regime in the1960s. In response to the Iraq invasion of Kuwait in 1990, however, and largely under the leadership of the George H.W. Bush Administration, U.N. mandatory sanctions broadly and effectively isolated the occupied Kuwait and stymied the Iraqi Government, as a prelude to the first Gulf War. The success of this program led to frequent and pervasive application of mandatory sanctions as the primary U.N. Security Council response to many crises over the decades that followed. This development means that there is now a formidable array of sanctions programs in which implementation is mandatory for all U.N. member states, actively monitored by the Security Council through sanctions committees. As a result, moving contract activities off-shore – a typical maneuver in many pre-1990 sanctions situations (including the Southern Rhodesian sanctions) – is no longer an easy and viable option. In addition, many states – and principally the United States – have continued to promulgate unilateral sanctions programs, often paralleling multilateral sanctions, and these have benefited from the newly pervasive incidence of sanctions as a risk factor in transnational contract practices.
Second, the emergence of “smart sanctions” strategies in the design of sanctions programs. Contemporary sanctions are often more carefully targeted, and include specific and distinct sanctions against intermediaries – e.g., business brokers, freight forwarders, purchasing agents, banks and other financial intermediares – which means that the direct and indirect costs of sanctions avoidance and evasion have grown significantly for indirect and secondary contract actors who would not have otherwise viewed themselves as “targets” of sanctions programs.
Third, the existence of licensing authority within sanctions programs. Ironically, the existence of authority within participating member states to license activities and transactions otherwise affected by a sanctions program, subject to oversight by U.N. sanctions committees, has increased the ongoing compliance and enforcement impact of sanctions programs. This feature has resulted in greater accountability for transnational contract parties.
The casual observer might respond that generally applicable contract doctrines of impracticability (or impossibility) and frustration would ameliorate the impact of these developments in sanctions practice. To the contrary, I believe that the interaction of these doctrines with current practice in transnational business may be more complicated than one might expect at first glance.
It is true that, under Restatement of the Law - Contracts (Second) § 261, a party to a contract affected by sanctions might claim that performance has been rendered “impracticable,” thus discharging its duty to perform. However, § 261 is grounded on the occurrence of an event “after a contract is made” that occurs “without his fault.” The pervasiveness and persistence of an array of sanctions programs challenges both of these premises. There is no end of sanctions already in place, and in the typical sanctions program the party bears the burden of demonstrating that it did not know, nor had no reason to suspect, that the subject transaction was prohibited or restricted. As comment d to § 261 observes, “If the event that prevents the obligor's performance is caused by the obligee, it will ordinarily amount to a breach by the latter. ... If the event is due to the fault of the obligor himself, this [§ 261] does not apply. As used here ‘fault’ may include not only ‘willful’ wrongs, but such other types of conduct as that amounting to breach of contract or to negligence.” Of course, this dilemma exists quite aside from any administrative or criminal consequences that might be visited on the parties by a sanctions-enforcing state. Goods or services that are the subject of the contract may be susceptible to being “blocked” or “frozen” by the enforcing state.
The same problem would exist for a contracting party who attempted to invoke the doctrine of discharge by a supervening frustration under Restatement (2d) § 265. This may be a particular concern for indirect or intermediary parties, a point that is neatly demonstrated by Illustration 5 under § 265:
A contracts to sell and B to buy a machine, to be delivered to B in the United States. B, as A knows, intends to export the machine to a particular country for resale. Before delivery to B, a government regulation prohibits export of the machine to that country. B refuses to take or pay for the machine. If B can reasonably make other disposition of the machine, even though at some loss, his principal purpose of putting the machine to commercial use is not substantially frustrated. B's duty to take and pay for the machine is not discharged, and B is liable to A for breach of contract.
Furthermore, given the typical licensing regime that is included in sanctions programs, “impracticability” may be even less apparent in a particular contracting situation. As comment d to § 261 goes on to note, “ ‘impracticability’ means more than ‘impracticality.’ A mere change in the degree of difficulty or expense . . . unless well beyond the normal range, does not amount to impracticability since it is this sort of risk that a fixed-price contract is intended to cover.”
One might respond, however, that if performance of a duty is made impracticable by having to comply with a domestic or foreign governmental regulation or order, then the regulation or order is “an event the non-occurrence of which was a basic assumption on which the contract was made,” according to Restatement (2d) § 264. Comment a to § 264 undercuts this argument, however, because “[w]ith the trend toward greater governmental regulation, however, parties are increasingly aware of such risks, and a party may undertake a duty that is not discharged by such supervening governmental actions, as where governmental approval is required for his performance and he assumes the risk that approval will be denied. ... Such an agreement is usually interpreted as one to pay damages if performance is prevented rather than one to render a performance in violation of law.” This problem is underscored by Restatement (2d) § 266, dealing with existing impracticability or frustration. In a situation in which, at the time a contract is made, the party's performance is impracticable without his fault “no duty to render that performance arises,” but only if this fact is one which it had “no reason to know,” a difficult position to maintain in an environment of persistent and pervasive sanctions programs.
All of this suggests a need for caution and proactive monitoring of contract activity in the transnational market. It is extremely naïve – if not outright disingenuous – to assume that one can casually rely on traditional doctrines of impracticability (or impossibility) and frustration in transnational commerce. Over-reading these doctrines can result in bitter lessons, and embarrassment, in the modern environment of transnational contract practice.
Monday, December 9, 2013
Every once in a while, a student will send me a story about contracts, but when multiple students send me the same story, you know they must be desparate for a study break -- and that there is some rather comical contracts story in the news.
And so it is with this story about a woman who won a $50,000 judgment on her claim that her fiance had breached his promise to marry her. A Georgia appellate court upheld the judgment, which included an award of attorney's fees, on appeal. The court more or less treated the couple as married and upheld an award of roughly half the property acquired during the relationship, which was a house valued at $86,000. The couple had co-habited for ten years and had a child together. The woman had looked after the child, as well as one she had from a previous relationship.
The man had had sexual relationships with other women both before and after he led his live-in partner to believe that he would marry her and gave her a ring worth $10,000. For what it's worth, the woman also had other sexual relationships.
According to media reports, the defendant's argument on appeal was that his alleged promise arose in the context of a meretricious relationship and was therefore unenforceable. Moreover, he denied any intention to marry. He claims he never said "will you marry me" or words to that effect. He just gave her a ring.
The meretriciousness argument is rather confusing, as a defense to the claim that he broke a promise, since the promise was to cleanse the relationship of its meretriciousness. As the appellate court noted, according to FoxNews, “the object of the contract is not illegal or against public policy.” If we still live in a world in which courts think they can pass judgment on people's long-term relationships (and we seem to), then a court is likely to uphold an agreement that will "make an honest woman" of the plaintiff.
The award of damages is also confusing. the effect of the ruling seems to be to treat the couple as married even though they weren't. In effect, the court is recognizing a common law marriage where such marriages do not seem to be recognized. I suppose the court could do so as a mechanism of giving the woman her expectation for the broken promise. The California Supreme Court endorsed such an approach in Marvin v. Marvin, but other courts have rejected marriage by judicial decree where the legislature has expressed its disapproval of recognition of common law marriages.
Wednesday, December 4, 2013
Unconscionability and the Contingent Assumptions of Contract Theory, 2013 Mich. St. L. Rev. 211 (2013), by Dr. M. Neil Browne and Lauren Biksacky, argues that basic assumptions of liberal contract theory – for example, that contracts are made by rational and informed parties – don’t hold. Therefore, courts should find more contracts unconscionable.
This short article would be a nice primer for law students on basic liberal contract theory, especially in conjunction with some Judge Posner readings. The authors argue that people often yield to irrational motives. They get in bar fights. They have road rage. They buy books on feng shui. Judge Posner might respond that the human rationality economists speak of is that of pigeons or rats, not angels. Dr. Browne, himself an economist, seems to take exception to that conception of human beings.
The article argues courts can do better than simply making people keep their ratty promises. Courts can allow people to be their best, most-informed selves by invalidating “irrational” promises made under distorting influences like advertising and cognitive biases. Courts can and should step in like adults over wayward children and guide them toward eudaimonia.
Yet the article notes that despite research showing people are often irrational and ill-informed, courts are not finding more contracts unconscionable. Why? The article doesn’t answer, but the reason is probably that to do so seems unworkable. If human irrationality were grounds for invalidating a contract, how many contracts would be secure? The law tends to be a great guardian of the status quo, and apparently some people like books about feng shui.
[Image by Vicky TGAW]