Учебный год 22-23 / Binding Promises - The Late 20th-Century Reformation of Contract Law

Sales of New Dwellings and Construction Services

The rule of caveat emptor governed the sale of new buildings and the provision of building construction services until the 1950s. The seller’s obligations were over when he delivered the deed to the land. The only warranties he made were those in the deed covering clear title.30 This traditional law was in contrast with the law for the sale of “goods” (tangible, movable property), which had had implied warranties of quality and freedom from defect since the nineteenth century.31 The traditional practices of the building industry are presumably the explanation. Until after the Second World War, builders did not construct residences on land they owned. Rather, they constructed buildings on land that was owned by the person who intended to live in the building or use it for business purposes. The only thing the landowner purchased were the construction services, and the law did not traditionally imply warranties in the sale of services unless they were professional (a lawyer’s or doctor’s services, for example).

After the Second World War, land developers began purchasing large tracts of land, subdividing them into lots, and building residences on the lots, which they sold “door-key ready.” The courts of a few jurisdictions changed the rule of caveat emptor in the 1950s, but the flood of cases that changed the rule nationally did not come until after the 1968 decision of the Texas Supreme Court in Humber v. Morton.32 The new rule, by now in force almost everywhere, is that the sale or construction of a new dwelling carries with it a warranty of habitability. There is no settled rule yet for buildings that are not dwellings.33

There was initially some doubt as to whether a seller could contractually disclaim the warranty of habitability. The Texas Supreme Court held he could not in 1987, in Melody Home Manufacturing Co. v. Barnes, and held at the same time that the warranty sounds in tort as well as contract.34 I have found only three decisions allowing a seller to disclaim the warranty, and they all support the proposition that a seller generally cannot disclaim it by resting their allowance of a disclaimer on the presence of special circumstances. In Frickel v. Sunnyside Enterprises, Inc.,35 the Supreme Court of Washington held that implied warranties of habitability do not apply to the sale of a used apartment building. The court also noted that the buyer was just as experienced as the seller in the business of owning and managing apartment buildings. In Lenawee County Board of Health v. Messerly,36 the Supreme Court of Michigan also held that there is no implied warranty of habitability when the building being sold is not new. In Schepps v. Howe,37 the Supreme Court of Oregon held that the buyer waived the implied warranties of habitability when the contract provided the sale was “as is” and

the sellers were amateur builders who were not intending to engage in a commercial venture when they constructed the dwelling. Frona M. Powell has concluded from an analysis of cases across the country that all the highest state courts will decide that sellers of new dwellings cannot disclaim the warranty of habitability as quickly as home buyers bring their cases to the courts for decision.38

Landlord and Tenant

The law characterizes a lease both as a conveyance of an interest in property and as a contract. Courts began creating duties that landlords owe to their tenants regardless of the terms of the leases in the late 1960s. Residential tenants especially have been the beneficiaries of these duties, although commercial tenants have also benefited. The courts have usually characterized the new duties as property laws rather than tort laws, for understandable reasons. Many of the decisions expressly rest on the tenant’s relative lack of bargaining power.

The principal such relational tort is the warranty of habitability. The law imposes a warranty that the premises shall be habitable at the beginning of the lease and that the landlord shall maintain them in a habitable condition throughout the lease term. Generally speaking, the applicable building codes define the minimum requirements of habitability, but only the minimum, especially if the court considers the building codes to be inadequate. The other such relational torts limit the landlord’s rights to terminate the tenancy. Whereas prior to the late 1960s these rights were unlimited except as the lease limited them, landlords now generally cannot evict tenants in retaliation for exercising any right they have under the lease, and in some jurisdictions not unless the landlord has a good cause for evicting the tenant.39

Services Generally

When the Texas Supreme Court held in Melody Home that a seller of construction services could not waive the warranty of habitability the court had created in Humber, the court based its holding on the broad ground that the seller of any services to a consumer gives an unwaivable warranty that the services shall be done “in a good and workmanlike manner.”40 The court used “consumer” in the narrow sense of individual consumer rather than in the broad sense in which I have been using the term, which also includes businesses.

Texas is the only state yet in which all services now come with undisclaimable warranties, but many states seem to be heading in the same direction. Courts and legislatures everywhere have been characterizing more and more occupations as professions for the purpose of applying traditional professional malpractice duties, which have always been undisclaimable.41 For example, California’s Business and Professional Code now includes building contractors, barbers, hearing aid dispensers, motor vehicle mechanics, private investigators, and pest controllers. The code makes these persons legally responsible for maintaining professional standards of competence and care.42

William L. Prosser and W. Page Keeton’s torts treatise takes a view of the matter that would effectively duplicate that of the Melody Home decision. The treatise treats professional malpractice as just a particular application of the reasonable person standard of behavior applicable to all conduct. The treatise concludes that everyone

must . . . use care which is reasonable in light of their superior learning and experience, and any special skills, knowledge or training they may personally have over and above what is normally possessed by persons in the field. . . . Professional persons in general, and those who undertake any work calling for special skill, are required not only to exercise reasonable care in what they do, but also to possess a standard minimum of special knowledge and ability.43

The treatise cites cases that apply these standards to experienced milk haulers, hockey coaches, skiers, construction inspectors, dentists, pharmacists, architects, engineers, accountants, lawyers, doctors, “and many other professions and skilled trades.”44 In other words, if you hold yourself out as possessing a skill, you must exercise the care and competence that is commonly associated with it. It does not matter that people generally or the practitioners themselves do not regard the skill as a professional one.

The latest edition of the Prosser and Keeton treatise was published in 1984. An Indiana court took essentially the same approach as the treatise in 1986 when it held a computer consultant liable in tort for his incompetent advice. The court did not find that computer consultancy was a profession; rather, it held that being a trade is enough:

Those who hold themselves out to the world as possessing skill and qualifications in their respective trades or professions impliedly represent they possess the skill and will exhibit the diligence ordinarily possessed by well-informed members of the trade or profession. . . . We hold these principles apply with equal force to those who contract to develop computer programming.45

Additionally, a U.S. court of appeals held computer consultancy to be a profession for malpractice purposes in 1989, although it recognized that it

was departing from the traditional criteria for identifying a profession in doing so. There are no certification requirements, professional examinations, or codes of ethics for computer consultants. The court held it enough that the ordinary person does not understand computers and their associated software well enough to protect his or her interests in the contract.46 The same reasoning would support inferring unwaivable warranties of competence and care in almost any service offered to the public.

Warranty Disclaimers under the Uniform

Commercial Code

In both the cases just noted concerning computer services, the computer consultant advised his client what to buy, but did not sell the product to him. Should it have mattered if he had sold the product he recommended? Not in principle, but at this point principle has to accommodate legislation. Article 2 of the Code covers sales of goods. A situation in which the seller offered special advice on the product (if the product were “goods”) would fall under Section 2-315, which reads:

Sec. 2-315. Implied Warranty: Fitness for Particular Purpose.

Where the seller at the time of contracting has reason to know any particular purpose for which the goods are required and that the buyer is relying on the seller’s skill or judgment to select or furnish suitable goods, there is unless excluded or modified under the next section an implied warranty that the goods shall be fit for such purpose.

The Code thus imposes essentially the same duty of competence and care on a seller of goods who offers advice as Prosser and Keeton and the two cases mentioned imposed on persons who offer services or just advice. Indeed, the duty the Code imposes is stronger. It makes the seller liable if the goods are not fit for the particular purpose even if the seller exercised competence and care that they would be. The Code also provides warranties that apply in any case, whether or not the seller offers special advice. The most important of these are the so-called warranties of merchantability in Section 2-314. However, Code Section 2-316 allows a seller to disclaim any of the warranties it imposes so long as the disclaimers are conspicuous and clear, and sellers who use standard forms routinely disclaim all the Code warranties and substitute much more limited warranties of their own. Thus, except to the extent that courts have used liberal constructions to overcome its provisions, the Code blocks the extension of relational torts to contracts for the sale or lease of goods. I will treat the effects of the Code on each of the four major developments in contract law in more depth in Chapter 6.

Brokers’ Commissions

Although a property owner ordinarily expects to pay a commission to a real estate broker only if the broker sells the property, the standard contracts used to provide that the broker earned the commission if he produced a person wanting to buy, whom the property owner accepted, even if the sale never went through. The courts always found for the broker if there was a dispute in such cases until 1967, when the New Jersey Supreme Court held differently in Ellsworth Dobbs, Inc. v. Johnson.47 Justice John J. Francis wrote the opinion. Justice Francis had also written the opinion in Henningsen v. Bloomfield Motors, Inc., the pathbreaking 1960 decision overriding warranty disclaimers and remedies limitations in consumer contracts.

In Dobbs, the Johnsons listed their farm for sale for $250,000 with Ellsworth Dobbs, Inc., a real estate broker. The commission was to be $15,000, payable in parts as the Johnsons received portions of the purchase price from the buyer. Dobbs found Iarussi, who appeared to be financially able. Iarussi signed a contract to buy the property and made a $2,500 deposit. However, after several delays, including a court action in which the Johnsons won a decree of specific performance, Iarussi convinced all concerned that he lacked the financial resources to continue. The Johnsons settled with him on the basis of their keeping the deposit and his indemnifying them for anything they owed Dobbs. Dobbs sued both the Johnsons and Iarussi for his commission. The trial court gave judgment for Dobbs on the ground that the contractual provisions making the commission payable in parts went only to the time of payment.48

The New Jersey Supreme Court reversed.49 If there is “substantial inequality of bargaining power, position or advantage” between broker and seller, the broker does not earn his commission until the seller sells the property unless the seller was at fault in failing to consummate the sale.50 The court found the requisite substantial inequality of bargaining power in the broker’s experience and expertise in the brokerage business, the seller’s lack of both, and the broker’s use of a standard form contract with which only he was familiar.51 The decision effectively makes the rule for when a real estate broker earns his commission a rule of law and thus a relational tort, because the elements the court deemed sufficient to demonstrate substantial inequality of bargaining power are present in virtually every case. Although the highest courts of most states still have not decided the point,52 all those that have have followed Dobbs.53

Ordinarily the seller of real estate receives the purchase price as soon as the property is sold; the buyer obtains any credit he needs from a lending institution. Three recent cases deal with the application of the Dobbs rule

if this is not the case, but the seller extends credit to the buyer. In each case, the court decided that the seller takes the risk of the buyer’s nonpayment and so must pay the broker even if the buyer does not pay the seller. The rationale is that the seller chose to take this risk when he accepted the buyer’s credit instead of demanding cash.54

Fiduciary Relationships

A “fiduciary,” generally speaking, is a person whom the law requires to be loyal to the interests of some other person, who is usually called the “beneficiary.” The classical instance of a fiduciary is a “trustee,” who is a person who holds title to property for the benefit of someone else, again, the “beneficiary,” but the law has long since expanded the category of fiduciary beyond just those who are trustees. Now, for example, agents are fiduciaries for their principals.55 Each partner in a partnership is a fiduciary for every other partner and for the partnership as a separate entity.56 Professionals are fiduciaries for their clients or patients.57 Courts have held virtually all the relationships that exist in a corporate context to be fiduciary either per se or at least under certain circumstances. These include the relationships among the corporation, its officers, directors, shareholders as a group, and shareholders of different classes or kinds.58 As a result, fiduciary duties govern the making and the performing of any contracts these people make with one another on the subjects concerned.

The law imposes certain duties on fiduciaries that they cannot disclaim. Fiduciary duties require that the fiduciary put the interests of the beneficiary before his own. If two people in a fiduciary relationship make a contract that concerns the object of the trust, the fiduciary duties apply to the making and the performance of the contract. Fiduciary relationships are sometimes called “confidential” rather than “fiduciary” in contract law, especially if the relationship is informal.59

Courts in the 1960s began characterizing certain contractual relationships as fiduciary and imposing fiduciary duties on the dominant party even if the fiduciary relationship did not exist prior to the contract. Although sometimes the reason they gave was that the fiduciary character of the relationship was implicit in the position that the dominant party occupied in the community—for example, the position of banker or insurer—more often, the reason or reasons given were more specific to the facts of the case. The court found either that one party had placed trust and confidence in the other or that the relationship made one party dependent on the other’s good faith, honest intentions, or judgment. Deborah A. DeMott has found decisions imposing fiduciary duties on one or more of these grounds between franchisor and franchisee, manufacturer and distributor, bank and bor-

rower, bank and depositor, and among the holders of different kinds of interests in oil and gas estates.60

Austin W. Scott, the late eminent authority on the law of trusts,61 defined a fiduciary as “a person who undertakes to act in the interest of another person.”62 This definition rests the determination on the fiduciary’s intent. John C. Shephard would characterize a relationship as fiduciary if one person entrusted another with something.63 Shephard’s determination would rest on the beneficiary’s intent. However, as DeMott points out, neither of these determinations captures the full range of situations in which the law imposes fiduciary duties, because the law sometimes imposes them although neither party has manifested the appropriate intent.64

DeMott suggests what she calls an “instrumental” definition: a fiduciary obligation is one the law imposes when a “person’s discretion ought to be controlled because of characteristics of that person’s relationship with another” (emphasis added).65 Her formulation would make the determination a normative one. Although the normative judgment would take the manifested intentions of either party into account, presumably neither the presence nor the absence of appropriate manifestations would be determinative. Her suggestion is descriptive; she believes it captures the essence of current case law.

DeMott’s definition shows how broad the fiduciary principle has become. Unless sufficient standards for controlling it are set out in the contract, any contractual discretionary power “ought to be controlled because of characteristics of . . . [the parties’] relationship.” A unlimited discretionary power inherently places one party at the mercy of the other. Therefore, the law should control a discretionary power if the contract itself does not, in every case. The only real question is the standard of control the law should impose. Good faith is the minimum, because even classical contract imposes a duty to perform a contract in good faith. In fact, courts have already reached the conclusion that the law should control the exercise of any contractual discretionary power by a more direct route, as the next section demonstrates.

Discretionary Powers

Even classical contract requires that a party exercise a discretionary contract power in good faith. This requirement is simply a part of the broader requirement that a party perform all his contractual duties in good faith.66 Many decisions have gone further and held that a party must also exercise a discretionary power reasonably. Some of these decisions have justified the additional requirement by saying it presumably was the parties’ intentions.67 When the party with the discretion could exercise it over every

contractual duty he owed, the court decisions have often justified the reasonableness requirement by saying that the contract would otherwise be illusory.68 Still other decisions offer no justification but simply hold that a party must exercise a contractual discretionary power reasonably as a matter of law.69 The laws reflected in all these decisions are relational torts except possibly for the decisions that rest on the parties’ presumed intentions, and these are probably also relational torts in effect, because if the parties made clear their intentions that a discretionary power could be exercised arbitrarily, presumably a court would invalidate the declarations of intention as unconscionable.

So-called satisfaction clauses are a kind of discretionary power. They condition a contractual duty on the party’s being satisfied with something. For example, the buyer’s duty to take and pay for real property may be conditional on his ability to find satisfactory mortgage financing within a certain period of time. The law for satisfaction clauses is the same as the law for discretionary powers of other kinds. Courts always require that the party not be satisfied in good faith. In many cases they also require that he prove that his dissatisfaction had reasonable grounds.70

The Covenant of Good Faith and Fair Dealing

Not Sounding in Tort

We saw earlier that in California and elsewhere, courts developed the concept of the relational tort out of the covenant of good faith and fair dealing. The covenant originally required only that a party to a contract perform a duty the contract imposed in good faith. However, courts developed the covenant to impose duties on parties to certain kinds of relationships regardless of the contract, and when they used it this way, they generally at least eventually recognized that it sounded in tort. On the other hand, some courts have not recognized that the covenant sounds in tort when they use it in this manner.

Thus, for example, in K.M.C. Co. v. Irving Trust Co.,71 the U.S. Court of Appeals for the Sixth Circuit held that the defendant breached the contract by terminating the plaintiff’s line of credit without giving reasonable notice, even though the contract did not require notice. Among other things, the defendant argued that the contract implicitly permitted termination without notice, because it expressly permitted the defendant to obtain repayment of all outstanding amounts on demand. The court answered the argument by saying that the covenant would also override these provisions and require reasonable notice for a repayment demand. The court mistakenly assumed that Article 2 of the Uniform Commercial Code (which governs “transactions in goods”) covered the case and consequently applied

the definition of good faith set forth in Code Section 1-208, but it also cited decisions under the common law.

A large portion of the decisions of this kind involve lending institutions. Charles L. Knapp and Nathan M. Crystal have collected the citations to the recent literature on the relatively recent law of lender liability.72

Consumer Protection Legislation

Congress enacted the Federal Trade Commission Act in 1914.73 It authorizes the Federal Trade Commission to issue cease and desist orders against persons who engage in unfair or deceptive practices affecting interstate commerce and to impose fines (subject to court approval) in certain instances. The courts and the Commission have used the act in a variety of ways to protect consumers. Many states enacted similar statutes in the 1960s and 1970s, and by the mid-1990s every state and the District of Columbia had some form of statute prohibiting what are commonly called “unfair or deceptive acts or practices.” Unlike the federal act, state acts generally authorize private actions as well as administrative enforcement. The private actions provide damages in addition to those that a plaintiff could obtain under classical contract law.74

In addition, virtually all states have statutes requiring sellers of certain services to disclose certain facts before they sell the services. For example, automobile repair garages must give itemized estimates of what they will do and how much they will charge,75 and providers of home repair services must disclose their hourly rates before they begin their work if the customer asks them.76 Penalties for violations range from small fines to excusing the consumer from paying for anything the seller failed to disclose.

In 1975, Congress enacted the Magnusen-Moss Federal Trade Commission Improvement Act.77 It allows a seller to label his warranties “full” only if he disclaims none of the warranties implied by law. Otherwise, he must label his warranties “limited.” The idea was that competition would compel most sellers not to disclaim the warranties implied by law, but the result has been that sellers simply label their warranties “limited.” Consequently, the act accomplishes nothing of substance.

Analysis

Relational torts limit freedom of contract because they impose duties on parties to relationships that they cannot contractually avoid. One justification for a relational tort is that it prevents abuses of bargaining power. If the law did not impose the duties, the party with the superior bargaining power

could use its contractual freedom to oppress the party with the inferior bargaining power. A relational tort also at least implicitly gives the party to which the duty is owed certain remedies if the party with the duty should fail to perform the duty. Therefore, a relational tort also prevents abuses of bargaining power in any dealings the parties have with each other if the party owing the duty violates it. If the party on which the relational tort imposes a duty is a producer, which he almost invariably is, there is also the possibility of justifying the duty as serving a public purpose. In that case, the parties should not be able to avoid the duty by contract even if the consumer party possesses sufficient bargaining power to protect his interests. The courts that have created relational torts have justified them on both these grounds, although the prevention of abuses of bargaining power seems to predominate.

The California Supreme Court held in Seaman’s Direct Buying Service, Inc. v. Standard Oil Co.78 that the “covenant of good faith and fair dealing” sounds in tort (and therefore justifies the creation of a relational tort) only if the parties’ relationship possesses “elements of public interest, adhesion and fiduciary responsibility.”79 The New Jersey Supreme Court referred to the same three elements, along with unequal bargaining power, to justify the relational tort it created for real estate brokers in Ellsworth Dobbs.80 The Texas Supreme Court referred to the same three elements, among others, as justifications for an unwaivable warranty that services offered to consumers shall be performed “in a good and workmanlike manner” in Melody Home.81 The Indiana Supreme Court referred in F.D. Borkholder Co. v. Sandock82 to the public interest, to the necessity for trust (which is tantamount to fiduciary responsibility), and to the producer’s superior expertise in finding that the breach of contract concerned was also a tort and could therefore support an award of punitive damages.

The public interest requirement is obviously the public purpose justification, and the adhesion requirement is the justification of preventing abuses of bargaining power, although perhaps not so obviously. I related the derivation of “contract of adhesion” in Chapter 3. Its literal meaning is a contract one party prepares to which the other must adhere if he chooses to make the contract, because the first party will not bargain over its terms. Thus, a contract of adhesion is simply a standard contract. Although the use of a standard contract is only evidence of unequal bargaining power, the evidence becomes conclusive for all practical purposes if we add the fact that the party providing the standard contract is a producer and the other party a consumer, which was invariably the case in these decisions.

We dealt with the concept of fiduciary responsibility a few pages back. I concluded that, generally speaking, a finding that a relationship is fiduciary merely expresses a conclusion that the law ought to control the dominant party’s exercise of some contractual power. Although the cases in