Supp. To § 1.6 Voidable Contracts

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(A) The following cases cite this section:

(1) Ladenburg Thalmann & Co., Inc. v. Imaging Diagnostic Sys., Inc., 176 F. Supp. 2d 199 (S.D.N.Y. 2001) . Where a release was procured by fraud in the inducement, the court cited Corbin at § 1.6 to support its holding that a contract induced by fraud provides the defrauded party with the choice of affirming the contract or exercising its power of disaffirmance or avoidance created by the fraud.

(2) Residential Capital, LLC v. Premier Trust Deed Servs., Inc., 2003 Cal. App. Unpub. LEXIS 4729 (Cal. Ct. App. 2003) . This case is fully discussed at § 1.7. On appeal, the plaintiff, citing Corbin, argued that it should have been allowed to affirm or ratify the contract and that the contract should therefore have been characterized as voidable, rather than void. The court held that the issue was subject to detailed statutory regulation and should not be governed by contract principles. This case is also noted at § 89.21.

(3) Giannone v. Ayne Inst., 290 F. Supp. 2d 553 (E.D. Pa. 2003) . The plaintiffs contracted with the defendant to admit the plaintiffs' 14-year-old son to the defendant institute's program for educational and rehabilitative services. The son suffered physical and emotional injuries while under the care of the defendant, and the plaintiffs filed a 23-count complaint against the institute. The defendant moved to compel arbitration under a clause in the agreement. The plaintiffs resisted arbitration on the grounds of fraud. The court distinguished fraud in the inducement, making the contract voidable, from fraud in the factum, rendering the entire contract void including the arbitration clause. Citing this section of Corbin, the court recognized that a voidable agreement was still operative in that the innocent party may either avoid or ratify the contract. The court held the facts demonstrated a claim for fraud in the inducement of the contract in general, making the contract voidable, but not the arbitration clause. Absent a claim that the arbitration clause itself was induced by fraud, the court held that under Section 4 of the Federal Arbitration Act as interpreted in the leading case of Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 87 S. Ct. 1801, 18 L. Ed. 2d 1270 (1967) , federal courts may consider only issues relating to the making and performance of the agreement to arbitrate. The court held that the plaintiffs' claim had to be submitted to arbitration.

This case is also discussed at § 28.22.

(4) King vs. Fox, 2006 N.Y. LEXIS 1481, 2006 NY Slip Op. 4746 (2006) . Edward C. King, a musician and songwriter with rock band Lynyrd Skynyrd was involved in a legal dispute with MCA and retained Attorney Lawrence Fox on a contingency basis. Their 1975 agreement provided that Fox's contingency fee would be based upon one third of money recovered from the defendants, whether by settlement, trial or otherwise. King claimed that he assumed the fee would be taken only from whatever accumulated royalties were recovered, not from future royalties. In 1978, the parties discussed a settlement, and Fox advised King that under the King-Fox fee arrangement for the proposed settlement, Fox would be entitled to one-third not only of all past royalties recovered from MCA, but also of all future royalties. King claims to have been ''shocked and surprised'' at this revelation but did not pursue the matter at that time. Moreover, after the final settlement was entered into, King accepted payment of royalties pursuant to the contingent fee arrangement as outlined by Fox for the next 17 years. Finally, in 1997, King filed suit against Fox claiming, among other things, that the one-third contingent fee agreement with Fox was unconscionable. The District Court accepted Fox's argument that King ratified the fee agreement since he accepted payment of royalties pursuant to the agreement with Fox for 17 years. The Second Circuit affirmed the judgment in part and certified several questions for the New York Court of Appeals, including whether a client may ratify an unconscionable agreement. The Court of Appeals explained that at common law, an unconscionable agreement was one that no promissor, absent delusion, would make on the one hand, and no honest and fair promisee would accept on the other. An unconscionable contract is one that is grossly unreasonable because of the absence of meaningful choice on the part of one of the parties together with contract terms that unreasonably favor the other. The court cited Corbin for the proposition that such contracts are usually voidable. The court explained that with respect to attorney fee arrangements, courts give particular scrutiny to fee arrangements, casting the burden on attorneys who have drafted the retainer agreement to show that the contracts are fair, reasonable, and fully known and understood by their clients. A contingent fee may be set aside where the amount becomes large enough to be out of all proportion to the value of the professional services rendered. The court explained that contingent fee agreements provide benefits to clients who are without the financial means to obtain legal access to the civil justice system. Aside from the amount of the fee, perhaps the most important factor in assessing whether the arrangement is unconscionable is whether the client was fully informed in entering into the agreement. The court explained that it will be a rare case where an unconscionable agreement may be ratified by the client because of the special protections given to clients. In furnishing guidance for the Federal Court in deciding the issue, however, the court explained that it was not prepared to say that ratification of an unconscionable fee arrangement can never occur. Where a fully informed client with equal bargaining power knowingly and voluntarily affirms an existing fee arrangement that otherwise would be unconscionable, ratification can occur.

(B) The following cases are noteworthy:

(1) Blakeney v. Lomas Information Systems, Inc., 65 F.3d 482 (5th Cir. 1995) . The defendant's employees signed a termination agreement in which they waived their rights to all discrimination claims against their employer in exchange for severance benefits. Despite their agreement, the employees initiated the instant suit for age discrimination, claiming that the release was void since it did not fulfill the requirements of the Older Workers Benefit Protection Act. The district court granted the employer's motion for summary judgement and the appellate court affirmed. The court agreed with the employees that the release did not fulfill the statutory requirements but it found that this made the agreement voidable, not void. As such, the employees, in order to rescind the agreement, were required to relinquish the benefit of their bargain, i.e., the severance benefits, upon discovery of the deficiency. The employees failed to do so and thus ratified the agreement.

(2) Lyn-Lea Travel Corp. v. American Airlines, Inc., 283 F.3d 282 (5th Cir. 2002) . Holding that the Airline Deregulation Act, 49 U.S.C. § 41713, which encourages maximum reliance on competitive market forces in the airline industry by freeing airlines from restrictive state regulation, does not preempt core contract principles, the court cited Restatement (Second) of Contracts, § 164 in recognizing the travel agency's fraudulent inducement claim which, if proven, precluded the requisite mutual assent to make a contract enforceable.

(3) Larian v. Larian, 123 Cal. App. 4th 751 (2004) . The plaintiff claimed that a court rather than an arbitrator should decide whether the plaintiff was fraudulently induced to consent to an arbitration agreement. The trial court denied the defendant's motion to compel arbitration, concluding that the allegation of fraud in the execution of the arbitration agreement must be decided by a court. The instant court distinguished fraud in the execution or inception of a contract, where the promisor is deceived as to the nature of what he is signing and there is no mutual assent rendering the agreement void, and fraud in the inducement of a contract where the promisor knows what he is signing but was induced to consent, rendering the agreement voidable. In general, fraud in the execution or inception is not arbitrable, while fraud in the inducement is arbitrable. Fraud in the inducement of the arbitration clause itself, however, as contrasted with fraud in the inducement of the entire contract, must also be decided by a court rather than the arbitrator. The court found no evidence of fraud in the execution or of fraud in the inducement of the arbitration clause itself. This case is also noted at § 28.22.

Supplement to Notes in Main Volume

5. In Abbadessa v. Moore Business Forms, Inc., 987 F.2d 18 (1st Cir. 1993) , the court held under New Hampshire law that resignation agreements allegedly signed under economic duress constituted voidable contracts. By accepting the benefits of the agreements and failing to notify the employer promptly that they intended to repudiate the agreements, however, the employees had ratified the agreements and were bound by them.

6. Tenn.- Rawlings v. John Hancock Mut. Life Ins. Co., 78 S.W.3d 291 (Tenn. Ct. App. 2001) . A wife confined to a nursing home was diagnosed with senile dementia and depression. After her husband, the sole beneficiary of her life insurance policy, informed her that he wanted a divorce, the wife gave her brother a power of attorney and signed a change of beneficiary form naming her brother as beneficiary of the policy. The husband had not filed for divorce at the time the wife died. In response to the husband's challenge of incompetency, the court found that competency to contract does not require an ability to act with judgment and discretion. Rather, it only requires the contracting party to know and understand the nature, extent, character and effect of the transaction. The husband failed to prove incompetency and also failed to plead or prove undue influence by the wife's brother.