Law for Accountants – 3 Questions


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9–4. Types of Contracts
Burger Baby restaurants engaged Air Advertising
to fly an advertisement above the Connecticut beaches. The advertisement
offered $1,000 to any person who could swim from the Connecticut beaches to
Long Island in less than a day. At 10:00 A.M. on October 10, Air Advertising’s
pilot flew a sign above the Connecticut beaches that read: “Swim across the
Sound and Burger Baby pays $1,000.” On seeing the sign, Davison dived in.
About four hours later, when he was about halfway across the Sound, Air
Advertising flew another sign over the Sound that read: “Burger Baby
revokes.” Davison completed the swim in another six hours. Is there a contract between Davison and Burger Baby? Can
Davison recover anything? Why or why not?
9–5. Acceptance
Evelyn Kowalchuk, an eighty-eight-year old widow,
and her son, Peter, put their savings into accounts managed by Matthew
Stroup. Later, they initiated an arbitration proceeding before the National Association
of Securities Dealers (NASD), asserting that Stroup fraudulently or
negligently handled their accounts. They asked for an award of $832,000.
After the hearing, but before a decision was rendered, Stroup offered to pay
the Kowalchuks $285,000, and they e-mailed their acceptance. Stroup signed a
settlement agreement and faxed it to the Kowalchuks for their signatures. Meanwhile,
the NASD issued an award in the Kowalchuks’ favor for $88,788. Stroup
immediately told them that he was withdrawing his settlement “offer.” When
Stroup did not pay according to its terms, the Kowalchuks filed a suit in a
New York state court against him for breach of contract. Did these parties have a contract? Why or why not? [Kowalchuk v. Stroup, 873 N.Y.S.2d 43 (N.Y.A.D.
1 Dept. 2009)]

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10–9. A QUESTION OF ETHICS: Remedies.
In 2004, Tamara Cohen, a real estate
broker, began showing property in Manhattan to Steven Galistinos, who
represented comedian Jerry Seinfeld and his wife, Jessica. According to Cohen,
she told Galistinos that her commission would be 5 or 6 percent, and he agreed.
According to Galistinos, there was no such agreement. Cohen spoke with
Maximillan Sanchez, another broker, about a townhouse owned by Ray and Harriet
Mayeri. According to Cohen, Sanchez said that the commission would be 6
percent, which they agreed to split equally. Sanchez later acknowledged that they
had agreed to split the fee, but claimed that they had not discussed a specific
amount. On a Friday in February 2005, Cohen showed the townhouse to Jessica.
According to Cohen, she told Jessica that the commission would be 6 percent,
with the Seinfeld’s paying half, and Jessica agreed. According to Jessica,
there was no such conversation. Later that day, Galistinos asked Cohen to
arrange for the Seinfeld’s to see the premises again. Cohen told Galistinos
that her religious beliefs prevented her from showing property on Friday
evenings or Saturdays before sundown. She suggested the following Monday or
Tuesday, but Galistinos said that Jerry would not be available and asked her to
contact Carolyn Liebling, Jerry’s business manager. Cohen left Liebling a
message. Over the weekend, the Seinfeld’s toured the building on their own and
agreed to buy the property for $3.95 million. Despite repeated attempts, they were
unable to contact Cohen. [Cohen v. Seinfeld, 15
Misc.3d1118 (A), 839 N.Y.S.2d 432 (Sup. 2007)](a) The
contract between the Seinfeld’s and the Mayeris stated that the sellers would
pay Sanchez’s fee and the “buyers will pay buyer’s real estate broker’s fees.” The
Mayeris paid Sanchez $118,500, which is 3 percent of $3.95 million. The Seinfeld’s
refused to pay Cohen. She filed a suit in a New York state court against them,
asserting, among other things, breach of contract. Should the court order the Seinfeld’s
to pay Cohen? If so, is she entitled to a full commission even though she was
not available to show the townhouse when the Seinfeld’s wanted to see it?
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he noted legal scholar Roscoe
Pound once said that “[t]he social
order rests upon the stability and
predictability of conduct, of which keeping promises is a large item.”1 Contract
law deals with, among other things, the
formation and keeping of promises. A
promise is a person’s manifestation of
an intent to act or refrain from acting in
a speci?ed way.
Like other types of law, contract
law re?ects our social values, interests,
and expectations at a given point in
time. It shows, for example, to what
extent our society allows people to
make promises or commitments that
are legally binding. It distinguishes between promises that create only moral
1. Roscoe Pound. Jurisprudence. Vol. 3
(St. Paul, Minn.: West Publishing Co.,
1959), p. 162.
obligations (such as a promise to take a
friend to lunch) and promises that are
legally binding (such as a promise to
pay for merchandise purchased).
Common law governs all contracts
except when it has been modi?ed or
replaced by statutory law, such as the
Uniform Commercial Code (UCC),2 or
by administrative agency regulations.
Contracts relating to services, real
estate, employment, and insurance, for
example, generally are governed by the
common law of contracts.
Contract law also demonstrates
which excuses our society accepts for
breaking certain types of promises. In
addition, it indicates which promises
2. See Chapters 1 and 11 for further discussions of the signi?cance and coverage of the UCC. Excerpts from the UCC
are presented in Appendix C at the end
of this book.
No aspect of modern life is entirely free of contractual relationships. You acquire rights and obligations,
for example, when you borrow funds, when you buy
or lease a house, when you obtain insurance, and
when you purchase goods or services. Contract law
is designed to provide stability and predictability, as
are considered to be contrary to public
policy—against the interests of society
as a whole—and therefore legally
invalid. When the person making a
promise is a child or is mentally incompetent, for example, a question will
arise as to whether the promise should
be enforced. Resolving such questions
is the essence of contract law.
Contracts for the sale and lease of
goods, however, are governed by the
UCC—to the extent that the UCC has
modi?ed general contract law. The
relationship between general contract
law and the law governing sales and
leases of goods will be explored in detail
in Chapter 11. In this chapter’s discussion
of general contract law, we indicate in
footnotes the areas in which the UCC has
signi?cantly altered common law contract
well as certainty, for both buyers and sellers in the
Contract law deals with, among other things, the
formation and enforcement of agreements between
parties (in Latin, pacta sunt servanda—“agreements
shall be kept”). Clearly, many promises are kept
because the parties involved feel a moral obligation
to keep them or because keeping a promise is in
their mutual self-interest. The promisor (the person
making the promise) and the promisee (the person
to whom the promise is made) may also decide to
Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Contract Formation
honor their agreement for other reasons. In business
agreements, the rules of contract law are often followed to avoid potential disputes.
By supplying procedures for enforcing private
contractual agreements, contract law provides an
essential condition for the existence of a market
economy. Without a legal framework of reasonably
assured expectations within which to make long-run
plans, businesspersons would be able to rely only on
the good faith of others. Duty and good faith are usually suf?cient to obtain compliance with a promise,
but when price changes or adverse economic factors
make compliance costly, these elements may not be
enough. Contract law is necessary to ensure compliance with a promise or to entitle the innocent party
to some form of relief.
The De?nition of a Contract
A contract is “a promise or a set of promises for the
breach of which the law gives a remedy, or the performance of which the law in some way recognizes
as a duty.”3 Put simply, a contract is a legally binding
agreement between two or more parties who agree
to perform or to refrain from performing some act
now or in the future. Generally, contract disputes
arise when there is a promise of future performance.
If the contractual promise is not ful?lled, the party
who made it is subject to the sanctions of a court
(see Chapter 10). That party may be required to pay
damages for failing to perform the contractual promise. In a few instances, the party may be required to
perform the promised act.
The Objective Theory of Contracts
In determining whether a contract has been formed,
the element of intent is of prime importance. In
contract law, intent is determined by what is called
the objective theory of contracts, not by the
personal or subjective intent, or belief, of a party.
The theory is that a party’s intention to enter into
a legally binding agreement, or contract, is judged
by outward, objective facts as interpreted by a
reasonable person, rather than by the party’s own
secret, subjective intentions. Objective facts include
3. Restatement (Second) of Contracts, Section 1. As mentioned in
Chapter 1, Restatements of the Law are scholarly books that
restate the existing common law principles distilled from court
opinions as a set of rules on a particular topic. Courts often
refer to the Restatements for guidance. The Restatement of the
Law of Contracts was compiled by the American Law Institute in
1932 and is now in its second edition (a third edition is being
(1) what the party said when entering into the contract, (2) how the party acted or appeared (intent
may be manifested by conduct as well as by oral or
written words), and (3) the circumstances surrounding the transaction.
C A S E I N PO I NT Linear Technology Corporation
(LTC) makes and sells integrated circuits for use in
cell phones and computers. LTC sued its competitor,
Micrel, Inc., for patent infringement of a particular
chip. In its defense, Micrel claimed that LTC’s patent
was invalid because LTC had offered to sell the chip
commercially before the date on which it could be
legally sold. The issue was whether LTC had entered
into sales contracts when it solicited input on pricing and accepted distributors’ purchase orders using
a “will advise” procedure before the critical date.
The court ruled that under the objective theory of
contracts, no reasonable customer could interpret
LTC’s requests for information about pricing and
potential orders as an offer that could bind LTC to a
sale. Therefore, LTC did not violate the ban on sales
and could continue its suit against Micrel for patent
Elements of a Contract
The many topics that will be discussed throughout
this chapter concerning contract law require an
understanding of the basic elements of a valid contract and the way in which a contract is created. It
is also necessary to understand the types of circumstances in which even legally valid contracts will not
be enforced.
REQUIREMENTS OF A VALID CONTRACT The following list brie?y describes the four requirements that
must be met before a valid contract exists. If any of
these elements is lacking, no contract will have been
formed. (Each requirement will be explained more
fully in later sections of this chapter.)
1. Agreement. An agreement to form a contract
includes an offer and an acceptance. One party
must offer to enter into a legal agreement, and
another party must accept the terms of the offer.
2. Consideration. Any promises made by the parties
to the contract must be supported by legally suf?cient and bargained-for consideration (something
of value received or promised, such as money, to
convince a person to make a deal).
4. Linear Technology Corp. v. Micrel, Inc., 275 F.3d 1040 (Fed.Cir.
Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
3. Contractual capacity. Both parties entering into
the contract must have the contractual capacity
to do so. The law must recognize them as possessing characteristics that qualify them as competent parties.
4. Legality. The contract’s purpose must be to accomplish some goal that is legal and not against public policy.
Even if all of the requirements listed above are satis?ed, a contract may be unenforceable if the following requirements are not met. These requirements
typically are raised as defenses to the enforceability
of an otherwise valid contract.
1. Voluntary consent. The consent of both parties
must be voluntary. For example, if a contract
was formed as a result of fraud, undue in?uence, mistake, or duress, the contract may not be
2. Form. The contract must be in whatever form the
law requires. For example, some contracts must
be in writing to be enforceable.
There are many types of contracts. In this section,
you will learn that contracts can be categorized
based on legal distinctions as to formation, performance, and enforceability.
Contract Formation
Contracts can be classi?ed according to how and
when they are formed. Exhibit 9–1 below shows
three such classi?cations, and the following subsections explain them in greater detail.
contract involves at least two parties. The offeror is
the party making the offer. The offeree is the party
to whom the offer is made. Whether the contract is
classi?ed as bilateral or unilateral depends on what
the offeree must do to accept the offer and bind the
offeror to a contract.
Bilateral Contracts. If the offeree can accept
simply by promising to perform, the contract is a
bilateral contract. Hence, a bilateral contract is
a “promise for a promise.” No performance, such as
payment of funds or delivery of goods, need take
place for a bilateral contract to be formed. The contract comes into existence at the moment the promises are exchanged.
For example, Javier offers to buy Ann’s digital
camcorder for $200. Javier tells Ann that he will give
her the $200 for the camcorder next Friday, when he
gets paid. Ann accepts Javier’s offer and promises to
give him the camcorder when he pays her on Friday.
Javier and Ann have formed a bilateral contract.
Unilateral Contracts. If the offer is phrased so that
the offeree can accept the offer only by completing the
contract performance, the contract is a unilateral
contract. Hence, a unilateral contract is a “promise
for an act.” In other words, the time of contract formation in a unilateral contract is not the moment when
promises are exchanged but the moment when the
contract is performed. For example, Reese says to Celia,
“If you drive my car from New York to Los Angeles, I’ll
give you $1,000.” Only on Celia’s completion of the
act—bringing the car to Los Angeles—does she fully
accept Reese’s offer to pay $1,000. If she chooses not to
E X H I B I T 9–1 • Classi?cations Based on Contract Formation
A promise for a promise
Requires a special form for creation
A promise for an act
Requires no special form for creation
Formed by words
Formed by the conduct of the parties
Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Contract Formation
accept the offer to drive the car to Los Angeles, there
are no legal consequences.
C A S E I N PO I NT Applicants for vacancies in the
police department in Providence, Rhode Island, ?rst
completed a series of tests. The city then sent the
most quali?ed applicants a letter that said it was “a
conditional offer of employment” and informed the
applicants that they could attend the police training
academy if they passed a medical exam. Meanwhile,
a new chief of police revised the selection process
and rejected some of those who had received this letter. The rejected applicants sued, claiming that the
city had breached its contract. The court held that
the letter was a unilateral offer that the plaintiffs had
accepted by passing the required medical exam. As a
remedy for the breach, the court ordered the city to
allow the plaintiffs to attend the police academy.5
Contests, lotteries, and other competitions
involving prizes are examples of offers to form unilateral contracts. If a person complies with the rules
of the contest—such as by submitting the right lottery number at the right place and time—a unilateral
contract is formed, binding the organization offering the prize to a contract to perform as promised in
5. Ardito v. City of Providence, 263 F.Supp.2d 358 (D.R.I. 2003).
the offer. If the person fails to comply with the contest rules, however, no binding contract is formed.
See this chapter’s Insight into Ethics feature below
for a discussion of whether a company can change
the advertised prize after the contestants have completed the contest.
Revocation of Offers for Unilateral Contracts.
A problem arises in unilateral contracts when the
promisor attempts to revoke (cancel) the offer after
the promisee has begun performance but before the
act has been completed. The promisee can accept
the offer only on full performance, and under traditional contract principles an offer may be revoked
at any time before the offer is accepted. The presentday view, however, is that an offer to form a unilateral contract becomes irrevocable—cannot be
revoked—once performance has begun. Thus, even
though the offer has not yet been accepted, the
offeror is prohibited from revoking it for a reasonable time period.
For instance, recall the earlier example in which
a car is to be driven from New York to Los Angeles.
Now suppose that Celia is driving through Nevada
and is only a few hundred miles from Los Angeles
when Reese calls her on her cell phone and says, “I
revoke my offer.” Under traditional contract law,
Is It Right for a Company to Change the Prize Offered in a Contest?
Courts have historically treated contests as unilateral contracts. Unilateral
contracts typically cannot be modi?ed
by the offeror after the offeree has begun to perform.
But this principle may not apply to contest terms if the
company sponsoring the contest reserves the right to
cancel the contest or change its terms at any time, as
Donna Englert learned to her dismay.
Englert entered the “Quarter Million Dollar Challenge”
contest sponsored by Nutritional Sciences, LLC.
Contestants were to use Nutritional Sciences’ products
and training plans for thirteen weeks to lose weight and
get ?t. A panel of judges would then pick winners in
certain categories based on their success in transforming
their bodies. When Englert was chosen as female runnerup in her age group, she thought that she would receive
the advertised prize of $1,500 cash and $500 worth of
Nutritional Sciences’ products. Instead, the company sent
her a “challenge winner agreement” for $250 cash and
$250 worth of products. Englert refused to sign the agreement and ?led a lawsuit alleging breach of contract. The
state trial court dismissed her claim, and she appealed.
The state appellate court observed that the contestant’s compliance with the rules of a contest is
necessary to form a binding unilateral contract. Here,
the contest rules stipulated that “all winners must
agree to the regulations outlined speci?cally for winners before claiming championship or money.” Next to
this statement was an asterisk corresponding to a note
reserving the right of Nutritional Sciences to cancel the
contest or alter its terms at any time. Because of this
provision, the court ruled that Nutritional Sciences did
not breach the contract when it changed the cash prize
from $1,500 to $250.a
Why would a company that changes its advertised
prizes have to worry about its reputation?
a. Englert v. Nutritional Sciences, LLC, 2008 WL 4416597 (Ohio App.
Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Reese’s revocation would terminate the offer. Under
the modern view of unilateral contracts, however,
Reese will not be able to revoke his offer because
Celia has undertaken performance and has driven
more than 2,500 miles. In these circumstances, Celia
can ?nish driving to Los Angeles and bind Reese to
the contract.
classi?cation system divides contracts into formal
contracts and informal contracts. Formal contracts
are contracts that require a special form or method
of creation (formation) to be enforceable.6 One
example is letters of credit, which are frequently
used in international sales contracts (see Chapter
8). Letters of credit are agreements to pay contingent on the purchaser’s receipt of invoices and bills
of lading (documents evidencing receipt of, and title
to, goods shipped).
Informal contracts (also called simple contracts)
include all other contracts. No special form is
required (except for certain types of contracts that
must be in writing), as the contracts are usually
based on their substance rather than their form.
Typically, businesspersons put their contracts in
writing to ensure that there is some proof of a contract’s existence should disputes arise.
may also be categorized as express or implied. We
look here at the differences between these two types
of contracts.
Express Contracts. In an express contract, the
terms of the agreement are fully and explicitly stated
in words, oral or written. A signed lease for an apartment or a house is an express written contract. If
one classmate calls another on the phone and agrees
to buy his textbooks from last semester for $300, an
express oral contract has been made.
Implied Contracts. A contract that is implied
from the conduct of the parties is called an implied
contract or an implied-in-fact contract. This type of
contract differs from an express cont …
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