Contracts Final Exam

Adam CherlinContracts: Gordon

1/23,2008

Contracts Final Exam

Question I:

A:

N’s grievance against Hanover Bank (HB) has substantial merit despite the fact that such

credit card contract terms are quite common. We will consider three separate issues regarding

N’s contract in turn. First, using the doctrine of unconscionability we will attempt to void the

initial contract, and as such allow N to withhold her performance. The second defense against

HB’s claim that will be considered is whether the contract contained definiteness sufficient to

satisfy contract law. Finally, it will be argued that N’s subsequent agreement in March of 2007,

to pay at 20% interest does not render a consideration of the initial contract moot, as the March

2007 agreement is similarly voidable on grounds of unconscionability, and undue influence.

The defense of unconscionablity requires that the contract manifest both procedural and

substantive unconscionability. Procedural unconscionability relates to the manner in which the

agreement was made, while substantive unconscionability relates to the terms themselves (See

Armendariz). Procedural unconscionability is generally defined as clear inequality of bargaining

power. While this may manifest itself in various manners, a contract of adhesion is considered

procedurally unconscionable on its face. The credit card contract that HB supplied to N was a

formal contract, drafted by its attorneys, the terms of which N had no chance to negotiate. This

clearly meets the definition of a contract of adhesion, and as such the initial contract is

procedurally unconscionable.

A finding that this contract is adhesive on its own will not, however, render the contract

void. A finding of substantive unconscionability is additionally required. The Armendariz court

delineated two varieties of substantive unconscionability: hidden or surprise terms, and unfair

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terms that are shocking to the conscience. Although form contracts with small print barely

recognizable as English are quite common in modern credit card contracts, it should nonetheless

be argued that this practice is inconsistent with contract doctrine, and such contracts should be

found voidable. The contract is question here certainly manifests the quality of “hidden terms.”

The term that N objects to is the ability of HB to radically adjust its interest rates at will. This

term appeared in fine print in N’s initial mailing and in the densely printed terms she was later

mailed. The printing of this term clearly is hidden, but the wording of the interest adjustment

term is likewise vague in likely to be misunderstood. Specifically, the fact that this adjustment

term becomes operable if the customer “is determined for any other reason to be an increased

credit risk.” It is unlikely that any individual contracting for a credit rate will recognize that “any

other reason” could allow adjustment quite literally for any reason. The problem lies in HB’s

perceived credentials. No consumer will assume that a major Bank would be able to sustain

business when subjecting its customers to such practices. As such, they will likely interpret “any

reason” to mean any reasonable reason. There is little chance that N was aware of the fact that

applying for a Macy’s discount card would allow HB to raise her interest to over three times its

original percentage.

That fact that these terms are hidden also precludes any claim on HB’s part that the

contract was not adhesive, due to the opt-out clause, which allows the customer to cancel further

usage and retain their original interest rate if written notice is made in 30 days. This is not

sufficient to render the contract non-adhesive, because the opt-out term itself is hidden. The

general public, unversed in the intricacies of contract manipulation will not be accustomed to

sending formal written notice, and will not to look for such terms. Therefore, just as the Supreme

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Court found in Adams v. Circuit City Stores Inc., such an opt-out clause will not save a contract

from a finding of adhesion.

The second varieties of substantive unconscionability is likewise applicable here. The

terms HB set forth in its interest adjustment clause are manifestly unfair and shocking to the

conscience. This bank advertises its credit card as a way of relieving heavy interest payments,

and encourages its customers to transfer debt to the card to this end, then uses this vulnerability

to enforce unforeseen and devastating increases in its customers' credit. By engaging in this

practice HB is able to further entrap its customers to continue payment at its unforeseen and

outrages interest rate because consumer will fear defaulting, and damaging their credit rating, as

Everett, HB’s representative, threatened N with. Thus, even if the court rules that the “small

print” issue with the interest adjustment clause is not unconscionable due to its customary usage,

it nonetheless can find the contract unconscionable on the grounds of its shocking unfairness.

Now if the court rules in our favor, and voids the contract because of unconscionability,

the question remains as to what remedy is available to N. If the contract is deemed void, we

should demand that she be able to withhold her performance of the contract, i.e. that she is not

required to pay any interest on the base of her debt. If this is granted, HB will only be entitled to

payment of the base of N’s debt, minus the amount of interest she has already paid. IF the

amount N has paid in interest has already exceeded the base of the debt, then she should seek

restitution of that amount, because HB has been unjustly enriched by its illegal dealings.

Furthermore, if the events that surround Ns dealings with HB have caused her credit rating to be

negatively affected, a tort claim against HB should be filed which attempts to seek damages for

pain and suffering, as well as punitive damages to prevent Credit Companies from further

disgraceful dealings. Or, alternatively, N can seek reliance damages against HB for the damage

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to her economic condition that resulted from relying on HB to deal with her debt, rather than a

more honest Bank. The possible amount of damages N can receive in either venue should be

compared and the right amount should be pursued. Because damage to one’s credit rating can

lead to substantial economic detriment, and such damages are not recoverable under a tort claim,

it is possible that the reliance claim will be greater, but he facts must be further researched.

Another route in seeking to void N and HB’s initial contract is to claim it lacks

definiteness. Seemingly, the customer of a credit company is paying interest in return for the

bank in question holding its debts temporarily. Under classical contract doctrine for the

agreement to be valid, the terms must be definite. Under the adjustment terms, N agreed to pay

an amount of money, to be determined, for HB holding her debt. N’s performance is left almost

completely undefined. The fact that the initial interest rate was set at 7.99% is largely irrelevant

if HB is able to change the rate at will. It would be akin to sales contract in which B agree to buy

S’s car for some amount of money, I will pay you eight-thousand dollars now, but you S can

demand more money at any point in the future for the car that was sold. That scenario certainly

lacks definiteness, and is doctrinally identical to the contract HB created.

HB will likely argue that the initial interest rate of 7.99% is definite, because the

consumer can lock in that rate, by canceling their card’s further use by written notice within 30

days of the terms change by HB. It is clear, however, that HB has no expectation that customers

will actually do as much, and simply inserts this opt-out clause in a hidden manner, in order to

deflect claims of indefiniteness. The 30-day limit is clearly arbitrary, there is no conceivable

need for HB to know its customer’s intent o opt-out in that time frame. If HB stipulated in its

contracts that customers could opt-out of its interest changes by flying from New to Alaska 40

times in the month following the interest change it would be identical, because neither that, nor

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the written notice requirement have any likelihood of occurring. There is scarcely an instance

imaginable where a customer would knowingly and freely accept 20-30% interest rate increases,

simply for the “privilege” to borrow further funds from HB.

HB will similarly cite U.C.C. § 2-209 to further deflect the problem of indefiniteness,

which states, “An agreement modifying a contract within this Article needs no consideration to

be binding.” They will argue that their contract modification was agreed upon, and the fact that

N did not get anything in return from HB is irrelevant under U.C.C. standards. There are three

arguments against this claim. First, § 2-209 deals with a valid contract, which had definite terms

that were subsequently altered. This scenario is entirely different from ours, in which there was

no initial agreement, rather HB simply stated from the outset that N was to pay an amount of

interest to be determined by HB at anytime and effectively for any reason. Second, as the

official comment on § 2-209 states, “modifications made thereunder must meet the test of good

faith imposed by this Act.” The same qualities of the contract that prompted our argument for its

unconscionability, will testify to the fact that HB’s interest modifications were not made in good

faith. It had no expectation that N would be aware of her opt-out ability, and took advantage of

this fact in bad faith to impose severe increases in her interest rate. Finally, although the U.C.C.

presents doctrinal concepts seemingly generally applicable, it must bee remembered that its

terms are meant to apply only to sales contracts, and primarily those between commercial

entities. Contract modification is commonplace and expected when occurring between

organizations which have repeated and cordial dealings. § 2-209 merely exists to acknowledge

this practice in the event that those entities’ cordiality is replaced by animus. This is quite

distinct from the dealings of an individual consumer in relation to a large faceless corporate

entity. The consumer themselves is subject to unalterable and nonnegotiable term, and expect

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that the corporation will be similarly “locked in.” Therefore, U.C.C. § 2-209’s principles have

little place in determining the viability of N and HB’s contract.

The final issue that must be considered is the March 2007 agreement between N and

Everett, HB’s representative, in which N agreed to keep her account open for fear of credit rating

damage and accepted a 20% interest rate. HB will argue that even if the over arguments are

granted, that this subsequent agreement renders that discussion moot, as N agreed to a new

contract with a locked in interest rate of 20%. However, this agreement should be similarly

voided on grounds of undue influence. In Alaska Packers v. Domenico the court invalidated a

contact formed by the parties, because the packers demanded higher wages at a time that

Domenico was unable to find replacements. In other words, when due to one party’s

machinations a situation is set up whereby the other party has no option to refuse the court can

void the contact on grounds of undue influence. The situation with N’s March 2007 agreement

matches the Alaska case almost exactly. One party, HB, set up a system where it could charge N

arbitrarily high interest rates. When N sought to escape the interest rates by taking out loans to

exit her agreement, HB forced her to say on with them despite their rates, through the threat of ill

affecting her credit rating because of default. However, it is obvious that the default here was

created by HB, as it was not a default on the loan payment itself, but rather a failure to opt-out in

writing, a term which HB had no expectation would be fulfilled. In this situation HB created a

situation, intentionally, in which N had no option but to acquiesces to HB’s demands. As such

the March 2007 agreement should be voided on the grounds of undue influence.

As a final note, if the court is reluctant to void N’s contract on these doctrinal grounds

because of the practices describes pervasiveness in the industry, a line of argument based on

public policy concerns should be engaged. It is clear to any morally uncorrupted individual that

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HB’s practices are purposefully designed to prey on individuals unaware of contract intricacies.

Its attempt to lure in victims with promises of low interest, and then suddenly change its terms

poses a substantial risk to a large portion of the public. As such the court should invalidate the

contact on this basis alone if necessary.

B:

The problem of exploitative credit card contracts is pervasive in modern America. These

companies attempt to exploit the public’s consumerism, largely fueled by marketing industries,

and lock consumers into inescapable credit card debt, which can be increased on a whim.

Respectability is granted to the industries practices by relying partially, though not in a binding

manner, on credit report institutions that give quasi-scientific support for the Banks’ exploitative

practices. As is often the case with statistics, they can, and often are manipulated to suit the

interests of parties financially connected. Because the credit report industry’s sole client is

banking and credit companies, the problem of corruption is likely. It is in credit report companies

interest to please its customers, i.e. banks, by giving unfavorable credit reports to those in debt to

it, thus justifying immense interest rate increases. Because of the entrenched and formally

respectable quality of these practices it is necessary to take legislative action to regulate such

practices.

A possible solution is to outlaw adjustable interest rates entirely from the loan process.

That is to say, party initiated rate adjustment. When a lender to credit card company accepts an

individual into their program they must present a fixed rate of interest based on their evaluation

of their current status. Thus, the credit rating industry would still serve some purpose, but would

not be as susceptible to corruption. Banks will argue that inflation would render fixed interest

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economically unviable, but if a regulatory agency set the rate of interest adjustment based on

their calculations of inflation, then this complaint form the banking industry would be resolved.

A similar argument will be made that with this schema banks will have to charge higher interest

rates upfront to cover possible losses, and consumers will be hurt. This argument is deceptive,

however. Currently lender covers losses by raising individual interest rates according to their

own judgments. This hurts the individual affected to a degree unimaginable in seemingly

civilized society, whereas, overall rate increase would spread the risk across all consumers, thus

lessening the burden to a manageable level, with the added benefit of removing fraud and

deception from the credit industries practices.

Banks will likely argue that by impeding their ability to adjust interest rates, the

government will effectively ruin their business, by eliminating marketing viability. Credit card

companies will not be able to send out mail, declaring low interest rates, because it will need to

examine the individual applicant more carefully before promising a fixed low interest rate. This,

however, is exactly the type of activity that this regulation would seek to curb. The lending

industry harms the public greatly by promising loan contracts that it has no intention of fulfilling.

This regulation would impose sorely needed discipline on the lending industries practices. There

is no policy concern that would require the state of abide by lenders’ unconscionable contracts

simply to save them the trouble of adjusting their deceptive marketing strategies.

Although this degree of regulation would likely have drastic effects on the lending

industry, such regulation is not without precedent. The deceptive contracting practices of life

insurance resulted in heavy legislative intrusion, because of the manifest and overwhelming

injustice of that industry’s practices. The current crisis in the lending industry is severe, and

intolerable enough to warrant similarly drastic measures.

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Question II:

The question of whether or not informally cohabiting couples should be grated legal

recognition to promises made in that relationship presents numerous difficulties. The essence of

the problem is the informal nature of these arrangements themselves. More often than not,

individuals living in these situations are not certain of the extent of the others commitment, and

likely are unwilling, or afraid to make such issues explicit. Nonetheless, the individuals in these

scenarios often are promised, and promise in turn certain economic interests which are

intertwined with their romantic relationship. If a man agrees to support his partner through

school, and does so for a number of years with the expectation that the same will be returned in

kind at a later date, does this constitute a binding contractual agreement, or simply a gift with the

hope of reciprocity? Furthermore, it is possible that all such arrangements have the implied term,

“so long as the relationship persists.” Because individuals typically do not enter into such

mutually supportive arrangements with non-romantic friends and acquaintances, it would seem

that the romantic involvement itself is a predicate of the agreement. If so, does its dissolution

render the contract inoperable at such an event, or can the romantic involvement be seen as a

perquisite for the agreement to occur, but not a condition of its continued viability? A standard

based approach would be able to deal with particular situations and determine, with proper

evidence, how to answer these questions on an individual basis. However, discretionary regimes

can be difficult to implement, certainly it would be here where the judge would be asked to

consider the nature of the individuals relationship, an issue likely misunderstood by the parties

themselves. As such the three rules will be considered as they relate to exceptional cases, as well

as standard cases, with the goal of evaluating their respective ability to approximate the standard

that lies at the core of this question.

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Draft Statute 1 proposes that agreements between informally cohabiting couples should

be unenforceable, unless the agreement can be shown to be independent of their romantic

relations. This proposal privileges the understanding of cohabitation which sees all agreements

between parties as gifts, or promises dependant on the continued viability of their romantic

involvement. It does, however, allow the judge to consider exceptional cases where purely

economic agreements occur between the parties. This approach has the advantage of

acknowledging the informal nature of such relationships, and allows individuals to engage in

such relationships without fear of continued contractual obligation. If the court were to grant

cohabitants the same protections as married couples, there would be effectively no distinction

between the two manners of living. This is not an argument based on the anachronistic notion of

promoting marriage, but rather that individuals should be allowed to live together, if they please,

without fear of massive future economic burden. The escape valve of allowing enforceability if

independence from the relationship is found is essential to this approach. It allows the judge not

only to enforce obviously economic arrangements between the two, but conceivable is a manner

in which manifest injustice can be prevented by classifying the agreement as “independent” to

allow enforceability. This discretionary ability is likely to be utilized, as it is a clear pigeonhole

which will make judges less fearful in its implementation, but is vague enough to allow for the

usage described above, who can truly determine what is or is not totally independent from

romantic involvement.

Draft Statue 2 is the mirror image of Draft 1, in terms of its effect of individuals’ actions.

It explicitly allows judges discretion to enforce agreements where manifest injustice will occur.

Although this option attempts to limit the scope of enforceability by stating “The remedy will be

limited s justice requires,” this will not be sufficient to allow cohabitants the freedom to live

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together without substantial fear of economic entrapment. The discretionary standards provided

are so vague as to encompass almost any scenario. Consider, for example, if an unemployed man

lives for a number of years with a woman who provides him with economic sustenance. Imagine

that the woman demanded at some point that the man contribute economically, and he persuaded

her to support him for another year to “finish his novel.” Although the man relies heavily on the

“promise” of the woman, it would be clearly unjust to force her to continue his support in the

event of their romantic relationship’s dissolution, and yet such a ruling would be consistent with

this draft’s terms. If the legislature wants to allow for cohabitation, without the obligations of

marriage, then it will be bestiary to allow for such promises to be made without legal

enforceability. Indeed, it is unlikely that the woman in our scenario understood that her promise

was dependent of the implicit assumption of their relationship’s continued viability.

Draft Statue 3 departs from the virtues of Draft 1, in a direction opposite that of draft 2.

While 2 would result in the over enforcement of cohabitants promises, 3 would result in its under

enforcement. Both drafts 1 and 2 allow judges some discretion in enforcement, thus taking a

hybridized rule/standard approach. Draft 3, in contrast suggests a non-discretionary formal

approach. No agreements will be enforced unless in writing. In effect this draft would render all

cohabitants promises unenforceable, except in the most unlikely of scenarios, a written contract.

Even in the formal arrangement of marriage, ante-nuptial agreements are taboo, and undesirable

by the parties, it is even less likely such written documentation will occur in the more volatile

relationship between cohabitants. In the “I’ll support you through school if you support me”

scenario cohabitants will take on substantial burden, and likely expect return independent of their

relationship, even if they do not wish to make this explicit at the time. Under the regime of this

draft, no such agreements will be enforceable.

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It should be obvious form the preceeding discusiion that Draft Statute 1 is favored by this

author. It allows cohabitants the freedom to live together without fear of substantial economic

obligation, and is consistant with the largely informal quality of such relationships, and the

promises made therein. Draft 3 is far too sweeping in its exclusion of all informal agreements,

while Draft 1 makes the enforceability of exceptional cases possible, yet allows them to remain

exceptions. It is not the legislature’s intention to force marriage-like obligations on cohabitants,

as Draft 2 would result in, but rather simply to remove the taboo on enforcement, in exceptional

cases where contractual agreements have occurred, or manifest injustice would result from a lack

of enforcement.

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