One rule of contract law that's useful to know, and that can come into play each time an invoice is issued, is "account stated."

The Restatement (Second) of Contracts (1981) (the "Restatement") defines "account stated" as follows:

(1) An account stated is a manifestation of assent by debtor and creditor to a stated sum as an accurate computation of an amount due the creditor. A party's retention without objection for an unreasonably long time of a statement of account rendered by the other party is a manifestation of assent.

(2) The account stated does not itself discharge any duty but is an admission by each party of the facts asserted and a promise by the debtor to pay according to its terms.

Restatement § 282. Comment b to § 282 states, "[u]sually it is the creditor who submits the statement, but it may be the debtor who does so. In either case, the recipient's assent may be inferred from his conduct. . . . How long a time is unreasonable is a question of fact to be answered in light of all the circumstances." Id., cmt. b. Comment c states, "[a]n account stated does not itself result in discharge, but operates as an admission of its contents for evidentiary purposes. It also operates as promise to pay. . . . If it is in writing it may also satisfy the Statute of Frauds. In the absence of a requirement of a writing, however, an account stated may be oral." Id., cmt. c.

Ohio courts recognize the account stated rule. See, e.g., Hamilton Farm Bureau Coop., Inc. v. Ridgway Hatcheries Inc., Marion App. No. 9-03-45, 2004-Ohio-809 (click here). The Hamilton Farm Bureau case involved a dispute over finance charges on late payments. The finance charges represented a term that was added to the original contract, pursuant to R.C. § 1302.10 (click here), but the debtor, Ridgway Hatcheries, did not object to the finance charges in a timely fashion. The trial court granted summary judgment in favor of the creditor, Hamilton Farm, and the appeals court affirmed. The appeals court held:

Ridgway Hatcheries continued to pay on the monthly statements, at least as to the principal, and continued to order goods from Hamilton Farm despite the inclusion of the added term for finance charges. Ridgway Hatcheries failed to make any objections as to the term for finance charges until approximately a year after the term appeared on the monthly statements, and then only objected after receiving written correspondence from Hamilton Farm attempting to recover the balance due on the account. Such inaction by Ridgway Hatcheries constitutes an acceptance of the added term of finance charges to the contract between the parties and also constitutes an agreement between the parties as to the amount of the account stated. Ridgway Hatcheries was under a duty to examine its monthly statements for incorrect accounting and its lack either to do so or to object to such is acquiescence on the part of Ridgway Hatcheries to the new terms of the contract.

2004-Ohio-809, at ¶18.

Being mindful of the account stated rule, and making timely, appropriate, written objections to statements of account that differ in some respect from what you understand the parties' agreement to be, can be useful in avoiding the application of the account stated rule against you.

Tags: Contracts, Account Stated

Liquidated damages provisions are fairly common in commercial agreements, but I suspect that, many times, parties don’t pay much attention to the question whether the provisions would be enforceable in a particular transaction if a dispute were to arise.

A liquidated damages provision is “[a] contractual provision that determines in advance the measure of damages if a party breaches the agreement.” Black’s Law Dictionary (8th ed. 2004), at 949-950. It might, for example, specify that the breaching party will pay to the nonbreaching party a fixed dollar amount in the event of a default. Or, it might take the form of a monetary cap on the breaching party’s damages.

A liquidated damages provision (which is also sometimes referred to as a stipulated damages provision) is appropriate when the non-breaching party’s actual damages would be difficult to estimate at the time of contracting. If the provision acts as a penalty, however, it will be unenforceable on public policy grounds, “[b]ecause the sole purpose of contract damages is to compensate the nonbreaching party for losses suffered as a result of the breach[.]” Lake Ridge Academy v. Carney (1993), 66 Ohio St.3d 376, 381, 613 N.E.2d 183. “Thus, when a stipulated damages provision is challenged, the court must step back and examine it in light of what the parties knew at the time the contract was formed and in light of an estimate of the actual damages caused by the breach. If the provision was reasonable at the time of formation and it bears a reasonable (not necessarily exact) relation to actual damages, the provision will be enforced.” 66 Ohio St.3d at 382. In Ohio, a liquidated damages provision will be upheld if it meets the following test:

Where the parties have agreed on the amount of damages, ascertained by estimation and adjustment, and have expressed this agreement in clear and unambiguous terms, the amount so fixed should be treated as liquidated damages and not as a penalty, if the damages would be (1) uncertain as to amount and difficult of proof, and if (2) the contract as a whole is not so manifestly unconscionable, unreasonable, and disproportionate in amount as to justify the conclusion that it does not express the true intention of the parties, and if (3) the contract is consistent with the conclusion that it was the intention of the parties that damages in the amount stated should follow the breach thereof.

Samson Sales, Inc. v. Honeywell, Inc. (1984), 12 Ohio St.3d 27, 465 N.E.2d 392 (syllabus) (holding that $50 cap on liability in burglar alarm contract was unenforceable); see also Midamco, L.P. v. Fashion Bug of Solon, Inc. (1996), 116 Ohio App.3d 854, 857-858, 689 N.E.2d 605 (collecting cases in which liquidated damages provisions were held unenforceable).

The party that seeks to benefit from a liquidated damages provision should obviously avoid using the term “penalty” to describe the damages. See, e.g., Wright v. Bassinger, Mahoning App. No. 01CA81, 2003-Ohio-2377 (holding that a liquidated damages provision that specified a five percent “penalty” was unenforceable). That party should also be able to demonstrate that the parties arrived at the method of calculating the amount of the specified damages in a reasonable manner. Id. at ¶20. It may also make sense to provide affirmatively in the contract (to the extent that circumstances permit) that actual damages would be uncertain as to amount and difficult of proof, that each party understands the liquidated damages provision and has had access to counsel in connection with reviewing and negotiating the terms of the contract, that the provision is the result of arm’s length negotiations, that the specified damages are “proportionate in amount compared to the value of services under” the contract (Republic Services of Ohio Hauling, L.L.C. v. Pepper Pike Properties, Inc., Cuyahoga App. No. 81525, 2003-Ohio-1348, at ¶41) and “proportional to the anticipated ‘harm’ from the ‘breach’ of the contract” (Westbrock v. W. Ohio Health Care Corp. (2000), 137 Ohio App.3d 304, 323, 738 N.E.2d 799), that the parties intend “to provide for liquidated damages in the specified amount” (Young v. Int’l Bhd. of Locomotive Engineers (1996), 114 Ohio App.3d 499, 509, 683 N.E.2d 420), and that the parties intend the damages to serve merely as compensation, and not as a penalty.

Tags: Contracts, Liquidated Damages

Sometimes, a business can run into big public relations problems by enforcing contract rights. This week, The Washington Post has run stories about how the Washington Redskins have been suing some fans for breach of contract. Click here and here. Today’s Post includes a scathing piece by columnist Thomas Boswell, entitled “A Public Distrust.” Boswell states, “the team has taken the bad faith prize for mean and greedy business practices toward its own fans,” and “[t]he Redskins have a right to enforce contracts. But that doesn't make it right.” Boswell’s also states, “[if ticket buyers with multiyear contracts suffer from economic hard times, the Redskins do not emulate at least nine other NFL teams, as well as local franchises such as the Capitals, and simply cancel the tickets and sell them to someone else. Nope. Despite a ‘waiting list’ they claim is 160,000 long, the Redskins sue some of their own fans for the money and, at times, even resell the tickets.” One wonders whether enforcing contract rights in this case is worth the hit the team is taking on the public relations front.

Update: click here.

Tags: Contracts

Last month, I had a post about a recent Ohio Supreme Court case, Olympic Holding Co., L.L.C v. Ace Ltd. (2009), 122 Ohio St.3d 89, 2009-Ohio-2057, in which the Court rejected a claim that promissory estoppel removed an agreement from the statute of frauds in the context of negotiations between sophisticated business entities concerning a proposed five-year agreement. The Eighth District Court of Appeals has issued an opinion in which it relied on the Olympic Holding case, holding that promissory estoppel did not remove a case from the statute of frauds in a transaction involving a proposed sale of real estate. Seaman v. Fannie Mae, Cuyahoga App. No. 92751, 2009-Ohio-4030 (affirming motion to dismiss under Civ. R. 12(B)(6)). In Seaman, the plaintiffs-appellants alleged that Fannie Mae “represented to appellants that the price and terms were agreed and instructed appellants to execute the purchase agreement attached to the complaint and to pay the earnest money to appellee,” and that they detrimentally relied on the promise “‘by paying the earnest money, foregoing the purchase of other properties and spending time and resources on the purchase of the subject property.’” Fannie Mae never signed the agreement. The Eighth District unanimously held, “[i]n most negotiations for transactions included within the statute of frauds, the parties contemplate that the contract will be reduced to writing. If a written agreement is contemplated, reliance upon statements made before an agreement is signed will be unreasonable as a matter of law, particularly when sophisticated business parties are involved in the negotiations.” (emphasis added).

Tags: Contracts, Statute of Frauds

Black’s Law Dictionary (8th ed. 2004) defines the term “indemnification” as “[t]he action of compensating for loss or damage sustained.” Id. at 783. In business contracts, the parties can provide for indemnification, to make whole the party that suffers a loss arising out of certain events. Indemnification can be one-way or reciprocal. A few days ago, Ken Adams posted a good piece that sets forth some general principles about when it’s appropriate to use (and not to use) indemnification provisions in a contract.

Tags: Contracts

Much of a company’s value is contained in its contracts. Those contracts can be either oral or written. Oral contracts involve less work at the front end, but may end up costing a company more in the long run. Written contracts, in contrast, involve more work at the front end, but may end up costing a company less in the long run.

Good written contracts can help protect a company’s value by reducing risk, such as litigation risk. It’s no secret that litigation is expensive, time-consuming, and slow. It’s therefore prudent to reduce litigation risk, to the extent reasonable.

One source of contract litigation is a dispute about an issue that the parties didn’t consider. Drafting a contract, even a relatively simple one, can help the parties think through basic issues such as term, termination, payment terms, confidentiality, ownership of work product, governing law, etc. The process of committing an agreement to paper can help parties identify and amicably resolve potential problem issues in advance.

Another source of contract litigation is an ambiguous contract term. Ambiguity means that there is more than one reasonable interpretation of a contract term. The odds of having an ambiguity are much greater when there’s nothing in writing, which, in turn, increases the chances that, at some point, the parties will have a dispute about the terms of the agreement. Such disputes can lead to litigation. Not having a written contract also complicates any litigation that arises out of the ambiguity. Proving the terms of an oral contract in litigation can be a complicated and unreliable exercise. That translates into greater expense and risk.

A well-drafted written contract, on the other hand, can serve as a hedge against litigation, by discouraging it in the first place. If litigation does occur, a good contract can, all things being equal, increase the chances of obtaining a favorable result, either at trial or at an earlier stage of litigation. A court would attempt to establish what the parties intended at the time they entered into the agreement, and a written contract is usually the best evidence of that intention.

Tags: Contracts

It’s a well-settled rule of law that certain agreements must be reduced to writing and signed. Ohio has codified that rule, known as the “statute of frauds,” in Chapter 1335 of the Ohio Revised Code. For example, R.C. 1335.05 provides that “an agreement that is not to be performed within one year from the making thereof” must be in writing and signed.

What happens when sophisticated business entities enter into lengthy negotiations concerning a five-year joint venture agreement, which reach an advanced stage, including an exchange of nine drafts of a proposed written agreement, one party allegedly promises the other that the agreement would be signed, the other party relies on that statement, and then the first party indicates that it won’t go forward with the agreement? In the lawsuit that follows, can the first party raise the statute of frauds as an affirmative defense to a breach of contract claim, because nothing was signed?

Yes, according to the Supreme Court of Ohio in in a recent 5-2 decision, Olympic Holding Co., L.L.C v. Ace Ltd. (2009), 122 Ohio St.3d 89, 2009-Ohio-2057. The Court rejected the plaintiffs’ claim that doctrine of promissory estoppel (see the dissent for a fuller discussion of the doctrine) removed the agreement from the statute of frauds and barred the statute of frauds as an affirmative defense. The Court held, “‘[r]eliance on a statement of future intent made prior to the conclusion of negotiations in a complex business transaction is unreasonable as a matter of law. * * * Such a rule is particularly appropriate when two sophisticated business entities are involved in negotiations.’” (emphasis added) (citations omitted). The Court further held, “promissory estoppel is an adequate remedy for a fraudulent oral promise or breach of an oral promise, absent a signed agreement,” and that the plaintiffs could, under a promissory estoppel theory, pursue their claim for reliance damages (which represented a smaller measure of damages than what the plaintiffs sought). The majority noted the presence of disclaimers on each page of the term sheets that were exchanged early in the negotiations, that it was “not an offer of insurance,” and on the drafts that were exchanged later in the negotiations, that the document was “for discussion purposes only” and didn’t represent an offer to enter into a transaction. The majority also noted ancillary agreements that remained in draft form.

The dissent states that “an overwhelming majority of jurisdictions recognize that promissory estoppel may bar a party from asserting a defense under the statute of frauds in certain circumstances” and was persuaded that application of the Statute of Frauds in the case was inequitable. For example, the parties had reached a “mutual understanding on the essential terms of their joint business venture,” and the plaintiffs were told that the agreement was “just awaiting signature.” The dissent would have adopted a rule that promissory estoppel “‘may be used to preclude a defense of statute of frauds, but only when there has been (1) a misrepresentation that the statute’s requirements have been complied with or (2) a promise to make a memorandum of the agreement.’” (citation omitted).

Tags: Contracts, Statute of Frauds

This recent Ohio appeals court case illustrates the importance of paying attention to how a corporation or LLC signs a contract. The case involved a lease in which the tenant was a corporation. Three doctors signed for the corporation. Each of their signatures followed the name of the corporation, which was identified as an Ohio corporation, and the word “By.” The corporation subsequently dissolved with several years remaining on the lease, and the landlord sued the three doctors who had signed the lease. The trial court granted summary judgment for the doctors (because there was no genuine issue of material fact as to personal liability), and the landlord appealed. On appeal, the landlord argued that “the doctors were personally liable on the lease because they personally signed the lease.” The appeals court rejected that claim, holding that because “the named physicians are clearly signing the lease in their capacity vis-a-vis [the corporation], the only liability established on the face of the lease is liability for [the corporation]. Corporations are viewed as separate legal entities or ‘persons’ under Ohio law.” (Note: it’s not clear whether the doctors also signed with reference to their corporate titles - the contract language quoted in the opinion suggests that they didn’t - but doing so may have put the doctors in an even stronger position.) The appeals court also rejected the landlord’s claim that the court should “pierce the corporate veil,” because the landlord had not shown fraud or illegality. The landlord has filed an appeal with the Supreme Court of Ohio. The case serves as a reminder, too, that, where appropriate, it may be in a party’s interest to get a personal guarantee of a corporate obligation.

Another recent Ohio appeals court case illustrates some potential pitfalls when signing a contract in a corporate capacity. As in the case described above, the appeals court rejected a claim that an individual was personally liable on a lease, but the language at issue is far from clear. As the dissent states, the documents didn’t make clear what type of entity the tenant was, and it could have been simply a fictitious business name or a partnership, in which case the individual could have been personally liable.

Tags: Contracts

I’m a big fan of Ken Adams and his AdamsDrafting blog, which is full of excellent contract drafting tips. (His Manual of Style for Contract Drafting is on my bookshelf.) I admire his attempt to bring consistency to contract drafting and to eliminate ambiguous language, which can be a source of transaction costs, including litigation. It’s a worthwhile endeavor.

Tags: Contracts, Drafting, Litigation