Thursday, May 7, 2009 - FEEBAYS new user agreement - Part 2G. The Principles of Contract

1. Chapter Six - Covert Tools of the Judiciary

2. Courts employ other tests to invalidate standardized contract terms. Three widely recognized tests are: unconscionability, unfair surprise and defeat of reasonable expectations.[180] Yet, the different names of these tests do not imply fundamental differences in definition. The implied rule underlying these devices for managing terms is: what shocks the judicial conscience. Systematic rules thus are replaced with heartwarming intentions. As applied, courts mix the tests to establish a bouillabaisse of rules governing particular terms. The tests also leech from one compartment of law to another by analogical reasoning. The result: they behave with the uncertainty characteristic of measuring sub-atomic particles at high velocity. Courts hide the basis of their decisions, making it impossible for parties to plan for the future.[181] In a remarkable statement, since he introduced unconscionability in the Uniform Commercial Code, Llewellyn has remarked, "covert tools are never reliable tools." [182]

   Unconscionability

3. Unconscionability is an integral part of equity, and has been enacted in statutory form by Uniform Commercial Code Article 2 (Sales). Section 2-302, which applies to the sale of goods, provides:

   "(1) If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result."

   (2) When it is claimed or appears to the court that the contract or any clause thereof may be unconscionable the parties shall be afforded a reasonable opportunity to present evidence as to its commercial setting, purpose and effect to aid the court in making the determination."

4. The provision bestows authority upon a court to invalidate unconscionable terms but does not require that result. The Official Comment states, "The basic test is whether, in light of the general commercial background and the commercial needs of the particular trade or case, the clauses involved are so one-sided as to be unconscionable under the circumstances existing at the time of the making of the contract." The parties are allowed to introduce evidence, but the question of whether a contract or term is unconscionable is considered a question of law. The Official Comment continues, "The principle is one of the prevention of oppression and unfair surprise." Uniform Commercial Code Article 2A (leases) contains a mirror provision.[183]
5. In 1967, Arthur Allen Leff in Unconscionability and the Code - The Emperor's New Clause exposed the "statutory pathology" of Section 2-302. Discussing the ten cases cited in the Code to illustrate the operation of Section 2-302, Leff observed:

   Assuming, therefore, that the ten cases are to illustrate what judges do when faced with appealing fact situations and unhelpful legal doctrines, how do they do that job? First, they illustrate only "adverse construction of language," which is only one of the four evasive techniques named in the comment. They do not exemplify "manipulation of the rules of offer and acceptance," or any findings that a clause is contrary to public policy." Thus, the cases are apparently not designed to be exhaustive on the subject of manipulative techniques. What they do illustrate, however, and quite well, is the skewing of legal doctrine that may be caused by an emotional pressure to get a more heartwarming result. It cannot be denied that uncertainty of a particularly virulent kind enters the picture when the basis of a decision and its stated basis part company.[184]

6. Since Leff published his article in 1967, courts have applied Section 2-302 without adopting a uniform definition. The West Group 2002 pocket part to the Uniform Laws Annotated cites 20 law review articles on unconscionability and contains 15 fine print pages of case summaries. Despite this intellectual output, courts cannot even agree on whether both "procedural" and "substantive" unconscionability are required to invalidate a contract or term.
7. The failure of "unconscionability" to control terms derives principally from the inability to define it. The Code does not define the term and the common law definition is slippery: a term that is oppressive or that gives the stronger party an unfair advantage over the weaker party.[185] One court has stated, it is "an amorphous concept obviously designed to establish a broad business ethic."[186] One commentator has put it better, and bluntly, "The word "unconscionable," as finally used in the Code, describes neither the dramatic situation of two persons bargaining nor the "imbalance" or "lopsidedness" or other quality of the resulting contract, but rather describes the emotional state of the trier which will justify his use of the section."[187] The courts have gone no farther in explaining unconscionability than Lord Hardwicke in 1867 who stated it is a bargain "such as no man in his senses and not under delusion would make on the one hand, and as no honest man would accept on the other."[188] Unconscionability cannot be reduced to a precise formula.[189] No generally accepted tests have emerged. "The cases are too fact specific to lead to a useful body of precedent."[190] "The courts thus continue to manipulate the unconscionability principle in order to reach the equitable results they desire."[191]

   The reasonable expectations test: unfair surprise

8. State courts often use the "reasonable expectations" test to determine whether a non-negotiated term in a standard form contract should be enforced against the buyer. A typical statement of the test is, "In dealing with standardized contracts, courts have to determine what the weaker contracting party could legitimately expect by way of services according to the enterpriser's 'calling' and to what extent the stronger party disappointed reasonable expectations based on the typical life situation."[192] The "reasonable expectations" test consists of two parts. First, the parties do not have equal bargaining power. Second, the term in dispute must frustrate the reasonable expectations of the weaker party. "As this provision is applied, courts have focused on the expectations of the party manifesting assent rather than the drafter of the term, notwithstanding the language suggesting a contrary focus."[193]
9. In order to determine what is the "reasonable expectation" of the weaker party, courts examine the written contract, the prominence of the term in dispute, the circumstances under which the contract was made, and the purpose of the term. The courts use these factors to determine whether the weaker party actually had knowledge of the term. If the weaker party had actual knowledge of the term, then the term could not have frustrated the party's expectations since a party cannot be surprised by what he knows. The signature of the weaker party, the clarity and conspicuousness of the term, as well as actual notice of the term are the key considerations in determining what the weaker party actually knew about the standardized term. If the weaker party knows about the term, it is enforceable unless it contravenes public policy.
10. However, if the court determines that the weaker party had no knowledge of the term, then it must decide whether the term is beyond the reasonable expectations of an ordinary person. This determination of "reasonable expectation" is left to the discretion of each individual court. Because the "reasonable expectations" test lacks hard standards, courts using this test reach conclusions based on nothing more than the predilections of individual judges without supporting evidence.
11. Take the 1976 case of Wheeler v. St Joseph Hospital.[194]Prior to his admission to St. Joseph Hospital for an angiogram and catheterization test, David Wheeler signed an admission form containing an agreement to arbitrate claims with the hospital. The Wheelers sued the hospital for damages arising from his injuries sustained during his medical treatment. The hospital sought to enforce the arbitration agreement in the admission form. The Appellate Court produced a majority opinion and a dissenting opinion. In the majority opinion, the Court noted, "a party cannot be compelled to arbitrate a dispute he has not agreed to submit" and held that Mr. Wheeler's signature did not constitute his consent to be bound by the written and clear terms of the contract.[195] The Court stated, "Absent notification and at least some explanation, the patient cannot be said to have exercised a "real choice" in selecting arbitration over litigation," despite that fact that Mr. Wheeler had the option to refuse arbitration.[196]
12. The Court found that the admission document was a contract of adhesion. Stating, "Enforceability depends upon whether the terms of which the adherent was unaware are beyond the reasonable expectations of an ordinary person or are oppressive or unconscionable."[197] This characterization allowed to the Court to conclude that something as vague as the parties' reasonable expectations, really constituted the contract instead of the words contained in the contract itself. Without substantiation, the Court concluded that a patient, "[w]ould hardly expect his signature to an admission form to be taken as an agreement to give the hospital as well as any doctor the option to compel arbitration of a malpractice claim."[198] Taken to its logical conclusion, the rule in Wheeler would require face-to-face encounters between sellers and buyers where the seller's representative would have to explain the contents and legal effects of standard terms to the buyer.
13. However, the dissent in Wheeler reached the opposite conclusion based on the identical set of legal rules. The dissent found that, "Almost every written commercial transaction, except one hammered out by two lawyers representing two individuals of equal bargaining power, is in a broad sense, a contract of adhesion."[199] Merging the reasonable expectations test with the unconscionability test, the dissent stated that the rules governing adhesion contracts come into play only when the contract contains terms giving the party with the superior bargaining power an unconscionable advantage. Contrary to the majority view, the dissent found that the hospital did not take any unconscionable advantage of Mr. Wheeler. The arbitration clause was spelled out in plain English, in normal size type, and appeared right above the signature line.
14. Comparing the majority and minority opinions demonstrates the arbitrary nature of the reasonable expectations test. In juxtaposition, the majority and minority opinions represent the honest but personal preferences of the judges. Neither opinion constitutes a logical chain of legal reasoning but a broad-based policy analysis unsupported by evidence required to fortify the decision. Without taking a public opinion poll, the majority found that no reasonable person would expect to find an arbitration clause in a hospital agreement. Based upon an equal lack of evidence, the dissent found that no reasonable person would prefer litigation to arbitration. The reasonable expectations test posits the source of contract terms outside the written contract. The test permits courts to substitute their judgments for that of the authoring party. While some may argue it is better to have courts write contracts than firms, the practical consequences of judicial opinions often have unintended consequences. Courts also are unable to assemble the data needed to resolve public policy issues that transcend the limits of particular cases.

    Restatement (Second) of Contract

15. The Restatement (Second) of Contracts is a restatement of common law in the form of a Code. It carries weight by virtue of the authority of the American Law Institute that publishes the Restatement. Although the Restatement is not enacted by any legislature, courts often cite it in support of their decisions. With respect to standard form contracts, the Restatement (Second) of Contracts, Section 211 provides: "Where the other party has reason to believe that the party manifesting such assent would not do so if he knew that the writing contained a particular term, the term is not part of the agreement." This standard focuses on the state of mind of the party preparing the standard form contract. This party usually is a professional: merchant, seller, manufacturer or attorney. The author of the contract is put in the position of asking itself what the other party to the contract would think of a particular term included in the contract. In effect, the author of the contract must ask and answer a counterfactual question: If the other party to the contract knew about the term before making the contract, would the other party reject the contract?
16. To vacate a term under this standard, a court must find that: (1) the author of the contract had reason to believe, (2) that if the other party knew of the term, (3) the term would cause the other party to reject the term. The drafters of the Restatement explain: "For that to occur... the terms must not only be surprising, but also highly adverse to the deal."[200] Only a few states have adopted the Restatement (Second) of Contracts test.[201] In contrast to the "reasonable expectations" test, which focuses on the knowledge and expectations of the buyer, the Restatement test focuses on the knowledge and expectations of the seller. However, as implemented, there is no meaningful distinction between the straight "reasonable expectations" test and Section 211 of the Restatement (Second) of contracts. The latter, like the former, invites courts to re-write explicitly clear contracts based on the judicial view of doing justice, a method usually leading to arbitrary and debatable results.
17. Take Lauvetz v. National Car Rental for example. The Alaska Supreme Court held that the average person renting a car would not know that the collision damage waiver would not apply to damage caused by driving the car while intoxicated.[202] Two vacationers in Alaska arranged to rent a van from National Car Rental. Osborne actually signed the rental agreement but listed Lauvetz as an authorized driver. In addition, Osborne purchased the collision damage waiver option. The terms and conditions of the rental agreement, including an explanation of the collision damage waiver, were printed on the inside of the travel folder containing the rental agreement. One term stated that the vehicle shall not be used "by any driver under the influence of intoxicants, drugs, or any other substance to impair driving ability." The rental agreement further provided:

    I understand that if the vehicle is obtained or used for any prohibited use or in violation of this agreement, then the CDW option shall be void and, where permitted by the law, the liability and comprehensive protection, PAI, PEC, and SLI insurance shall be void."[203]

    Neither Osborne nor Lauvetz read the terms and conditions. Three days later, Lauvetz, driving while he was intoxicated, got into a single car accident and wrecked the van. Lauvetz pleaded no contest to charges of reckless driving.

18. National Car Rental sued Lauvetz and Osborne to recover compensatory and punitive damages for the wreck of the van. The complaint alleged that Lauvetz was intoxicated at the time of the accident, that the intoxication caused the accident and that the CDW did not apply because Osborne and Lauvetz were liable for damage resulting from a prohibited use of the van. The trial court ruled that the "terms and provisions of the collision damage waiver in the car rental agreement governing drunk and reckless driving are valid, binding, and enforceable, and the Court rejects defendants' position that the CDW is insurance."[204]
19. The Alaska Supreme Court, relying upon Section 211 of the Restatement (Second) of Contracts, reversed, citing the following:

    (1) Except as stated in Subsection (3), where a party to an agreement signs or otherwise manifests assent to a writing and has reason to believe that like writings are regularly used to embody terms of agreements of the same type, he adopts the writing as an integrated agreement with respect to the terms included in the writing....

    (3) Where the other party has reason to believe that the party manifesting such assent would not do so if he knew that the writing contained a particular term, the term is not part of the agreement."

    This section establishes the general enforceability of the terms of standardized forms, whether the customer reads or understands them. However, customers "are not bound to unknown terms which are beyond the range of reasonable expectation."[205] Parsing the Restatement (Second) test from the common law "reasonable expectations" test, the Alaska Supreme Court noted that the latter reflects those "reasonable expectations" a customer would have after reading the standardized form, while the former actually presumes that the customer does not read the form.[206] Given the clarity of the terms in the National Car Rental Agreement, Osborne and Lauvetz could not plausibly have argued that the exclusions were beyond their reasonable expectations.

20. Contrary to that view, however, the Alaska Supreme Court stated "Section [211]on the other hand, emphasizes the reasonableness of the term or condition, no matter how clear its meaning might be to the layman if he happened to read it."[207] The Court then dismissed National's arguments that "no person who drives a car that does not belong to him can have any reasonable expectation that he can drive that car recklessly or while intoxicated" and that "Lauvetz's position that a prohibition against drunk and reckless driving is an unconscionable or unreasonable limit on the CDW is absurd."[208][209] Without any empirical support, such as a study of customer habits and perceptions, the Court concluded "a consumer would not reasonably expect the damage waiver to be less than complete."[210] In the Court's view, the term "complete" meant that the driver would not be accountable for any loss, even that caused by his fault. Rather, for the Court, the relevant question was "whether the purchaser of the damage waiver reasonably expected the waiver to be subject to any exclusions."
21. The Court's holding is nothing more than judicial law making in the insurance field. If the Alaska legislature wanted to hold insured's completely blameless for their actions in rented automobiles, the legislature could have enacted a law producing that result. The Court's holding also vindicates a dubious, even outrageous, claim made by a supposedly "ignorant" consumer. The one-thing consumers know about insurance policies, maybe the only sure thing they know about them, is that they contain exclusions. Where did the Court come up with the remarkable conclusion that a person who rents a car, drives it while intoxicated and wrecks the vehicle, then can walk away from the destruction without further cost because the person bought the CDW option? In the name of ignorance, the Court exonerates the consumer from the consequences of his fault. There is nothing in the Restatement (Second) to support this holding. First, the Restatement does not constitute an invitation to re-write insurance contracts. Second, the restatement does not suggest that a person who damages property because of a voluntary act of intoxication should be surprised to find out his contract makes him responsible for the consequences of his behavior. While the policy virtues of spreading risk across the customer base has its proponents, the Restatement (Second) has taken no position in this political debate.
22. More important, the Restatement (Second) contains two flaws. First, if the language of "surprise" is taken literally, then the test does not hold consistently over time. When a standardized term in a contract is revealed to be a surprise, then it ceases to be a surprise if it is contained in subsequent contracts. Second, Comment f of the Restatement appears to efface the distinction between "surprise" terms and manifestly unreasonable terms. Comment f provides: customers "are not bound to unknown terms which are beyond the range of reasonable expectation." If that interpretation is correct, the Restatement (Second) test is indistinguishable from other doctrines used to police contracts and invalidate terms such as public policy and unconscionability.