Last week, we posted a list of our mid-April readings. Now it’s time for us to review the first few chapters of “Framing Contract Law” by Victor Goldberg. Part I of Goldberg’s excellent book (pictured below) consists of three chapters of varying lengths and presents three classic cases on the problem of contract formation:
- Wood v. Lucy (Chapter 2);
- Oscar Schlegel Manufacturing Co. v. Peter Cooper’s Glue Factory (Ch. 3); and
- Mattei v. Hopper (Ch. 4).
What is the common thread here? These leading cases ask in one form or another the same fundamental question: what does it take to make a legally-binding and enforceable contract? Let’s discuss the last case first:
Mattei v. Hopper
Let’s begin with Mattei, a California case that was decided in 1958. In this case, Peter Mattei, a real estate developer, wanted to purchase a plot of land from Amelia Hopper to build a shopping center. After negotiating a purchase price of $57,500 for the land, Mr Mattei and Ms Hopper signed an agreement called a “deposit receipt.” Here is how the court described the terms of their deal:
The parties’ written agreement was evidenced on a form supplied by the real estate agent, commonly known as a deposit receipt. Under its terms, [Mr Mattei] was required to deposit $1,000 of the total purchase price of $57,500 with the real estate agent, and was given 120 days to “examine the title and consummate the purchase.” At the expiration of that period, the balance of the price was “due and payable upon tender of a good and sufficient deed of the property sold.” The concluding paragraph of the deposit receipt provided: “Subject to Coldwell Banker & Company obtaining leases satisfactory to the purchaser.”
Mr Mattei paid the deposit, but Ms Hopper got cold feet during the 120-day option period and backed out of the deal, so Mr Mattei sued her to enforce the contract. Ms Hopper’s lawyers, however, came up with a clever legal loophole to try to get out of the deal: lack of “consideration.” In contract law, not all promises are legally binding, only those promises that are backed up by “consideration.” In short, both parties must give up something of value (e.g. time, money, know-how, etc.) to meet the consideration requirement.
In the words of the court: “When the parties attempt, as here, to make a contract where promises are exchanged as the consideration, the promises must be mutual in obligation. In other words, for the contract to bind either party, both must have assumed some legal obligations. Without this mutuality of obligation, the agreement lacks consideration and no enforceable contract has been created.” Another way a contract could be declared defective for lack of consideration is when the parties make “fake promises” under the doctrine of illusory promises. Again, in the words of the court: “… if one of the promises leaves a party free to perform or to withdraw from the agreement at his own unrestricted pleasure, the promise is deemed illusory and it provides no consideration.”
But why did the Hopper-Mattei deal lack consideration? After all, the parties agreed to a definite price, and the buyer paid a deposit. According to Ms Hopper’s lawyers (George R. Gordon, John L. Garaventa, and Dean Ormsby), it was because the contract had a “satisfaction clause”: Mr Mattei was not obligated to pay the full amount for Ms Hopper’s land if he was not satisfied with the commercial leases to be obtained by Coldwell Banker for the future shopping center he was planning to build.
Although Ms Hopper prevailed in the lower courts, Mr Mattei (represented by Jay R. Martin and William F. Sharon) took his case up to the California Supreme Court and won! According to the high court, a satisfaction clause does not destroy mutuality or create an illusory promise because the parties to a contract must act in good faith. As a result, an implicit duty to always act in good faith applied to Mr Mattei’s decision regarding the suitability of the commercial leases under the satisfaction clause.
For his part, Professor Goldberg agrees with the result but not with the court’s reasoning (p. 98): “by making the buyer’s good faith a necessary element of the contract …, the [court’s decision] needlessly raises good faith from a default rule to a nearly mandatory rule; and … good faith does not provide a coherent constraint on the buyer’s discretion.” Instead, the contract should be reframed as an option contract: when Mr Mattei paid the $1000 deposit, he paid for the exclusive right to decide whether he wanted to go through with the deal or not.
For our part, we agree 100% with Professor Goldberg’s reframing of the substance of the Mattei-Hopper deal as an option, and we would add one further critique of the court’s decision in this case. The court upholds the deal because it says Mr Mattei was required to act in good faith at all times, even under the satisfaction clause, but alas, this reasoning is circular! It begs the fundamental question whether the parties had a binding contract in the first place. By reframing the Mattei-Hopper contract as an option, good faith becomes irrelevant, since there is no question that the parties in this case made mutual obligations to each other.
(We will discuss Oscar Schlegel Manufacturing Co. v. Peter Cooper’s Glue Factory and Wood v. Lucy in our next two blog posts.)