Saturday, September 26, 2009

What if you asserted a contract of the sort entered into and performed every day contained an illusory promise and you were right?

An illusory promise takes the form of a promise but commits its maker to nothing. Thus, as Comment a. to Restatement Section 77 states: "Words of promise which by their terms make performance entirely optional with the “promisor” do not constitute a promise." The Restatement offers the following illustrations:
1. A offers to deliver to B at $2 a bushel as many bushels of wheat, not exceeding 5,000, as B may choose to order within the next 30 days. B accepts, agreeing to buy at that price as much as he shall order from A within that time. B's acceptance involves no promise by him, and is not consideration. Compare §§ 31, 34.
2. A promises B to act as B's agent for three years from a future date on certain terms; B agrees that A may so act, but reserves the power to terminate the agreement at any time. B's agreement is not consideration, since it involves no promise by him.
I've always wondered about a situation raised in the comments to the last post. It is common in the sale of a home for the contract to provide that the buyer has a certain period (typically, in my experience, one week to 10 days) to inspect the property and to allow him in that period to cancel the contract (either explicitly or implicitly on the grounds that the inspection reveals conditions that cause him to want to do so). It has always been my understanding that during this period the buyer really has the power to cancel for any reason. The reasoning may be that any house will have defects and thus that any effort to dispute the legitimacy of cancellation on the grounds of a defect would be futile, but, at any event, the effect is to create a unilateral right to cancel.

What would happen if the seller cancelled during this period and argued that there was no binding contract because until the inspection period had passed the buyer had made no binding commitment and thus had made only an illusory promise? It's not a purely academic hypothesis -- imagining the seller receiving a better offer soon after the signing of the contract hardly seems unrealistic. My gut tells me a court would enforce the contract simply because the practice is so common and accepted, but I've always wondered how the result could be justified.

A similar problem is raised by the "attorney approval" clauses that also often included in house contracts. These clauses give the buyer a limited amount of time within which to consult an attorney and the right to back out of the deal within that time for any reason discovered by the attorney. Again, the purpose of the clause is to allow the buyer to discover legal issues he hasn't earlier had the knowledge or opportunity to notice, but the effect typically is to give the buyer a unilateral right to back out. See, e.g., Moran v. Erk (N.Y. 2008)(holding that "where a real estate contract contains an attorney approval contingency providing that the contract is 'subject to' or 'contingent upon' attorney approval within a specified time period and no further limitations on approval appear in the contract's language, an attorney for either party may timely disapprove the contract for any reason or for no stated reason.")

As is often the case when you look for a specific factual situation to research, however, the likelihood of finding a case directly on point is low, even if that factual situation is a common one. Remember, reported opinions are a tiny, tiny fraction of all the legal disputes that ever arise -- the vast majority of legal disputes do not become lawsuits. Over 95% of civil lawsuits settle before trial. Another healthy percentage settle after trial. Very, very few are decided by reported appellate decisions.

But in Devine v. Notter, 312 Wis.2d 521, 753 N.W.2d 557 (Ct. App. 2008), review denied,314 Wis.2d 71, 758 N.W.2d 91, 2008 WI 122 (Wis. 2008), the court did address a situation that was almost exactly the one I've always wondered about. In Notter, a home buyer sued sellers for breach of contract after sellers notified buyer ten days before closing that they would not complete the sale. The trial court granted specific performance for buyer, and the Wisconsin Court of Appeals affirmed, holding that the attorney approval agreement signed by the parties did not render the contract illusory by allowing the parties the unlimited right to walk away from the deal.

The sellers argued, as I would have expected, that the contract of sale was illusory because, since the the attorney approval clause allowed "either party to walk away from the deal, the clause left both parties free to do just as they wished." Id. at 525. The court first observed that there is very little, if any, case law on point, It concluded, however, that the contract was enforceable because the obligation to consult with an attorney and to provide notice of cancellation was enough to supply consideration:
The [sellers] are correct that an unlimited right to cancel can render a contract illusory, at least as to future performance, since a party can always avoid any obligations by simply invoking the cancellation right. See 1 Richard A. Lord, Williston on Contracts § 4.27, at 820 (4th ed.2007). Where, however, the right to cancel is limited even in slight ways, courts have found this enough of a detriment to the cancelling party to save the contract from illusoriness. See, e.g., Klug v. Flambeau Plastics Corp., 62 Wis.2d 141, 152, 214 N.W.2d 281 (1974) (“The provision that plaintiff could not terminate the contract except on written, ninety-day notice was itself a sufficient detriment so as to insure mutuality of obligation.”); 1 WILLISTON ON CONTRACTS § 4.27, at 820-25 (“[I]f the party may only cancel upon dissatisfaction, for good cause shown ... upon the giving of reasonable notice, or upon any other condition not within the promisor's control, the promise is nevertheless enforceable.” (Citations omitted.)). Here, the party wishing to cancel the deal was required, at minimum, to consult with an attorney and provide notice within five days. In our view these obligations, though not onerous, are enough to save the deal from being illusory. See also Chicago Fire Brick Co. v. General Roofing Mfg. Co., 133 Ill.App. 269, 1907 WL 1829, *4 (1907)(four-day right of cancellation did not render contract void for lack mutuality where four days had passed and no cancellation was effected).
We therefore hold that the attorney-approval agreement signed by the [sellers and buyers] did not render their contract illusory. Because no objection was made within the five-day window, the contract remains in force and Devine is entitled to specific performance. Because we so hold, we need not consider whether subsequent actions of the parties waived any claim of illusoriness.
Devine, 312 528-529. Of course, Devine is a much easier situation than the one I have long wondered about -- where the seller backs out before the cancellation period expires. Once the cancellation period passes, as it had in Devine, the buyer is committed. As the court in Devine observed, while a case in which the cancellation period had not expired before the seller tried to get out of the contract is a "completely different" one, its resolution is also very much open to question:
The issue of whether the parties to a contract containing an attorney-review clause can be held to anything during the review period is a matter of some dispute. See Alice M. Noble-Allgire, Attorney Approval Clauses in Residential Real Estate Contracts-Is Half a Loaf Better Than None?, 48 U. Kan L..Rev. 339, 358-62 (2000). In any case, this is clearly a completely different question than whether a party can escape the contract long after the review period has expired, as the [sellers] are attempting to do here.
Devine, 312 Wis.2d at 526, n. 3.                                                                                                                                        


  1. I wondered the same thing. I feel like it is an illusory promise because it is left open to the buyer to make the final say if they want the house. I recently got a house and I thought I could back out for any reason when they said I had 1 week to have the inspection and let them know if I wanted the house still. If a court enforced the contract I wonder their justification. Would the court possibly say backing out is contingent on the home inspection only and backing out for any other reason would be considered breach?
    R. Shefferly

  2. As I wrote, it has always been my understanding that the right to inspect and notify of an intent to back out within a certain amount of time really means that "during this period the buyer really has the power to cancel for any reason." Part of this is just a practical, not a strictly legal, judgment: is anyone really going to sue you to determine whether in fact you did cancel based on a defect you found? It will be very, very difficult to prove that there weren't grounds for you to cancel.

    But Moran v. Erik (cited in the post with a link to the opinion) suggests that the right is absolute as a LEGAL matter: the court stated that the "attorney approval" clause meant that "an attorney for either party may timely disapprove the contract for any reason or for no stated reason." In doing so, the court reversed a lower court holding that the defendants had breached the attorney approval clause because the evidence showed they had told their attorney to cancel the contract merely because they wanted to cancel it, not because the attorney had found some legal problem with the contract.

    In its ruling, the NY Court of Appeals pointed out the practical difficulties that would arise if there were a requirement that the cancellation be made in good faith -- not only would it raise difficult factual questions that would require subjective judgment (is that legal problem really sufficient to cancel? is that defect really sufficient to cancel?), but it would also require the court to inquire into lawyer-client communications that are considered privileged, something that is very problematic.

    The precise same reasoning can be applied to the inspection clauses.

    But, then, if the buyer has a right to back out for any reason, is the promise illusory until the cancellation period expires? If so, the seller could back out the instant he gets a better offer. But I suspect courts would be reluctant to go there -- our practices in home contracts seem to accept these clauses and to accept that the seller is in fact bound during the pendency of the inspection period. But it would be very interesting to see a court struggle with the conflict between doctrine and practice in a case such as this.

  3. Anjela Freeman9/28/09, 12:29 PM

    I think the answer to your question is whether the buyer actually fulfils his obligation to hire a house inspector or attorney, as the contract specifies.

    You see, I would argue that the buyer’s promise is not illusory. The buyer is making a promise to hire an attorney/inspector within a specified period of time and complete the transaction once the cancellation period expires. The seller is promising to sell the property at the price and terms spelled out in the contract and (in the case of the inspection) make his property available to the buyer’s inspector. In the event that a seller cancels the contract prior to the end of the inspection period, the seller is in breach of contract. That having been said, however, a Buyer who attempts to exercise his right to cancel without doing a proper inspection or hiring an attorney to review the contract could also be held in breach.
    I do not believe a “right to cancel” clause should be looked at as a mere escape clause. In practice, I did on occasion assist a buyer who wanted to back out of his contract, but I always explained that he had agreed to do an inspection, so he better do it.