The Complex Commercial Litigation Law Review: USA - California
California's gross domestic product has surpassed that of India and the United Kingdom to become the fifth largest in the world. It is home to the world's leading technology sector in Silicon Valley and its premier entertainment capital in Hollywood. Given the volume and variety of economic activity in California, understanding its commercial laws has become increasingly important.
Each of the 50 states has its own court system and commercial laws, but most of these regimes grew out of the same legal tradition and have looked to each other for insights and guidance throughout their evolution. As a result, the substance of California contract law is generally consistent with that of New York and other major commercial centres in the US. One formal difference is that California has codified much of its contract law and related rules of evidence. Codification makes the rules less flexible but also more easily accessible and predictable. There are some notable substantive variations as well, which are highlighted in this chapter, but they are the exceptions to the general rule of consistency in commercial law across the United States.
i Basic elements
A contract is nothing more than an agreement to exchange things of value. In California, an enforceable contract requires reasonably certain terms, mutual assent to those terms, and something of value for both parties. To be 'reasonably certain', a contract's terms must be sufficiently definite that they provide a basis for later determining whether the parties have complied with their obligations and what remedy they would expect for a breach. An enforceable agreement must also have a lawful purpose and both parties must have the legal capacity to enter into a contractual relationship – children generally cannot enter into binding agreements, for example.
If an offer meets these requirements, it becomes a contract the moment it is accepted, provided the offeree accepts the terms without changes or preconditions. Acceptance does not have to be explicit. It can be communicated by beginning performance or by taking the consideration offered. Silence in the face of an offer is not acceptance unless there is a relationship between the parties that would indicate to a reasonable person that silence means acceptance. An offer may be revoked any time prior to acceptance, provided there was no binding agreement to leave the offer open for longer. An offeror can assign an expiration date to its offer, at which time the offer will automatically expire if not accepted. If no time period is specified, an offer will lapse after a 'reasonable time' an amount which varies based on the circumstances.
Consideration is an essential element of any contract, but offering most any benefit, or agreeing to suffer most any prejudice, is generally enough. Although little is required, a recommitment to perform a pre-existing obligation has no value and, therefore, cannot constitute consideration. Parties should be aware, however, that consideration can be so inadequate in comparison to the benefit received that it raises questions about whether the contract was obtained by fraud or duress and is, therefore, unenforceable. These issues are addressed elsewhere in this chapter.
ii Oral contracts
California does not require that parties set down their agreement in writing except under specific circumstance identified in a rule known as the statute of frauds. While there are others, the primary circumstances in which the statute of frauds requires that an agreement be in writing is when an obligation is not intended to be performed within a year or within the promisor's lifetime, or when an agreement involves the sale of real property or an interest therein. Even when the statute of frauds requires that an agreement be in writing, emails and electronic signatures are sufficient.
Any contract may be subsequently modified by agreement of the parties, provided the same elements required for validity of the original contract are present. Except in those circumstances where the statute of frauds applies, parties to a written contract in California do not need a new written agreement to modify an existing one. It is enough that both parties fully perform in a manner that is consistent with the new understanding or that the modification is supported by additional consideration. However, if parties to an oral agreement in California modify the original contract in writing, there is no need for new consideration.
If a contract has a term requiring that all modifications be made in writing, California will generally enforce it. But a court may also find that the parties' consistent divergence from the agreements' terms, without objection from either side, effectively modifies the agreement, notwithstanding a contractual provision forbidding oral modifications. For example, one California court addressed a provision in a written shareholder agreement requiring that shareholders approve all billing contracts in writing. According to the court, by repeatedly approving billing contracts orally, the shareholders 'orally amended' the agreement to allow 'oral approval'.
Fundamentals of contract interpretation
California law requires that unambiguous contractual terms be applied as they are written. If, however, a contractual term is ambiguous, meaning it is capable of more than one reasonable interpretation, a California court will attempt to determine the parties' intent at the time they entered into the contract, taking into account the surrounding circumstances. The subjective state of mind of a party entering into a contract is generally irrelevant, however. What matters is what they said or did, and what those words or actions would lead a reasonable person to believe about their intentions.
As an initial matter, the judge, not the jury, will decide whether a contract's terms are clear or need clarification. To make this determination, a California court may look to evidence outside the plain language of the contract, including prior drafts of the agreement and communications exchanged by the parties during the drafting process. This extrinsic evidence, which is called parol evidence, is not admitted formally until the court determines that the contractual term is ambiguous. But a California court will provisionally consider parol evidence in the course of deciding whether the contract's meaning is 'reasonably susceptible' to the interpretation being urged. This is unlike some other jurisdictions in the U.S., which decide whether a term is ambiguous with reference to the contractual language alone.
When construing the language of an agreement, California courts are guided by several principles of construction. For example, they will assume words have their 'ordinary and popular' meaning, unless they are used in a special or technical sense, in which case those terms will be interpreted as understood by persons in the relevant field. Moreover, the contractual language will be interpreted in the context of the whole agreement, including other contracts executed by the same parties as part of the same transaction. California law also prefers that courts interpret contracts in a manner that gives each term effect, rather than rendering it superfluous or void. So, for example, if a term has two reasonable interpretations, and one would render the term unenforceable, the court will generally adopt the other interpretation. In addition, as a general matter, if the court determines that one party is responsible for creating an ambiguity during the drafting process, it will interpret the ambiguity against that party. A California court may also consider how the parties acted after the agreement was executed, but before a dispute arose, to determine what was meant by an ambiguous term.
If the judge concludes the contract is unambiguous, after construing the relevant language in light of the extrinsic evidence, he or she will instruct the jury on what the contract means. But if ascertaining the intent of the parties at the time the contract was executed turns on the credibility of the parol evidence, the jury will weigh that evidence and determine for itself what the parties meant.
i Contractual provisions regarding forum selection
Forum selection clauses can be permissive or mandatory. California courts find forum selection clauses to be mandatory when they 'expressly mandate litigation exclusively in a particular forum', rather than merely providing for 'submission to jurisdiction'. For example, a California court upheld a forum selection clause as mandatory because it specified 'Hamburg as “the” place where litigation should be conducted, indicating a single place'. When a forum selection clause is mandatory, it will be enforced unless the unwilling party can show that enforcement would be unreasonable. However, a California court will 'refuse to defer to the selected forum' if doing so would 'substantially diminish the rights of California residents in a way that violates' California public policy. For example, a court recently refused to enforce a mandatory New York forum selection and choice of law clause, because the contract contained a jury trial waiver that would likely be upheld in a New York court, but which was unenforceable under California law.
A forum selection clause is permissive if the parties merely agreed to submit to the jurisdiction of a named court – for example, when a clause states that a particular court 'shall have jurisdiction over the parties'. In such instances, California courts have held that the parties 'had not ruled out other jurisdictions'. Such a clause will not automatically be enforced, but is subject to a forum non conveniens analysis. Under that analysis, a court must (1) 'determine whether the alternate forum is a “suitable” place for trial'; (2) 'consider the private interests of the litigants'; and (3) consider 'the interests of the public in retaining the action for trial in California'.
ii Contractual agreements to resolve disputes through alternative dispute resolution
California courts generally refuse to enforce a waiver of the right to a jury trial before a dispute has arisen. But California law has codified at least two exceptions to this principle: arbitration and judicial reference.
Under California law, courts will generally honour provisions calling for a non-judicial means for resolving disputes arising out of or relating to an agreement. Arbitrations are generally subject to limited discovery rules, and awards provided for in contractual arbitration are governed by rules of the parties' own selection. Interpretation of an arbitration clause in a contract – including which, if any, of the disputed issues are arbitrable – is subject to standard rules of contract interpretation and defence. Due to the public policy favouring arbitration, however, such clauses are to be read broadly so as to resolve any doubt in favour of arbitration. This presumption in favour of arbitrability is stronger when the arbitration clause uses broad language, such as a clause covering 'any dispute regarding the contract'. An arbitrator's award is subject to judicial review only on narrow grounds set forth by statute.
Moreover, under the California Arbitration Act, a party to an agreement to arbitrate can avoid arbitration only under limited circumstances. An unwilling party may challenge an arbitration agreement by arguing that fraud 'permeates it', that the compelling party waived the right to arbitrate, or that there are grounds that would justify non-enforcement of any type of contract.
If an agreement concerns interstate commerce (as opposed to commerce entirely within the state of California), the defences to the enforceability of other contracts will not apply to an arbitration clause to the extent those defences facially discriminate against arbitration by interfering with its fundamental attributes, such as lower costs, greater speed, and the ability to choose experts to adjudicate specialised disputes. For example, in one California case, a court found unconscionable a contract of adhesion requiring consumers to waive the right to bring a class action and arbitrate all disputes. The United States Supreme Court held that this ruling categorically disfavoured agreements to arbitrate, which are not typically conducted on a class-wide basis, and required that the arbitration agreement be enforced.
A party opposing the enforcement of an arbitration agreement is not entitled to a jury trial on that issue in California. A dispute on arbitrability will be submitted to a judge for decision or, if the parties 'clearly and unmistakably' so provide in their arbitration agreement, by the arbitrator itself.
Like contractual arbitration, general judicial reference is a process whereby the parties contractually agree to submit their dispute to an appointed third-party neutral, usually chosen by the parties, who renders a binding decision. The main distinction between arbitration and judicial reference is that judicial reference proceedings are conducted much like non-jury trials. For example, referees are bound to follow applicable substantive law rather than more abstract notions of 'equity' or 'fairness'. A judicial referee's statement of decisions must be prepared within 20 days, and upon its filing, 'judgment may be entered thereon in the same manner as if the action had been tried by the court'. Moreover, unlike an arbitral award, which is only reviewable in a narrow set of pre-determined circumstances, parties have the right to full appellate review of a referee's decision, as well as the ability to file a motion for a new trial or a motion to vacate.
Breach of contract claims
The elements of a cause of action for breach of contract are: (1) the existence of an enforceable contract; (2) plaintiff's performance (or excuse for non-performance); (3) defendant's failure to perform; and (4) resulting damages to the plaintiff. The required harm or damages may be modest; even when a breach 'has caused no appreciable detriment', the non-breaching party may recover nominal damages or seek an order of enforcement.
In addition to an award of damages, parties claiming breach of contract may seek an order terminating the agreement and relieving them of their obligation to perform. But not just any breach of contract warrants termination. For that, the breach must be 'material', a designation that depends on the circumstances of the breach. A material breach generally refers to a situation where a party is substantially deprived of the benefit for which it bargained, but it could also include a less serious breach that indicates the likelihood of a future failure to perform. For instance, a minor breach 'prior to or at the outset of performance' may permit a termination, despite that the same breach would not be material if it had occurred after considerable performance.
If a party communicates that it will not perform under the contract, even before performance is due, that can be enough to justify termination. This is called anticipatory repudiation, and it does not have to be expressly communicated. It may be implied from the circumstances when, for example, one party to a contract takes steps that make it impossible for it to perform. In the face of an anticipatory repudiation, the non-breaching party does not have an obligation to act. He or she is permitted to seek relief immediately, but may also wait until the time of performance to initiate legal action.
In addition to the express terms of the agreement, every contract in California includes an implied covenant of good faith and fair dealing. While the implied covenant does not impose obligations to which the parties did not agree, it does require that the parties carry out their obligations in good faith and without attempts to thwart the other party from receiving the benefit of its bargain. The application of this doctrine does not require that a party act with malicious intent. It is enough that a breaching party's conduct was 'objectively unreasonable' and prevented its counter-party from receiving that for which it contracted.
Defences to enforcement
Parties sued for breach of contract in California have several available defences. In the first instance, they can establish that they in fact did perform their obligations under the agreement, or that no enforceable agreement was formed in the first place. But there are also several bases on which a California court might refuse to enforce a valid contract that has admittedly been breached. These are known as affirmative defences, and the burden is typically on the defendant to show that they apply in a particular case.
i No enforceable contract was formed
As noted above, to be enforceable, a contract requires 'reasonably certain' terms. If the parties leave essential elements to be worked out later, their understanding might be deemed a mere 'agreement to agree', which is typically not enforceable. Parties in California can, however, execute enforceable agreements to negotiate in good faith. Unlike some European jurisdictions, California does not impose a default obligation of fair dealing on parties to a negotiation. But an agreement to negotiate in good faith allows parties to create such an obligation by contract.
ii Limitation period unenforceable
The statute of limitations to assert a breach of contract claim in California is four years for written contracts and two years for oral contracts. The limitations period begins when the contract has been breached and the non-breaching party knows or has reason to know of the breach.
California permits parties to shorten or lengthen the time period for asserting a breach in their contract. If the parties agree to lengthen the limitations period, their agreement must be in writing and cannot extend the deadline for more than four years at a time. The parties may then make 'any number of successive, separately executed agreements for additional four-year' extensions. If the parties agree to shorten the limitations period, the cut-off date must still provide a reasonable period for the non-breaching party to raise a claim, a standard that varies based on the circumstances of the agreement.
iii Enforcement contrary to public policy
A contract with an illegal purpose is unenforceable as a matter of public policy. California takes a strict approach to illegal contracts, stating that an entire contract is void if any part of its consideration is unlawful. There are rare exceptions, however. California may uphold a contract with an illegal object if the nature of the contract's illegality is not 'grounded in common standards of morality', and the party seeking enforcement is 'less morally blameworthy' than its adversary.
A contract is unconscionable if it is so grossly unfair that it should not be enforced. Unconscionability has two components, one procedural and the other substantive, both of which must be present to find a contract unenforceable. Contracts that are substantively unconscionable have been described in a variety of ways, including 'overly-harsh', 'unfairly one-sided', 'unduly oppressive' or 'so one-sided as to “shock the conscience” '. The California Supreme Court held that all of these terms 'mean the same thing', which it characterised as 'a substantial degree of unfairness beyond 'a simple old-fashioned bad bargain''.
Procedural unconscionability refers to some element of 'surprise' or 'oppression' in the process of negotiating or executing the agreement. For example, a material term may have been hidden by the party seeking to enforce it (i.e., surprise), or there may be such a disparity in bargaining power that the weaker party is not given a meaningful choice (i.e., oppression).
Adhesion contracts, which are the standardised agreements offered on a 'take it or leave it' basis by parties with superior bargaining power, all contain an element of procedural unconscionability. But the surrounding circumstances may mitigate that unfairness. For example, the weaker party may have had other counter-parties with whom he could have contracted. And even an adhesion contract that is procedurally unconscionable will be enforced, provided it is not substantively unconscionable and complies with the 'reasonable expectations' of the adhering party.
In evaluating unconscionability, courts consider the totality of circumstances, in which a high degree of substantive unconscionability can be counteracted by a low degree of procedural unconscionability, and vice versa. For example, the presence of one-sided terms could be offset by the fact that the parties had relatively equal bargaining power.
California will allow a party to rescind a contract if it was 'under duress' when it agreed to the terms. Traditionally, duress refers to circumstances where a person or his property were unlawfully confined or threatened. California courts have extended the doctrine to cover economic duress, but that defence is generally only available to a party who had no choice but to agree or face financial ruin. For example, in one case, the fact that a party would merely have lost a job if he did not agree to the contract was not enough to show economic duress.
vi Impossibility or impracticality
California law provides a defence to the enforcement of a contract when, through some intervening event, performance becomes physically impossible or so excessively expensive or difficult that it is no longer practical. A merely unforeseen expense, even a sizeable one, is not enough to excuse performance. But if the difficulty of performance becomes so great that the parties could not have expected compliance under the new circumstances, the defence of impracticality is available. For example, in one case, a builder agreed to buy his gravel from the operator of a particular gravel pit. Unknown to the parties at the time, most of the gravel was under water and would cost ten times the anticipated amount to extract. The builder was excused from performance on the ground of impracticality.
vii Frustration of purpose
The doctrine of frustration of purpose is similar to the doctrines of impracticality and impossibility in that some development after the execution of the contract changes the basic expectations on which the agreement was reached. But, unlike those other defences, frustration of purpose applies to situations where performance is still feasible but would not accomplish the purpose of the agreement. For example, in one case, a hotel company agreed to pay a monthly fee to a golf club to allow access to the course for its guests, but the hotel later burned down. Payment of the fee was still possible, but achieving the underlying purpose of the agreement was not, and the agreement was not enforced.
Fraud, misrepresentation and other claims
If one party to an agreement obtained the other party's assent through a fraudulent misrepresentation, the agreement may not be enforceable. A party invoking a fraudulent inducement defence must prove that its counter-party made the misrepresentation knowing it was false and with the intention that it be relied upon. California, unlike New York, does not require the misled party to show that its ignorance was 'excusable'. As one court put it, California 'protect[s] the ignorant and credulous no less than the well-informed and analytical'. Courts in California may hold sophisticated parties to a higher standard, however. If a defrauded party's reliance was not reasonable 'in the light of his own intelligence and information', he will not succeed on this defence.
A party cannot exculpate itself from a fraudulent inducement defence with a contractual provision. Even when a contract says that neither party relied on any extrinsic representations, for example, the court will still consider extrinsic evidence of fraudulent misrepresentation.
Damages for breach of a contract are generally intended 'to approximate the agreed-upon performance' by putting the plaintiff in 'as good a position as he or she would have occupied if the defendant had not breached the contract'. To prevail on a breach of contract claim, a plaintiff generally must show damage caused by or likely to result from the breach.
i Compensatory damages
In an action for breach of contract, the non-breaching party can recover monetary payments for actual, provable, and foreseeable losses resulting from the other party's failure to perform according to the agreement's terms. A prevailing party is entitled to money damages whenever the party can show damages of a certain amount with reasonable certainty. Compensatory damages must also be reasonable, may not be unconscionable or oppressive, and cannot be greater than the benefit of full performance.
California recognises two primary types of compensatory damages for breach of contract: general damages and special damages. General damages are those that 'would be likely to result' from the breach and, as such, are deemed within the parties' contemplation at time of the agreement. These are the most common types of damages.
Special damages, also known as consequential damages, do not necessarily follow directly from the breach, but sometimes occur as a consequence. For example, profits lost by a business as an indirect result of the breach are typically considered special or consequential damages. Special damages must have been within the contemplation of the parties at the time they entered into the contract. If the breaching party did not have advance notice that this special harm might result from a breach, this category of damages is not recoverable.
ii Punitive damages
In California, punitive damages, also known as exemplary damages, are ordinarily not recoverable in a contract action, even if the defendant's breach was wilful. Punitive damages may be available, however, if – in addition to the breach of contract – an independent tort is involved. Even in such cases, however, a defendant must act with 'oppression, fraud, or malice' toward the plaintiff. Mere negligence, even gross negligence, is not sufficient to justify an award of punitive damages.
iii Specific performance
Specific performance is an equitable remedy that compels the breaching party to live up to his contractual obligations. A court will not order specific performance where monetary damages will make a plaintiff whole. Specific performance is available only where: (1) the contract's terms are sufficiently definite; (2) consideration is adequate; (3) substantial similarity exists between the requested performance and the contract's terms; (4) there is mutuality of remedies; and (5) plaintiff's legal remedy is inadequate.
The availability of specific performance typically depends on the uniqueness of the goods or services being exchanged. The classic example of a suit for specific performance seeks to compel the seller of real property to transfer the property to the buyer. Since each piece of real property is considered unique, money damages are considered inadequate. Specific performance is never available in certain specific circumstances defined by statute, such as contracts for employment or personal services. That is because the law generally views requiring performance in those circumstances as akin to involuntary servitude.
Rescission restores the parties to the position that they would have been in had they not entered the contract. Following an order of rescission, the parties no longer need to comply with their obligations and must restore any consideration exchanged. When a contract is induced by fraud, negligent misrepresentation, or duress, rescission is an appropriate remedy. California courts may award both damages and rescission (so long as the relief does 'not include duplicate or inconsistent' recovery), and they may also require the party to whom such relief is granted to compensate its counter-party or otherwise adjust the equities between them.
v Limitations of liability
Contractual terms limiting the parties' liability in the event of breach will generally be upheld, so long as no statute expressly prohibits it and no public interest is involved. The public interest may be involved where, for example, the limitation provision concerns a regulated business or an important public service. No matter what the contract says, however, it cannot exempt the parties from liability for intentional wrongs, gross negligence, or a violation of law.
vi Liquidated damages
California law allows for liquidated damages, in which the parties specify in the contract the amount that must be paid in the event of breach. Liquidated damages control regardless of the amount of actual damages incurred, thereby limiting the breaching parties' exposure and relieving the non-breaching party of having to prove an amount of damages. Liquidated damages agreements are enforceable unless another statute expressly controls damages or the liquidated damages provision was unreasonable. To avoid invalidation as an unlawful penalty, a liquidated damages provision must have a reasonable relationship to actual damages. Otherwise, it risks being deemed unconscionable and reduced by the court.
While California imposes some narrow restrictions on the freedom to contract as a matter of public policy, parties who choose California law to govern their agreement can generally expect judicial decisions that respect and enforce unambiguous language as written. They can also expect a reliable set of governing principles that are stable over time. Because of the codification of California contract law, significant changes require legislative action, which is generally less frequent than judicial developments. Moreover, as home to the world's leading tech and entertainment sectors, California is often where disputes related to cutting edge technologies and intellectual property are heard. As a result, parties who choose a California forum can benefit from sophisticated judges who are often more conversant in these emerging legal issues than those in other jurisdictions.