Ch3. Contracts I — Formation, Breach, and Creditor Remedies

The Basics of Contract Rights and Duties

Contract right (obligee’s claim): the right of one specific party (the obligee/creditor) to demand a specific performance from another specific party (the obligor/debtor). Contract duty (obligation): the obligor’s duty to perform for the benefit of the obligee.

Contractual relationship:
Obligee ──── right to demand performance ────→ Obligor
Obligee ←─── tender of performance ──────────

Property rights vs. Contract rights:

	Property Right (in rem)	Contract Right (in personam)
Enforceable against	The entire world	Only the specific obligor
Priority rule	First in time, first in right (generally)	Pro rata among equal creditors
Notice mechanism	Recording / possession	Contract; no public record required

Types of Contractual Duties (by subject matter)

Specific-goods duty: duty to deliver an identified, specific item
  ("deliver this particular painting")
Generic-goods duty: duty to deliver goods of a stated kind and
  quantity ("deliver 100 bushels of No. 2 winter wheat")
  — UCC § 2-105 (goods), § 2-614 (substituted performance)
Money duty: a debt; impossibility of performance is not recognized
  for money obligations
Installment duty: periodic monetary payments (principal + interest)
Alternative duty: the obligor may perform any one of two or more
  stated alternatives (choice belongs to the party designated)

Breach of Contract

A breach occurs when the obligor fails to perform in accordance with the terms of the contract.

Three Types of Breach

① Material breach (anticipatory or actual non-performance):
   The obligor does not perform by the due date.
   → Obligee must give notice (a "demand" or "cure period")
     before treating the contract as terminated.
   → Remedy: termination + general damages (expectation damages)

② Impossibility / frustration of purpose:
   Performance becomes objectively impossible or the purpose of
   the contract is totally frustrated.
   → Obligee may terminate immediately (no notice required).
   → Remedy: rescission + consequential/cover damages

③ Defective performance (substantial performance doctrine):
   The obligor has rendered performance, but it is incomplete or
   defective.
   → Obligee may demand cure or terminate + claim damages
   (Restatement (Second) of Contracts §§ 235–241)

Fault: in contract law, breach liability generally requires that the failure to perform be attributable to the obligor — i.e., within its control (not excused by impossibility, impracticability, or frustration).

Damages

Scope of Recoverable Damages (Restatement (Second) of Contracts § 351; Hadley v. Baxendale rule)

General (direct) damages: losses that flow naturally and
  foreseeably from the breach in the ordinary course of events
  → Recoverable as of right

Consequential (special) damages: losses that result from the
  obligee's particular circumstances, not typical of the ordinary case
  → Recoverable only if the breaching party had reason to know of
    those special circumstances at the time of contracting
    (Hadley v. Baxendale, 9 Exch. 341 (1854); adopted in the
    Restatement (Second) of Contracts § 351)

Contributory negligence / comparative fault: if the obligee’s own conduct contributed to the loss, damages may be reduced proportionally. Benefit-of-the-bargain offset: gains the obligee actually received as a result of the breach are offset against the damages award.

Liquidated Damages Clauses

A provision in the contract fixing the amount of damages in advance.

Enforceability (Restatement (Second) of Contracts § 356):
- The clause is enforceable if the amount is a reasonable pre-estimate
  of actual loss (not a penalty).
- The non-breaching party need not prove actual loss.
- Courts will strike a liquidated damages clause that is grossly
  disproportionate to actual harm as an unenforceable penalty.
  (UCC § 2-718 for goods contracts)

Creditor-Protection Remedies

Subrogation / Creditor’s Bill in Equity

Where a debtor owns a claim against a third party but refuses to enforce it — thereby impairing the creditor’s ability to collect — a court may allow the creditor to step into the debtor’s shoes and enforce the claim directly against the third party.

Requirements:
① The creditor has a valid, mature claim against the debtor
② The debtor is insolvent or its assets are insufficient to
   satisfy the creditor's claim
③ The debtor is failing to enforce the claim (passive inaction)
④ The creditor's claim is mature (due)

Example:
A (creditor) → B (debtor) → C (third-party obligor)
If B refuses to sue C, A may bring an action against C directly
to collect what C owes B, then apply it toward B's debt to A.

Fraudulent Transfer Avoidance

(Uniform Fraudulent Transfer Act / Uniform Voidable Transactions Act; Bankruptcy Code § 548)

Where a debtor transfers property or incurs obligations with the intent to hinder, delay, or defraud creditors, the creditor may seek to avoid (set aside) the transfer.

Requirements (UVTA / Restatement):
① A "voidable transaction" (transfer made or obligation incurred
   with actual intent to defraud, OR without reasonably equivalent
   value while insolvent)
② Debtor's insolvency (actual or constructive) at the time of,
   or resulting from, the transfer
③ Creditor's claim arose before the transfer (for constructive-
   fraud theories)

How to seek avoidance:
Creditor files an action in court to avoid the transfer
  (or in bankruptcy, the trustee avoids it under § 548)

Statutes of limitations:
Actual fraud: 4 years from the transfer (or 1 year from discovery)
  under the UVTA § 9
Constructive fraud: 4 years from the transfer
(State law varies; federal bankruptcy § 548: 2 years)

Discharge of Contractual Obligations

Primary methods of discharge:
① Performance (tender): the obligor renders the required performance
   — the most common and natural form of discharge
② Set-off (offset): cross-claims of the same kind are set off against
   each other for the equal amount
③ Release / accord and satisfaction: the obligee accepts a substitute
   performance or expressly discharges the duty
④ Merger (confusion of parties): the obligee and obligor become the
   same person (e.g., by inheritance)
⑤ Statute of limitations: the claim is time-barred if not asserted
   within the applicable period

Set-Off

Where two parties each hold a mature money claim against the other of the same type, the smaller claim is automatically extinguished and only the net balance is owed.

Requirements for set-off:
① Both parties hold mutual claims of the same type (e.g., both money)
② The set-off claim (the "active" claim) is mature
   (the "passive" claim need not be mature)
③ No valid agreement excluding set-off
④ Tort claims for personal injury or intentional wrongs generally
   cannot be used as the "passive" claim to be set off against
   (policy: tortfeasors should not escape liability by set-off)

Key Concept Cards

Material Breach vs. Impossibility ★★★★★ : Material breach requires a demand (notice to cure) before termination is permitted; impossibility discharges the contract immediately — no notice required. The measure of damages also differs. Memory hook: impossibility = immediate discharge; material breach = notice first

Fraudulent Transfer Avoidance ★★★★★ : When a debtor transfers assets to put them beyond creditors’ reach, an aggrieved creditor may sue to set aside the transfer. Under the UVTA: 4 years from transfer (actual fraud); 1 year from discovery for actual intent claims. Federal bankruptcy § 548 permits avoidance of transfers within 2 years. Memory hook: fraudulent transfer = UVTA 4-year / 1-year discovery period

Tort Claim Set-Off Bar ★★★★☆ : A claim sounding in intentional tort or arising from unlawful conduct generally cannot be used as the “passive” claim to be extinguished by set-off. Policy: a wrongdoer should not be allowed to wipe out a tort judgment by asserting a countervailing debt. Memory hook: tort judgment = cannot be offset away by the tortfeasor

Practice Quiz

Q. A buyer fails to pay the purchase price on the agreed date. What must the seller do before terminating the contract?

The seller must give the buyer a reasonable opportunity to cure (make a demand, fixing a time for payment). If the buyer fails to pay within the stated period, the seller may treat the contract as terminated and claim damages. Simply refusing to perform without notice exposes the seller to its own liability.

Q. Why must a creditor’s bill (subrogation) be used only when the debtor is insolvent?

If the debtor has sufficient assets, the creditor can enforce its judgment by levy and execution — no need to pursue the debtor’s claims against third parties. Subrogation is available only when the debtor is insolvent, to prevent the debtor from depriving the creditor of the only practical avenue of recovery.

OIYO Editorial