People routinely transact business in complete ignorance—or knowing disregard—of formal legal requirements, and some of them even proudly ridicule legal formalities. They may expatiate on how they "just shake hands." If they are out of the country, or from some rural state, they can evince a kind of class-based resentment that strives to drag you down to their own rustic level of pre-industrial cleverness.1 These "shakers" may even have a point, since sociologists stress that many informal customs and community networks of "tacit agreement" exist, and are important for any society to function at all.2 Perhaps they are only one generation away from being hunter-gatherers, or are ashamed to admit the importance of documents they cannot read.3
However, we live in a modern commercial society, which only functions due to complex relationships that must be enforced for things like catastrophic loss insurance, construction contracts, and the large scale distribution of products. The new capitalist frontier areas of the world are also discovering the limitations of proverbial simple handshakes.4 The phone call5 from the client stuck in a bad, undocumented deal invariably triggers a lawyer’s search for whatever paper fragments can be used to back up the preferred version of the business story.6
It therefore makes sense to understand some of the key legal issues involved with these everyday transactions before they occur, while all parties have a chance to improve their legal position, in case that position needs to be defended or attacked.
II. PRACTICAL ELEMENTS OF A CONTRACT
A contract is "any agreement the law will enforce."7
3 Main Points:
1. Get it in writing.
2. The exact form is not crucial.
3. Ambiguities go against the drafter.
When there are problems in a contractual relationship and one party is in the right, they must still be able to prove it. The party with the most cohesive and complete evidence to support its version of the story will most likely win. This highlights the importance of ordinary business records. Practically speaking, clients in certain businesses find it very hard to keep good records. If you can get the client to use any baseline writing8, you will have at least a foundation on which to build your version of the story. Better yet if this baseline writing can also include a kind of interpretive declaration9 of which kinds of written fragments will be allowed into the contract, which will assist a trier of fact later. Sample language may include something like this:
The parties hereto may from time to time agree to give notice of and agree to the terms of change orders modifying this Agreement, by telephone, email or fax, on the condition that Contractor’s phone notes, email or fax records shall be deemed to conclusively reflect the binding terms of any such changes.10
III. CASE LAW STRUGGLES TO PIN DOWN A CONTRACT
Action Construction and Restoration, Inc. v West Bend Mutual Insurance Co.11, shows what happens without clear writings when things go awry. In Action, a fire destroyed most of Burmac’s factory, insured by West Bend.12 A West Bend adjuster hired Action Construction to do preliminary board-up work.13 At this point the stories of the two parties diverge.14
Action claimed the adjuster then formed an oral contract with Action to "get [the factory] back in operation."15 West Bend denied hiring Action Construction and claimed that it was Burmac—the factory owner—who actually hired Action, and that Action’s $500,000 bill was Burmac’s problem after West Bend denied coverage.16 Action sued West Bend for breach of contract. The jury awarded Action the entire amount.17 On appeal, the Illinois Appellate Court confirmed that there was sufficient evidence to prove a contract between West Bend and Action.18
The Appellate Court relied on the jury’s response to this special interrogatory: "Did Plaintiff know or should it have known that Defendant’s obligation to pay Plaintiff for restoration and construction services was contingent upon an obligation on the part of Defendant to pay insurance benefits under its policy with Burmac?"19 The jury said "No." West Bend could not show any facts to the jury to back up West Bend’s claim that Action "should have known" that West Bend’s obligation to pay was inchoate, or uncommitted to either Action or Burmac.20
This jury discerned that a meeting of the minds between Action and West Bend had occurred, forming a contract.21 The Appellate Court agreed, finding that "[T]here is certainly evidence from which the jury could have concluded that West Bend hired Action directly and that West Bend’s promise to pay was never contingent upon coverage."22
Not surprisingly, something went wrong to produce a dispute. If West Bend had covered the loss, Action would have likely received payment in any event. Looking back on the string of events we see several red flags. First, from West Bend’s point of view, when its adjuster hired Action Construction to do preliminary board-up work, West Bend should have limited, in writing, the scope of Action’s work to board-up only. The writing need not have been a formal contract; a mere letter of understanding sent by West Bend to Action Construction—even after work had begun—would have had evidentiary value at trial.23 West Bend was reduced to arguing something like a "limited conditional handshake" that would be no good if West Bend later denied coverage. This made no sense to the jury. Seen in this way, Action’s decision to perform a half-million dollars of construction work without a written contract is also troublesome. Although they won at the trial level as well as at the appellate level and at the retrial, the time value of money and transaction costs of enforcement 24 produced a cash flow disaster for Action.
A letter from Action to West Bend confirming that West Bend had ordered Action to perform the work in question would also have helped make things clear and might have saved the expense of having to win at trial. However, West Bend may have reacted to Action’s clarity by ordering Action to stop working. Alternatively, West Bend could have taken a middle ground and confirmed its understanding that Action was authorized to do only preliminary board-up work.25
The lesson from Action is to put as much information as possible in contemporaneous writings for later use, including possible litigation.26 The form of documentation does not particularly matter, but notes written during important phone calls, letters or emails reflecting an understanding reached over the phone, and hard copies for the file can be decisive evidence of an enforceable agreement.
Perhaps the most famous case involving a handshake agreement is Ray Kroc’s ice cream cone deal, which resulted in a breach of contract suit by Central Ice Cream Co. against McDonald’s in the Circuit Court of Cook County, Illinois.27 Between 1971 and 1974, Central Ice Cream maintained a business relationship with McDonald’s Corporation pursuant to McDonald’s request that Central develop and supply the restaurant chain with "a three-flavor, slow-dripping, factory-filled and packaged ice cream known as ‘Triple Ripple,’" which was to be sold nationwide.28
Central claimed that McDonald’s founder and then-President Ray Kroc made a handshake agreement with Central Chairman and President Thomas Cummings for the "long term purchase" of Triple Ripple. Central further alleged that McDonald’s breached Kroc’s handshake contract when it stopped selling the ice cream in late 1974.29 Central originally sought $18,328,552 in actual damages, $5,000,000 in punitive damages, and attorneys’ fees. At trial,30 the jury found McDonald’s liable for $52 million in damages.31
It turned out that McDonald’s own records corroborated their intent to maintain a long term purchasing contract with Central.32 Central thus ended up like Action Construction: it prevailed on its essential handshake claim in the face of sophisticated lawyering designed to kill it.33
Contract law can and should provide guidance in everyday business practice. But when those practices are slipshod, undocumented, or based on a proverbial handshake with nothing more, the law struggles to enforce the intention of the parties, and as a result, may enforce nothing. On the other hand, as Action and the "Triple Ripple" case show, the law may end up enforcing something very unexpected and expensive for a party who may not subjectively realize that their conduct has objectively formed an enforceable obligation.34 A party on the short end of such an undocumented "handshake" deal is well advised to keep their hands—and their money—deep in their pockets.
1 The historian must admit that handshakes themselves are an advancement from another way of using your hand to solemnize a deal, used by Jacob on his deathbed as recorded in the book of Genesis: "When the time drew near for Israel to die, he called for his son Joseph and said to him, ‘If I have found favor in your eyes, put your hand under my thigh and promise that you will show me kindness and faithfulness. Do not bury me in Egypt, but when I rest with my fathers, carry me out of Egypt and bury me where they are buried.’ ‘I will do as you say,’ he said. ‘Swear to me,’ he said. Then Joseph swore to him." Genesis 47:29-31 (NIV Bible).
2 See generally, Albert-Laszlo Barabasi, Linked: The New Science of Networks (Perseus 2002).
3 See, e.g., Jared Diamond, The Worst Mistake in the History of The Human Race, http://anthropology.ibcc.edu/handoutsdocs/mistake.pdf
4 A recent Economist article noted that many Chinese recipients of foreign direct investment (FDI), until recently, "preferred contracts you could write on the back of an envelope." The Economist, "The Insidious Charms of Foreign Investment: China’s cup overflows; India catches the spillage" (May 3, 2005). Many China deals now are done with written contracts including mandatory China-based arbitration using government-run CIETAC rules. See, http://www.cietac.org.cn/english/news/news8.htm. So even the fabled guanxi (http://en.wikipedia.org/wiki/Guanxi) of Chinese business is constrained with external rules that will apply to a disputed "handshake" or "envelope" deal in that culture.
5 Not an email, since such clients are strictly verbal.
6 In Illinois, certain categories of contracts must be in writing, typically limited to consumer or "household" transactions. See generally, 815 ILCS 513/1, the Illinois Home Repair and Remodeling Act. These kinds of statutes essentially outlaw handshakes for certain categories of transactions. As such, this article concentrates on the comparatively unregulated universe of more "commercial" transactions inwhich each party has more freedom to operate more informally.
7 The Restatement of Contracts 2d. at Sec. 1 defines a contract as "a promise or a set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty."
8 At least a proposal, standard conditions form, or confirming letter.
9 This kind of provision may also neutralize the rule that a document’s "ambiguities are construed against the drafter." This is a variant of the commonly used contract provision declaring both parties to be aware of all terms, and disclaiming that any language should be interpreted against any party who technically drafted it. See, e.g., Restatement of Contracts 2d at Sec. 232: "In choosing the reasonable meanings of a promise or agreement or a term thereof, that meaning is generally preferred which operates against the party who supplies the words or from whom a writing otherwise proceeds."
10 In an ironic twist of concepts, using a clause like this preserves some room for the clients to exercise their instinct for informal dealing, while establishing an order of documentary precedence in favor of the designated Über record keeper.
11 332 Ill.App.3d 181, 748 N.E.2d 824 (2d Dist. 2001)
12 Id at 825
17 Id. Local folkways and community sympathies of the Rockford-area jury may have been activated by the way one key witness for Action wept openly during his testimony. However irrelevant such conduct may be as a matter of "law," it may have been one factor influencing the jury’s finding of a binding contract to console the witness with insurance company cash. These dramatic factors can be contained with ex ante contractual documents. Drama can also be controlled with arbitration clauses, which again require some contractual foundation.
18 Id at 827
20 So West Bend was arguing "no handshake."
23 Contracts need not be "pretty legal" or "very legal" in order to be legal. Cf., Chadwick C. Busk, "Once Legal, Twice Legal, Thrice Legal" at The Fine Print: Musings of a Corporate Contracts Lawyer Blog post dated August 1, 2006 at http://contractual musings.blogspot.com/search?updated-min=2006-01-01T00%3A00%3A00-05%3A00&updated-max=2007-01-01T00%3A00%3A00-05%3A00&max-results=11 discussing the Elizabethan English practice of using wax seals to sign contracts, thus certifying them as "pretty legal," and the confirming of a contract in the Groucho Marx movie "Horsefeathers" as "very legal" by the placement of a seal "of the mammal variety" on the desk (with an ensuing handshake). These extreme (and outlandish) examples poke fun at the misconception that a contract is worthless unless it follows certain formalistic guidelines. The basic elements of a contract are, in fact, much simpler; and having any proof of them is much more important than the form of the proof). A shorter way to say it is,"This magic-words approach is not the law in Illinois." PFT Roberson, Inc. v. Volvo Trucks North America, Inc., 420 F.3d 728, 732 (7th Cir. 2005).
24 This, however, cuts both ways, since not only enforcement, but conversely, the pre-enforcement formality of having to "hedge every sentence with cautionary legalese" amounts to steep transaction costs generating "extra negotiating expenses [that] raise the effective price" of the bargain. PFT Roberson, Inc., 420 F.3d at 731; citing, Richard Craswell, Passing on the Costs of Legal Rules: Efficiency and Distribution in Buyer-Seller Relationships, 43 Stan. L. Rev. 361, 367-68 (1991).
25 This is the doctrine of the "partial agreement" which "allows parties to approach agreement in stages, without fear that by reaching a preliminary understanding they have bargained away their privilege to disagree on the specifics." Empro Mfg. Co. v. Ball-Co. Mfg., Inc., 870 F.2d 423, 426 (7th Cir. 1989).
26 The practice by some people of scoffing at lawyers and litigation, as a rationale for NOT documenting a deal, is itself irrational and actually incentivizes the other side to a "handshake" deal to breach it.
27 Case No. 77 L 22117 spanned seven years before coming to trial.
28 In re Central Ice Cream Co., 59 B.R. 476, 479 (Bkr.N.D.Ill. 1985)
29 Id. Ray Kroc died ten years later, in 1984. http://en.wikipedia.org/wiki/Ray_Kroc
30 The "Triple Ripple Trial" lasted 13 weeks, involved 28 witnesses and did not commence until almost six years after the original complaint was filed. In re Central Ice Cream Co., 59 B.R. 476, 481 (Bkr.N.D.Ill. 1985)
31 59 B.R. 476, 481 (Bkr.N.D.Ill. 1985)
32 Id. at 479
33 Central was not as lucky as it may appear at first glance. Though the jury awarded $52 million, Central and McDonald’s reached a settlement outside of court reported to be around to $15 million. Central had filed for bankruptcy prior to the lawsuit, and after its victory became public, numerous people materialized claiming to own the equivalent of 372% of Central’s shares. Matter of Central Ice Cream Co. 836 F2d. 1068, 1069 (7th Cir. 1987). Judge Easterbrook likened Central’s situation to that of "People who win a big jackpot in the lottery and discover they have more lifelong friends than they remembered." Id.
34 Judge Ann Williams reminds us that "Surely, if there is any moral to this story, it is to ‘get it in writing.’ It is astounding in this day and age to find it necessary to repeat this admonition, but no less so than to find a sophisticated party willing to leverage an agreement involving multiple years and millions of dollars solely on the enforceability of a simple handshake." Trustmark Ins. Co. v. General & Cologne Life Re of America, 424 F.3d 542, 544 (7th Cir. 2005). Judge Easterbrook adds that business people should stop talking like idiots (e.g., emails full of things like "Let’s roll" or "we look forward to this ‘long-term partnership’"). PFT Roberson, Inc., 420 F.3d at 732; citing, Brian Fugere, Chelsea Hardaway & Jon Warshawsky, Why Business People Speak Like Idiots: A Bullfighter’s Guide (2005).
Edward N. Tiesenga (B.A. cum laude, Hope College, 1981; J.D. American University, 1984), practices commercial law with Tiesenga Gottlieb & Reinsma LLP in Oak Brook, Illinois.
Thaddeus H. Goodchild (B.A. magna cum laude, Hope College, 2008; J.D. expected 2011, Chicago-Kent College of Law), is a law clerk with Tiesenga, Gottlieb & Reinsma LLP.