United States: Contracts And The Importance Of Background Law

Introduction

Most people are relatively familiar with the importance of contracts when doing business or transferring property interests. They often rely on a general understanding of freedom of contract and the enforceability of voluntary contractual commitments, to enter contracts without legal advice.

Mandatory Legal Norms & Contracts

Less people are aware of how significantly background law can impact contracts, whether cemented in judicially developed case law, legislatively created statutes, or rules and regulations adopted by administrative agencies. When legal norms are mandatory, they are not waivable by contract, and they can have significant consequences on intended contractual arrangements.

Potential Consequences

Failure to consider background law can have an array of consequences, including fines or penalties. It can result in the non-enforceability of a contractual provision. In certain situations, it can even result in the nullity of a contract. For reasons like these (and many others), it is nearly always a good idea to consult with a qualified attorney when creating important contracts. This is true when creating contractual templates to be used repeatedly by a business, and when contracts address a sensitive subject matter like real property rights, transactions in securities, or employment. It should almost go without saying (but people sometimes need reminding) that this is especially the case when the value underlying an agreement is substantial.

Examples

The below paragraphs offer a few specific examples of how background law can impact contractual relationships. As the reader will note, failure to contemplate them can lead to extremely adverse consequences.

Exculpation Provisions

If a party wishes to disclaim all liability in connection with a given contractual relationship—including for their own gross negligence—the contract may be required to meet certain formalities to qualify for enforcement. In Texas, disclaiming liability for one's own negligence requires compliance with the judicially developed "fair notice doctrine." Ethyl Corporation, et al v. Daniel Construction Company 725 S.W.2d 705 (Tex. 1987). Generally, the fair notice doctrine requires that that contractual intent to absolve a party from even its own negligence be clearly and plainly expressed and that the provision meet certain "conspicuousness" requirements.

If a contractual provision meant to transfer all risk for a party's own negligence to another party fails the established standards, the provision will be unenforceable. The rule will apply even if the party seeking to transfer the associated risk would not have entered the contract but for the unenforceable provision. Substantial disputes on this issue have been litigated relatively frequently.

Securities Transactions

In connection with transactions in "securities"—which are essentially financial interests in pooled assets—a seller's failure to comply with regulatory requirements can be severe. If a seller of a security does not register the security and fails to qualify for a regulatory exemption, the purchaser may have a right to rescind the contract to recover the entirety of her investment or to sue for damages.

Household Sales

For most sellers of goods and services sold on a door-to-door basis like pest-control service plans or emergency residential construction services, Texas law gives consumers special rights that cannot be waived by contract. These include a "rescission" right, i.e., a right to cancel the transaction within three business days, and notification of the right to cancel the sale. If the merchant fails to comply with the notice requirements, the transaction is deemed void, and consumers can obtain actual damages, attorney's fees and court costs. Tex Bus. & Com. Code §§ 601.201, 601.202.

Contracts Concerning Residential Real Estate

With respect to requirements concerning transactions in real property, disclosure and notification requirements are plentiful:

• Residential contractors building for property owners are required to furnish specific notices to their customers. Prop. Code § 53.255. Their contracts should also contain specific disclosures regarding the liability-limiting effects of the Texas Residential Construction Act. Tex. Prop. Code § 27.007. Failure to provide this notice gives rise to a civil penalty.

• Sellers of property located in a Municipal Utility District (an area in which a local government assesses special fees against properties for certain improvements to benefit them) must notify buyers that the property is subject to such assessments prior to the execution of a purchase contract. Texas Wat. Code 49.452. If the seller fails to notify the buyer, the buyer is entitled to cancel the sales contract. The same is true for any transaction in connection with a Public Improvement District.

• Sales of property under rent-to-own arrangement are particularly burdened with statutory disclosure and notice requirements, in addition to special rights to protect the buyer. Prop. Code, Chapter 5, Subchapter D.

Usury

Agreements in which parties agree to the payment of interest are subject to Texas Usury laws. Charging interest in excess of the applicable maximum legal rate can result in significant consequences. A creditor can be liable to a debtor for the greater of 1) three times the interest contracted for charged, or received that exceeds the legal limit, or 2) $2,000.00 or 20 percent of the amount of the principal, whichever is less. Tex. Fin. Code § 305.001. Where a contract might be interpreted to violate usury laws, Texas Courts deem "usury savings clauses" as effective tools to avoid constructions that violate usury laws.

Conclusion

The above are many additional situations in which background law imposes mandatory terms or requirements on private arrangements. As the reader may deduce, knowledge of relevant background law is often crucial to creating adequate contracts. For readers needing a good reason to seek the assistance of an experienced lawyer when doing business, the importance of knowing background law is one additional good reason among many others.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.