Contracts are often unenforceable for several reasons
Often when I am assigned a project to review a managed care agreement for a client, I find all kinds of unenforceable or impracticable terms and phrases in contracts that would never be settled by arbitration. The primary reason for this is due to the fact that the arbiter cannot make up a solution to a dispute that doesn't already exist as a remedy in the contract. So let's review a few of the standard reasons why a contract could be voided on technicalities.
Since a contract is a legally binding agreement, in the typical scenario, once you enter into a contract with another person or business, you and the other party are both expected to fulfill the terms of the contract. But it’s possible for an otherwise valid contract to be found unenforceable in the eyes of the law, let’s look at some common situations where that might be the case.
Lack of Capacity
It’s expected that both (or all) parties to a contract have the ability to understand exactly what it is they are agreeing to. If it appears that one side did not have this reasoning capacity, the contract may be held unenforceable against that person. The issue of capacity to contract usually comes up when one side of the agreement is too young or does not have the mental wherewithal to completely understand the agreement and its implications. The general idea here is to prevent an unscrupulous person from taking advantage of someone who lacks the ability to make a reasoned decision.
Minors (those under the age of 18, in most states) lack the capacity to make a contract. So a minor who signs a contract can either honor the deal or void the contract. There are a few exceptions, however. For example, in most states, a minor cannot void a contract for necessities like food, clothing, and lodging. Also, a minor can void a contract for lack of capacity only while still under the age of majority. In most states, if a minor turns 18 and hasn’t done anything to void the contract, then the contract can no longer be voided. Special considerations may exist for emancipated minors.
Doogie Howser, M.D. -- look out!
Persons who lack mental capacity
While many contract analysts appear to have lack mental capacity for what they signed in the past, that's not really what the law enforces. A person who lacks mental capacity can void, or have a guardian void, most contracts (except contracts for necessities). In most states, the standard for mental capacity is whether the party understood the meaning and effect of the words comprising the contract or transaction. That argument could be sustained because many contracts are actually unintelligible! In all seriousness, though, this is called the “cognitive” test.
Some states use what’s called the “affective” test: a contract can be voided if one party is unable to act in a reasonable manner and the other party has reason to know of the condition. And some states use a third measure, called the “motivational” test. Courts in these states measure capacity by the person’s ability to judge whether or not to enter into the agreement. These tests may produce varying results when applied to mental conditions such as bipolar disorder. Something to consider in a healthcare context....
People who are intoxicated by drugs or alcohol are usually not considered to lack capacity to contract. Courts generally rule that those who are voluntarily intoxicated shouldn’t be allowed to avoid their contractual obligations, but should instead have to take responsibility for the results of their self-induced altered state of mind. However, if a party is so far gone as to be unable to understand even the nature and consequences of the agreement, and the other (sober) party takes advantage of the person’s condition, then the contract may be voidable by the inebriated party. Don’t sign contracts at meal-time meetings if alcohol is served.
Duress, or coercion, will invalidate a contract when someone was threatened into making the agreement. I've seen duress come about when a hospital executive threatens the anesthesia group with expulsion of they don't accept every contract that the hospital has in its portfolio - even when the anesthesiologists are self-employed and independent of the hospital.
In an often cited case involving duress, a doctor (Party A) agreed to take over the care of a patient who was a subscriber or member of an insurer or health plan (Party B) to consult and perform surgery. After the surgery was underway and the surgeon had the patient under anesthesia, the surgeon refused to complete the procedure the insurer or health plan agreed to pay a higher price. The insurer or health plan was forced to agree to the higher rate because there was no other way to get the procedure finished. The court ultimately found that this agreement to raise the price was not enforceable, because it came about through duress. Another common example of duress is blackmail.
If Person B forced Person A to enter into an agreement by taking advantage of a special or particularly persuasive relationship that Person B had with Person A, the resulting contract might be found unenforceable on grounds of undue influence. In general, to prove undue influence, Person A would have to show that Person B used excessive pressure against Person A during the negotiation process, and that for whatever reason Person A was overly susceptible to the pressure tactics -- or that Person B exploited a confidential relationship to exert pressure on Person A.
If fraud or misrepresentation occurred during the negotiation process, any resulting contract will probably be held unenforceable. The idea here is to encourage honest, good faith negotiation and transactions. Misrepresentations commonly occur when a party says something false (telling a potential participating provider or supplier that the other party will steer a certain volume of business to the supplier in order to negotiate a higher discount or commission when there would be no way to execute because the promising party doesn’t have the book of business to make to volume of referrals promised.) or, in some other way, conceals or misrepresents a state of affairs.
Nondisclosure is essentially misrepresentation through silence -- when someone neglects to disclose an important fact about the deal - like a near market competitor with an exclusive deal on a particular surgery or diagnostic testing, leaving the other competitor to spend upwards of $10,000 on negotiating a contract for the remaining crumbs. I see this often in DME/HME deals, lab deals, imaging deals and outpatient surgery deals.
Courts look at various issues to decide whether a party had a duty to disclose the information, but courts will also consider whether the other party could or should have easily been able to access the same information. It should be noted that parties have a duty to disclose only material facts. But if Party A specifically asks Party B about a fact (material or non-material), then Party B has a duty to disclose the truth.
When contract disputes involve fraudulent dealings like misrepresentation or nondisclosure, and one side of the agreement has already suffered financial losses as a result, a lawsuit for breach of contract might be filed over the matter.
In contract law, a “material” breach of contract is a breach (a failure to perform the contract) that strikes so deeply at the heart of the contract that it renders the agreement “irreparably broken” and defeats the purpose of making the contract in the first place. The breach must go to the very root of the agreement between the parties. If there is a material breach (sometimes referred to as a “total” breach), the other party can simply end the agreement and go to court to try to collect damages caused by the breach.
In deciding whether a breach is material, courts often look to guidance from a legal guide known as the Restatement (Second) of Contracts, as well as to other court decisions that arose from contract disputes.
Is The Other Party Deprived of “The Heart” of What It Bargained for?
If the purpose of the contract was to receive a good or service from a particular supplier or item, and the item is undeliverable, and no substitution will suffice, this is probably a material breach. If you pay to attend a conference specifically for scheduled networking (B2B) or a gala dinner to socialize and network but are then denied admission, there may be a material breach.
Can the Other Party Be Compensated for The Loss?
If it’s something that can be fixed with reasonable effort or expense, while keeping the contract in effect, it’s less likely to be material.
What Will the Breaching Party Lose (or Forfeit)?
How much has the breaching party already done to fulfill its end of the deal? This factor often hinges on timing: how far along the parties are in carrying out their contractual obligations when the breach of contract occurs. If most of the contractual obligations have been completed, you will be less likely to be able to say that a breach of contract is material and thus be able to cancel the contract.
What Are the Chances That the Breaching Party Will Fix Things?
The more likely it is that the breaching party can and will fix the problem, the less likely the breach of contract is material. If the other party shows that problems are likely to be solved; for instance, it provides security for its promised payment, or some other reasonable assurance that it will honor the deal, or if the economy or market shifts in favor of performance, then the breach of contract is less likely to be material. On the other hand, signs of financial weakness or defaults on payments show that the problems are less likely to be corrected (and make it more likely that you could rely on a material breach of contract to cancel the contract).
Did the Breaching Party Act in Bad Faith?
If the breach of contract was willful or resulted from bad faith or unfair dealing and the case is brought to court, the court is more likely to presume a material breach of contract. On the other hand, a breach that results from simple carelessness (“negligence”) or circumstances beyond the party’s control is less likely to be considered a material breach of contract.
Is the Non-Breaching Party “Ready, Willing, and Able” to Perform?
It’s not enough to simply claim that the other party committed a material breach of contract. The non-breaching party must also be “ready, willing, and able” to perform its obligations under the contract, if it hasn’t performed them already.
What Does the Contract Say?
Some contracts provide guidance as to what constitutes a material breach of contract. Rather than rely on a judge’s discretion or interpretation of the law should a dispute arise, the parties can include a clause in the contract stating that a breach of certain provisions of the contract will be considered material breaches. This could include, certain activities -- a failure to make payments, a failure to maintain insurance, or a failure to achieve certain objectives or outcomes -- will be considered material breaches of the contract. Because delays in performance and payment are not always considered material breaches, some contracts add a statement to the contract that “time is of the essence,” which means that these types of delays will be considered material breaches of the contract.
Unconscionability means that a term in the contract or something inherent in or about the agreement was so shockingly unfair that the contract simply cannot be allowed to stand as is. The idea here again is to ensure fairness, so a court will consider:
- whether one side has grossly unequal bargaining power
- whether one side had difficulty understanding the terms of the agreement (due to language or literacy issues, for example), or
- whether the terms themselves were unfair (like sky-high arbitration costs;
If a court does find a contract unconscionable, it has options other than just voiding the agreement altogether. It may instead choose to enforce the conscionable parts of the contract and rewrite the unconscionable term or clause, for example.
Contracts can be found unenforceable on grounds of public policy not only to protect one of the parties involved, but also because what the contract represents could pose harm to society as a whole. For example, a court will never enforce a contract promoting something already against state or federal law (you can never enforce a contract for an illegal marijuana sale) or an agreement that offends the “public sensibilities” (contracts involving some sort of relationship interference, Humana v Jacobsen, for example). Other examples of contracts (or contracts clauses) that are against public policy and therefore unenforceable include:
- an employer forcing an employee to sign a contract that forbids workers from joining a union
- an employer forcing an employee to sign a contract forbidding medical leave
- a landlord forcing a tenant to sign a contract forbidding medically necessary companion animals such as seeing eye dogs, and
- contracts that put the business terms in higher priority than a doctor’s relationship with their patient and duty of care
Sometimes a contract is unenforceable not because of purposeful bad faith by one party, but due to a mistake on the part of one party (called a “unilateral mistake”) or both parties (called a “mutual mistake”). In either case, the mistake must have been about something important related to the contract, and it must have had a material (significant) effect on the exchange or negotiation process. In one contract a health plan drafted the agreement between the plan and the doctors to state that the fee schedule would be 90% of billed charges. In the final version, an extra “f” was added to the word “of”, translating the value of the deal to only 10% of billed charges.
In some cases, a contract is deemed unenforceable because it would be impossible or impracticable to carry out its terms -- too difficult or too expensive, for example. To claim impossibility, you would need to show that:
- you can’t complete performance under the contract because of some unexpected event that’s not your fault
- the contract didn’t make the risk of the unexpected event something you needed to shoulder, and
- performing the contract will be much more difficult or expensive now.
For example, if a hospital agrees to include an implant or a certain medication to a patient covered by an insurance or health plan at a specific fee, and a natural disaster wipes out the supplier of the drug or implant, before the item can be obtained, the hospital might be able to have the contract ruled unenforceable on grounds of impossibility.