Principles of Business Law Week 8 lecture Circumstances that may invalidate legal transactions

About this lecture •

Objectives: To be aware of circumstances in which a contract might be vitiated; to distinguish between factual situations involving: duress, undue influence, mistake, unconscionable dealing, and misleading conduct; to explain the consequences of such circumstances.

1. Behavioural imperatives in legal transactions •

The law does not allow certain types of conduct, e.g. behaviour that is contrary to good conscience. If a legal transaction (including a contract) is entered into in such circumstances, it may be treated as void, or declared void by a court, even if the formal requirements of that transaction are satisfied.

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A legal transaction is said to be ‘void ab initio’ when the attempt to create it has no legal effect.

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A legal transaction is said to be ‘voidable ab initio’ when a valid transaction is initially created, but a court sets it aside as from its beginning. The word ‘vitiated’ is sometimes used to describe a contract that is made void.

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If a legal transaction is void ab initio, or after it is set aside as void ab initio, the parties must restored to their pre-contractual position. This is done by reversing any performance that was made. This process is called restitutio in intergrum.

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In Australian law, the validity of a legal transaction can be affected by any of the following circumstances: duress; mistake; undue influence; unconscionable dealing; and misleading conduct.

Particular vitiating circumstances In Australian law, the validity of a legal transaction can be affected by any of the following circumstances: • • • • • •

duress undue influence mistake unconscionable dealing misrepresentation illegality

Wildlife Park Wolfgang owns Wildlife Park, a small private zoo near Melbourne. Erica, aged 18, is an employee at the Park. She is also member of Green Peace and an animal-rights activist. She has a great emotional attachment to the gorilla she looks after. Wolfgang knows all of these things. Anxious to save money, he asks Erica to give part of her salary towards the gorilla’s upkeep. Otherwise, Wolfgang tells Erica, he will have the gorilla ‘put down’ because it is too expensive to keep. Erica does not trust Wolfgang, who she thinks is a very devious person, but even so, she believes he will carry out this threat. Without asking anyone for advice, she signs a contract prepared by Wolfgang in terms of which she agrees to give 25% of her salary to the zoo for as long as she is employed there. Two weeks later, on the advice of her family and friends, Erica regrets what she has done and wants to avoid the contract. On what grounds might she be able to do so?

Continued…

Wildlife Park continued… Wolfgang is the owner of a male tiger. Max, the manager of a Sydney Zoo, says to Wolfgang: “Will you make your male tiger available to mate with my female tiger?” Wolfgang says: “Yes, for a fee of $10,000.” Max agrees to these terms and Wolfgang sends his tiger to the Sydney Zoo for a fortnight. The two tigers get on very well and are dutifully amorous but the female does not fall pregnant. Max asks for tests to be carried out on Wolfgang’s tiger. Both Wolfgang and Max are surprised to find out that Wolfgang’s tiger is infertile. Max now wants to claim back the fee he has paid to Wolfgang. He says both he and Wolfgang believed the tiger was fertile and, because it was not, the contract should be treated as void.

Vitiating circumstances • • • • • •

DURESS undue influence mistake unconscionable dealing misrepresentation illegality

2. Duress • • • •

Duress exists when one party uses, or threatens to use, unlawful force or harm to obtain the other party’s agreement. The force or harm may be physical harm to the person; or economic harm; or illegal actions over their goods (such as refusing to return goods). The force or harm may be directed at the contracting party themselves, or to members of their family. If illegitimate pressure is used to get consent the contract comes into existence, but can be set aside as void by the court if the person who was forced acts within a reasonable time. – Barton v Armstrong [1973] 2 NSWLR 598; [1975] 2 All ER 465 – North Ocean Shipping Co Ltd v Hyundai Construction Co Ltd [1979] QB 705; [1978] 3 All ER 1170

Barton v Armstrong Armstrong seller

Barton -

Barton purchased some shares in a company from Armstrong. Some time later, Barton wanted to avoid the sale on grounds of duress.

purchaser

It was proved that Barton had decided to buy the shares, partly for business reasons, and partly because of the threats made by Armstrong to kill Barton and his family unless Barton bought the shares . Could the transaction be set aside as void on grounds of duress if the threats of harm were not the only reason for buying the shares?

North Ocean Shipping v Hyundai NOS Purchaser

Hyundai agreed to build a tanker for NOS at a price fixed in American dollars.

Hyundai manufacturer

After the contract was made, the value of the American dollar fell steeply. Hyundai said it would not build the ship unless the price was renegotiated. NOS, who could not afford a delay in delivery, agreed to a higher price. Was Hyundai’s threat to breach the contract and cause loss to NOS sufficient to constitute duress and have the new contract set aside?

Is duress applicable to the case-study?

Vitiating circumstances • • • • • •

duress UNDUE INFLUENCE mistake unconscionable dealing misrepresentation illegality

3. Undue influence •

Undue influence may exist when, because of their relationship, one party necessarily places confidence and trust in the other. The dominant party may influence the decisions of the weaker.

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If improper (undue) influence is used to make the weaker party enter a contract, the contract can be declared void.

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The weaker party must act reasonably soon to have the contract set aside. Continued…

The burden of proof The particular facts of each case will determine who has the burden of proving whether or not the transaction in question was brought about by undue influence. 1. Situations where a general controlling influence is presumed to exist

The weaker party must prove existence of relationship

The stronger party must disprove use of undue influence

2. Situations where a general controlling influence is proved to exist

The weaker party must prove existence of general controlling influence

The stronger party must disprove use of undue influence

3. Situations where an actual controlling influence is proved to exist

The weaker party must prove that undue influence affected the transaction

Relationships inevitably involving a general controlling influence •

Some relationships necessarily give the stronger party a controlling influence over the weaker and contracts between them are presumed to be the result of undue influence.

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Such recognised relationships are: parent and child; doctor and patient; solicitor and client; religious advisor and believer.

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To enforce the contract in such cases, the stronger party has the onus of proving that no undue influence was actually exercised. – Allcard v Skinner (1887) 36 Ch D 145 Continued…

Allcard v Skinner Allcard – Religious Convert

Allcard joined a religious order and was persuaded to give all her assets to the order. Some years later Allcard left the order and wanted to get her property back.

Skinner – Representative of religious order

What did Allcard have to prove to have the donation be set aside on grounds of undue influence?

Relationships in which a general controlling influence is proved to exist •

In some relationships, controlling influence is not inevitable but the weaker party may be able to prove that the stronger party had a general controlling influence.

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Such recognised relationships are: husband and wife; principal and agent; accountant and client; banker and customer; dentist and patient; employer and employee.

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If so, a presumption of undue influence arises and the stronger party has the onus of proving that no undue influence was actually exercised in relation to the contract in question. – Johnstone v Buttress (1936) 56 CLR 113 Continued…

Johnstone v Buttress Butress – elderly man

After his wife’s death Butress began to rely on Johnstone for help in managing his personal affairs.

Johstone lady friend

When he had became more reliant on her help, Johnstone persuaded Butress to transfer the ownership of his house to her. After Butress’s death, his children wanted the transfer of the house set aside as void. What did Butress’s children have to prove to have the transfer set aside as void on grounds of undue influence?

Actual undue influence affecting a specific transaction •

In some circumstances, while a general controlling influence does not exist, it may be possible for a weaker party to show that the stronger party actually used an improper controlling influence to bring about the particular transaction. Example: Your music teacher, who does not normally influence your decision making, but whose judgement you greatly respect in musical matters, persuades you to sign up for a six week music camp.

Is undue influence applicable to the case-study?

Vitiating circumstances • • • • • •

duress undue influence MISTAKE unconscionable dealing misrepresentation illegality

4. Mistake (error) •

A mistake is a misapprehension of facts. A mistake might prevent the parties from reaching sufficient consensus to create a valid contract.

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Agreement is judged objectively: what would a reasonable person conclude from the external evidence? – Raffles v Wichelhaus (1864) 2 H&C 906 Continued…

Raffles v Wichelhaus Raffles buyer

Raffles agreed to buy some bales of cotton from Wichelhaus. It was a condition of the contract that the cotton be placed by the seller on the ship Peerless at the port of Bombay.

Wichelhaus seller

After the contract was made it was discovered that there were two ships with the same name (Peerless) due into Bombay at the same time. In light of the error, was there sufficient agreement for a binding contract to have been made?

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If, despite the mistake, there is objective agreement, different rules apply, depending on whether a mistake is bilateral or unilateral.

Bilateral Mistakes •

‘Bilateral’ mistakes occur when both contracting parties are mistaken, for example: – Both parties assume the subject matter exists when it does not – Both parties wrongly assume a seller owns the subject matter – Both parties are mistaken about the identity or quality of the subject matter of the contract

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If it can be inferred that the agreement was intended to be conditional on the truth of the assumption, the contract is voidable in common law: otherwise the contract remains valid in common law.

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If a mistake is made as to the quality of the thing contracted for, the contract is only made voidable if the error 'makes the thing contracted for essentially different from the thing that it was believed to be'

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The error must not be the fault of the person relying on it. Continued…

Cases on bilateral mistake – Leaf v International Galleries [1950] 2 KB 86 – Great Peace Shipping Ltd v Tsavliris [2003] QB 679; [2002] 4 All ER 689 – McRae v Cth Disposals Commission (1951) 84 CLR 377

Leaf v International Galleries Leaf

Leaf saw a painting of Salisbury Cathedral in International Galleries shop. He offered to buy the painting and sale was made.

buyer

Int Galleries seller

Although nothing was said at the time of the sale, both parties believed the painting was by John Constable. But the painting was in fact the work of another artist. Could it be inferred from the circumstances that the transaction was intended to be conditional on the truth of the belief that the painting was by Constable?

Great Peace Shipping Ltd v Tsavliris Sinking ship Cape Providence

Tsavliris Salvage operator

The owners of the Cape Providence contracted with Tsavliris to tow their sinking ship. Tsavliris was worried the ship would sink before he could get there. Tsavliris contracts with the owners of the Great Peace for that ship to stand by as a rescue ship. Both parties thought that the Great Peace was the closest available ship.

Standby ship Great Peace

After the contract was made, it was discovered that another available ship was closer. The error related to a quality of the Great Peace. Did this error makes the Great Peace essentially different from the thing that it was believed to be?

McRae v Cth Disposals Commission CDC – Government seller

The CDC advertised a wrecked tanker for sale. McRae’s bid of 200 pounds was accepted.

McRae Salvage operator

Having bought he ship, McRae searched for her but found in the end she did not exist. Did the mistake as to the existence of the ship allow the contract to be avoided at the instance of the CDC?

Is bilateral mistake applicable to the case-study?

Unilateral mistake •

Unilateral mistakes exist when only one contracting party is mistaken. Examples are: – one party misunderstands the terms of the contract – one party misunderstands the type of agreement being created – one party mistakes the identity of the other contracting party

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If (objectively) there is unconditional agreement despite the unilateral error, the contract is valid in common law.

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But equity makes the contract voidable if it would be contrary to conscience for the other party to take advantage of the error: Taylor v Johnson (1983) 151 CLR 422. But note: Equity will not make the contract void if the rights of third parties would be adversely affected, for example, if the property in question has already been resold to an innocent third party.

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Taylor v Johnson (1983) Johnson Seller

Johnson sent a written offer to sell 10 acres of land to Taylor for $15,000. Realising the price was very cheap, Taylor quickly accepted the offer.

Taylor Buyer

After the contract was made, Johnson realised that the words ‘per acre’ had been left out of the original offer to sell the land for $15,000. Only Ms Johnson had been mistaken about the terms of the offer. Could the contract be enforced by Taylor?

Is bilateral mistake applicable to the case-study?

Time for a break We resume in 10 minutes

Vitiating circumstances • • • • • •

duress undue influence mistake UNCONSCIONABLE DEALING misrepresentation illegality

5. Unconscionable dealing •

The general law recognises that unconscionable dealing may exist when one contracting party suffers from a disability or disadvantage and so enjoys no reasonable equality of bargaining power.

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The disadvantage may arise in different circumstances, e.g. because of sickness, age, illiteracy, drunkenness, emotional dependence, lack of education, lack of independent assistance or advice.

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To establish unconscionable dealing it must be proved that: – The effect of the disadvantage is such that the weaker party can’t properly judge what is in their own best interest; AND – The disadvantage is, or should have been, evident to the stronger party; AND – The stronger party takes unfair advantage of the circumstances, e.g. to extract unconscionable terms or get consent to onerous terms

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If all these requirements are met, a court may set aside the contract on equitable grounds.

Cases on unconscionable dealing – Blomley v Ryan (1956) 99 CLR 362 – Commercial Bank of Australia v Amadio (1983) 151 CLR 447 – Garcia v National Australia Bank [1998] HCA 48; (1998) 194 CLR 395

Blomley v Ryan Ryan Seller

Blomley wanted to buy Ryan’s farm, but Ryan refused to sell.

Blomley Buyer

Knowing Ryan liked to drink excessively, Blomley took him to a pub, got him drunk and then got him to agree to sell his farm.

When he had sobered up, Ryan regretted the sale. Could the transaction be set aside as void on grounds of unconscionable dealing?

Commercial Bank of Australia v Amadio Vincente Amadio – son and primary debtor

Mr & Mrs Amadio – parents and guarantors

V. Amadio needed to extend his loan from the CBA. They insisted he find someone to guarantee the loan. He asked his parents to mortgage their property.

CBA Lender and security holder

Thinking their son’s business was doing well, and unaware of the extent of the guarantee, Mr and Mrs Amadio agreed to the mortgage. The bank accepted their signature without providing any explanation. When V. Amadio failed to repay the loan, the bank sought to enforce the mortgage. In the circumstances, could the mortgage be made void on grounds of unconscionable dealing by the bank?

Garcia v National Australia Bank Mr Garcia primary debtor

Mrs Garcia guarantor

Garcia wanted a loan from the NAB, who insisted he provide a guarantor. He asked his wife, a well educated woman, to mortgage her properties as security for the loan.

NAB Lender and security holder

Mrs Garcia agreed to her husband’s request and went to the bank with him to sign the papers. The bank provided no advice. When the bank tried to enforce the mortgage, Mrs Garcia asked for the security to be set aside as void on grounds of unconscionable dealing by the bank. Was she entitled to this relief?

Is unconscionable dealing applicable to the case-study?

Vitiating circumstances

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duress undue influence mistake unconscionable dealing MISREPRESENTATION illegality

6. Misrepresentation •

If one person is induced to enter into a contract because of a representation made by the other contracting party, and the representation turns out to be untrue, there is no action available for breach of contract, because representations are not terms of the contract.

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However, if the misrepresentations was made either deliberately or negligently, then the misrepresentation justifies setting the contract aside as void ab initio.

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Deliberate or negligent misrepresentations also give rise to an action in tort law.

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Misrepresentions that are made neither deliberately or carelessly are called 'innocent misrepresentations' and do not justify setting aside a contract as void, nor do they give rise to an action in tort. However they may give rise to liability for misleading conduct under the Australian Consumer Law.

Is misrepresentation applicable to the case-study?

Vitiating circumstances

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duress undue influence mistake unconscionable dealing misrepresentation ILLEGALITY

7. Illegality •

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In the general law, a transaction may be considered illegal if it contravenes public policy, for example, by unreasonably restricting a person's right to work or engage in trade, or because the transaction is considered immoral. There are also a great number of legislative provisions that may affect the legality of a transaction. How the law affects an illegal transaction depends on the particular case. Possible consequences are: - that the transaction is invalid - that the transaction is unenforceable - that the transaction is subject to a penalty Lindner v Murdock's Garage (1950) 83 CLR 628 Fitzgerald v FJ Leonhardt 1997 HCA 17; 189 CLR 215

Lindner v Murdock's Garage Lindner Mechanic

Murdock’s owned and operated two garages in towns ten miles apart. T5hey employed Lindner as a mechanic in one of the garages.

Murdock’s Garage

It was a term of Lindner’s contract that if he left Murdock’s employment, he would not work in either town for a year. Was this restraint of trade clause reasonable or unreasonable in its extent?

Fitzgerald v FJ Leonhardt Fitzgerald Employer

Fitzgerald employed Leonhardt to drill boreholes on his land. Permits were necessary for the drilling to commence.

Leonhardt Driller

Fitzgerald should have obtained the permits but failed to do so. Leonhard drilled seven holes and sued for payment. Was Fitzgerald entitled to rely on the illegality (drilling without permits) to avoid paying Leonhardt?

Is illegality applicable to the case-study?

Notices •

Do the tutorial ‘Avoiding a legal transaction’ and read Chapter 10 of the Source Book .

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Check the LMS for the results of your second skills-task.

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Go to one of the consulting sessions this week if you need to. Times and venues are on the LMS.