Selected Developments In Business Law Courtesy of CEB — Financing and Protecting California Businesses

Courtesy of CEB, we are bringing you selected legal developments in areas of California business law that are covered by CEB’s publications.  This month’s feature is from the April 2019 update to California Law of Contracts.  References are to the book’s section numbers.  See CEB’s BLS Landing Page for special discounts for Business Law Section members.  The most significant legal developments since the last update include developments in such important topic areas as authority to contract, contract formation and interpretation, the doctrine of unconscionability, warranties and covenants, breach of contract actions, and arbitration.

California Law of Contracts

April 2019 Update

Authority to Contract

The key features of an agency relationship are “(1) the agent’s power to alter legal relations between the principal and others, (2) a fiduciary relationship, and (3) the principal’s right to control the agent’s conduct.” Castillo v Glenair, Inc. (2018) 23 CA5th 262, 277. See §2.30.

A power of attorney may also grant authority to the attorney-in-fact by incorporating powers by reference to another statute. Prob C §4263(b). Compare Hutcheson v Eskaton FountainWood Lodge (2017) 17 CA5th 937, 951 (affirming trial court’s denial of a motion by residential care facility to compel arbitration, “[b]ecause the attorney in fact acting under [the health care power of attorney] did not have authority to make health care decisions for her principal, her execution of the admission agreement and its arbitration clause are void.”), with Garrison v Superior Court (2005) 132 CA4th 253, 266 (attorney-in-fact, acting on authority granted in durable power of attorney, may enter into binding arbitration agreements on behalf of principal). See §2.51.

Contract Formation and Interpretation

In Nielsen Contracting, Inc. v Applied Underwriters, Inc. (2018) 22 CA5th 1096, the court ruled that arbitration and delegation provisions that modified a workers’ compensation policy were illegal and unenforceable because they were not filed with the Insurance Commissioner as required by Ins C §11658. See §§3.37, 9.48.

In Petrolink, Inc. v Lantel Enters. (2018) 21 CA5th 375, 384, the court held that “[w]here an option to purchase exists within a lease agreement, the exercise of the option to purchase causes the lease and its incorporated option agreement to cease to exist, and, instead, a binding contract of purchase and sale comes into existence between the parties” (citations omitted). See §4.14.

In James v Global Tel*Link Corp. (3d Cir 2017) 852 F3d 262, 267, the court held that no contract was formed; the plaintiffs had enrolled in a telephone service over the phone, without ever seeing the defendant’s terms of use or being informed that use of the service would constitute consent to those terms. See §4.66.

In Rensel v Centra Tech, Inc. (SD Fla, June 14, 2018) 2018 US Dist. Lexis 100720 *26 (citing Ng, Blockchain and Beyond: Smart Contracts (ABA, Bus L Today, Sept. 2017)), the court defined so-called smart contracts as “self-executing contracts with the terms of the agreement between buyer and seller being directly written into lines of [software] code. Once a smart contract has been created, computer transaction protocols will execute the terms of a contract automatically based on a set of conditions.” The Rensel case was a class action alleging federal securities law violations arising from the plaintiffs’ purchase of digital currency or tokens from the defendants via a smart contract. The defendants sought to enforce an arbitration provision with a class action waiver that was part of a document on the defendants’ website, but not part of the smart contract itself. The plaintiffs argued that they were not bound by the arbitration provisions because of the manner in which the digital token purchase was made. The court agreed, stating that “[a] party making a purchase via the smart contract would not have had to agree to any of the terms contained in the Token Sale Agreement in order to complete the purchase and would have automatically received a corresponding amount of [the tokens] based on the amount of [currency] sent to the [defendants’] Smart Contract Address.” See §4.67.

Civil Code §1636 expresses the paramount rule of contract interpretation—that “[a] contract must be so interpreted as to give effect to the mutual intention of the parties as it existed at the time of contracting, so far as the same is ascertainable and lawful.” Saheli v White Mem. Med. Ctr. (2018) 21 CA5th 308, 317. See §5.5.

In the employment context, if a written agreement has been prepared entirely by the employer, it is well established that any ambiguities must be construed against the employer and in favor of the employee. Sandquist v Lebo Automotive, Inc. (2016) 1 C5th 233, 248. This rule applies with particular force in the case of an adhesion contract. Juarez v Wash Depot Holdings, Inc. (2018) 24 CA5th 1197, 1203. See §5.17.

Following Riverisland Cold Storage, Inc. v Fresno-Madera Prod. Credit Ass’n (2013) 55 C4th 1169, the court in IIG Wireless, Inc. v Yi (2018) 22 CA5th 630 held that parol evidence of the defendant’s representations to shareholders relating to treasury shares was admissible to prove fraud. See §5.41.

Enforcement of a forum selection clause may be denied in the trial court’s discretion when the underlying contract has no connection with California. See Quanta Computer Inc. v Japan Communications Inc. (2018) 21 CA5th 438, 441 (court dismissed breach of contract action by Taiwanese company that entered into contract to manufacture and sell phones to Japanese company). See §§5.44, 5.46.

The Erie doctrine holds that, in diversity cases, federal district courts should apply state law to substantive issues and federal law to procedural issues. Erie Railroad v Tompkins (1938) 304 US 64. There is a split among the circuits regarding whether state or federal law should apply to the interpretation of forum selection clauses. In the Ninth Circuit, it is clear that federal law, rather than state law, applies. Sun v Advanced China Healthcare, Inc. (9th Cir 2018) 901 F3d 1081, 1086; Doe 1 v AOL LLC (9th Cir 2009) 552 F3d 1077. In Sun, relying on Atlantic Marine Const. Co. v U.S. Dist. Court (2013) 571 US 49, 60, the Ninth Circuit explained that the appropriate way to analyze a forum-selection clause is through the doctrine of forum non conveniens. In general, the clause should control except in unusual circumstances. See §5.46A.

In Colaco v Cavotec SA (2018) 25 CA5th 1172, 1177, the court held that the parties’ choice of California law in an employment agreement controlled; there was no evidence that Delaware had materially greater interest in applying its law on the fiduciary duty claims at issue). See §5.52.

An adhesion contract is a standardized contract, drafted and imposed by a party having superior bargaining strength on the other party without giving that party a chance to negotiate its terms. The other party has “only the opportunity to adhere to the contract or reject it.” Baxter v Genworth N. Am. Corp. (2017) 16 CA5th 713, 723. See §§5.72–5.75, 9.43.

The Doctrine of Unconscionability

The doctrine of unconscionability is a defense to contract enforcement; it can be used to invalidate a contract provision or even an entire contract. De La Torre v Cashcall, Inc. (2018) 5 C5th 966, 979. See §5.75.

In Baxter v Genworth N. Am. Corp. (2017) 16 CA5th 713, the court held that an employee had no opportunity to negotiate an arbitration agreement that was presented to her on a take-it-or-leave-it basis as a condition of her continued employment; a high degree of oppression supported finding of procedural unconscionability. Further, the provisions that restricted communications with other employees, limited discovery to inhibit the employee from asserting her statutory rights, shortened the limitations period to pursue statutory claims, and required arbitration of statutory claims before any administrative investigation were substantively unconscionable). See §§5.76–5.77.

Warranties and Covenants

Instructions for use can constitute an express warranty. Weinstat v Dentsply Int’l, Inc. (2010) 180 CA4th 1213, 1227. In Patricia A. Murray Dental Corp. v Dentsply Int’l, Inc. (2018) 19 CA5th 258, however, the court held that the instructions at issue did not constitute a warranty that the device at issue could be used in surgery; evidence showed the plaintiffs, who were sophisticated dentists, were aware of the risks posed by use of the device, making it unsuitable for surgery, but purchased and used it anyway. See §6.13.

The Consumers Legal Remedies Act (CLRA) (CC §§1750–1784) authorizes any consumer “who suffers any damage” because of an unlawful method, act or practice to bring an action for various forms of relief. CC §1780(a); Gutierrez v Carmax Auto Superstores Cal. (2018) 19 CA5th 1234, 1264. However, plaintiffs may not recover for prospective violations of the CLRA. See §6.23.

Covenants can be either dependent or independent of the other party’s obligations under the contract. Colaco v Cavotec SA (2018) 25 CA5th 1172, 1183; Verdier v Verdier (1955) 133 CA2d 325, 334. Covenants are dependent when one party’s performance is a condition precedent to the other party’s performance. See §§6.41, 6.43. In that situation, if the other party fails to perform, the nonbreaching party is excused from its obligation to perform. In contrast, if the covenants are independent, one party’s breach does not necessarily excuse the other party’s performance. The nonbreaching party must still perform and, as a remedy, must seek damages for breach of contract from the breaching party. Colaco v Cavotec SA, supra. See §6.32.

In Golden v California Emergency Physicians Med. Grp. (9th Cir 2018) 896 F3d 1018, 1028, the Ninth Circuit held that an agreement between a physician and his former employer placed a “restraint of a substantial character” on the physician’s medical practice and was therefore void under Bus & P C §16600. See §6.38.

In AMN Healthcare, Inc. v Aya Healthcare Svcs., Inc. (2018) 28 CA5th 923, the court held that an agreement that prohibited the defendants, who were recruiters for a nurse staffing agency, from soliciting any employee of their former employer was void under Bus & P C §16600, because it restrained the recruiters from practicing their chosen profession. The court did not hold that all nonsolicitation agreements are unenforceable, but did state that, after Edwards v Arthur Andersen LLP (2008) 44 C4th 937 (see §6.38), it doubted the continuing validity of cases applying a reasonableness standard to nonsolicitation agreements. See §6.38A.

In Akorn, Inc. v Fresnius Kabi AG (Del Ch, Oct 1, 2019, No. 2018–0300–JTL) 2018 Del Ch Lexis 325, the Delaware Court of Chancery held that the buyer properly invoked the material adverse change clause as a basis for refusing to close the merger transaction. In so holding, the court emphasized that the buyer has a heavy burden and that a short-term dip in the seller’s earnings would not be sufficient. Instead, the material adverse change (2018 Del Ch Lexis 325, *122 (citations omitted))should be material when viewed from the longer-term perspective of a reasonable acquiror. . . In the absence of evidence to the contrary, a corporate acquirer may be assumed to be purchasing the target as part of a longterm strategy. . . .The important consideration therefore is whether there has been an adverse change in the target’s business that is consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months. See §6.47.

 Breach of Contract Actions

Intentional interference with contractual relations, also known as intentional inducement of breach of contract, is a cause of action in tort “against noncontracting parties who interfere with the performance of a contract.” Redfearn v Trader Joe’s Co. (2018) 20 CA5th 989, 997 (emphasis in original). This tort is distinct from breach of contract (see §§8.66–8.70). See §8.78.

In Marina Pacifica Homeowners Ass’n v Southern Cal. Fin. Corp. (2018) 20 CA5th 191, 205, the court held that the court determines which party, if any, prevailed on the contract if neither party achieves complete victory on all contract claims. See §9.17.

In Sheppard, Mullin, Richter & Hampton, LLP v J-M Manufacturing Co., Inc. (2018) 6 C5th 59, 90, the law firm was allowed to seek compensation in quantum meruit for legal services notwithstanding an improperly waived conflict of interest. See §11.72.

Arbitration

In Epic Sys. Corp. v Lewis (2018) ___ US ___, 138 S Ct 1612, the U.S. Supreme Court considered the potential scope of the FAA saving clause, 9 USC §2, stating that the clause saves only those defenses that apply to “any” contract, and that “[i]n this way the clause establishes a sort of ‘equal-treatment’ rule for arbitration contracts.” 138 S Ct at 1622. The Court clarified that the saving clause does not save “defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue. . . . [T]he saving clause does not save defenses that target arbitration either by name or by more subtle methods, such as by ‘interfer[ing] with fundamental attributes of arbitration.'” 138 S Ct at 1622 (citations omitted). See §§9.40A, 9.47B.

In McGill v Citibank, N.A. (2017) 2 C5th 945, 962, the California Supreme Court ruled that the contract defense at issue, CC §3513 (prohibiting private agreements from contravening laws established for a public purpose), was a generally applicable contract defense that did not apply only to arbitration and therefore fell within the FAA saving clause. See §9.40A.

In some circumstances, parties may consent to the jurisdiction of the arbitrator to decide the issue of arbitrability in absence of a delegation clause if that consent is “clear and unmistakable.” Douglass v Serenivision, Inc. (2018) 20 CA5th 376, 380. See §9.41.

A clause that provides for arbitration of disputes “arising from” or “arising out of” an agreement is usually interpreted to apply only to disputes concerning the interpretation and performance of the agreement. Ramos v Superior Court (2018) 28 CA5th 1042, 1052. See §9.41B.

A party may agree to arbitrate a claim based on a statutory right, but by doing so, the “party does not forgo the substantive rights afforded by the statute; it only submits to their resolution in an arbitral, rather than a judicial, forum.” Mitsubishi Motors v Soler Chrysler-Plymouth (1985) 473 US 614, 628; McGill v Citibank, N.A. (2017) 2 C5th 945, 963; Ramos v Superior Court (2018) 28 CA5th 1042, 1056. However, an arbitration agreement cannot serve as a mechanism for the forfeiture or waiver of statutory rights that are unwaivable (see §9.47B), such as discrimination claims under the Fair Employment and Housing Act (FEHA) (Govt C §§12900–12996)), the Consumers Legal Remedies Act (CLRA) (CC §§1750–1784), the unfair competition law (UCL) (Bus & P C §§17200–17210), or the false advertising law (Bus & P C §§17500–17509). Such agreements are invalid and unenforceable. McGill v Citibank, N.A., 2 C5th at 956; Armendariz v Foundation Health Psychcare Services, Inc. (2000) 24 C4th 83, 101; Ramos v Superior Court, 28 CA5th at 1055. See §9.46A.

Civil Code §3513 provides that, although anyone may waive a law intended solely for his or her benefit, “a law established for a public reason cannot be contravened by a private agreement.” See Iskanian v CLS Transp. Los Angeles, LLC (2014) 59 C4th 348, 382; Juarez v Wash Depot Holdings, Inc. (2018) 24 CA5th 1197, 1203. See §9.47B.

In Saheli v White Mem. Med. Ctr. (2018) 21 CA5th 308, 313, the court held that the special requirements for arbitration agreements in CC §51.7 (Ralph Civil Rights Act) and §52.1 (Tom Bane Civil Rights Act) were preempted by the FAA. See §9.47B.

In general, only the signatory parties to an arbitration agreement may enforce it. Fuentes v TMCSF, Inc. (2018) 26 CA5th 541 (dealer could not compel arbitration because dealer was not a party to customer’s agreement with bank that financed transaction). See §9.50.

In Hutcheson v Eskaton FountainWood Lodge (2017) 17 CA5th 937, the court found that an attorney-in-fact acting under a health care power of attorney did not have authority to make health care decisions for her principal; thus, her execution of an arbitration agreement was void. See §9.50.

An interim ruling in an arbitration that contemplates further proceedings in arbitration is not appealable. Uber Technols., Inc. v Google LLC (2018) 27 CA5th 953, 960. See §9.52.