MUTUALITY OF OBLIGATION-A CONTRACTUAL REQUIREMENT-SORT OF
As discussed in our article on Contracts, the elements that create an effective contract in the United States are myriad and have been subject to contested litigation and court and statutory guidance for well over a hundred years. Certain requirements are often a subject of dispute in the litigation, such as “consideration,” e.g. whether a party received anything of value for its commitment under the contract. Absent adequate consideration being given to a party, that party is usually not bound.
Closely related to the concept of consideration is the mutuality of obligation doctrine. Under this doctrine, both parties must be bound to perform their obligations or the law will treat the agreement as if neither party is bound to perform. When an offeree and offeror exchange promises to perform, one party may not be given the absolute and unlimited right to cancel the contract. The courts have often decided that one-sided arrangements are void for lack of “mutuality of obligation.” Some courts term such nullification of the agreement as void for lack of consideration, holding that a party who is given absolute power to cancel a contract suffers under no legal obligation that is required for adequate consideration.
However, the courts have established numerous exceptions to the mutuality doctrine and that doctrine and the exceptions are the subject of this article.
The Basic Law:
To avoid having a contract subsequently voided by a court, the parties must limit their discretion to cancel the contract or otherwise not perform. If the right to avoid performance is dependent on some condition or event outside the control of the party seeking to cancel the contract, courts normally rule that mutuality of obligation exists and the contract is valid. Thus, a farmer might lawfully be given the right to cancel a crop-watering service if the right to cancel were conditioned upon the amount of rain that fell during a given season, something outside the farmer’s control. But a court would find mutuality lacking if the farmer were given the right to terminate the service short of full performance simply by giving notice of his or her intention to cancel without any other criteria than the farmer’s own desire.
In short, a contract is a mutual obligation and without that mutual duty, the courts do not consider it a binding agreement. But there are numerous exceptions to the mutuality requirement:
UNILATERAL CONTRACT EXCEPTION:
Only bilateral contracts require mutuality. Certain types of contracts are allowed where only one party is obligated to perform and those are termed unilateral contract. Such contracts normally arise in the service context. One party makes an offer of payment if X does a service, such as painting a home. X is not required to paint the home…but if he does, X must pay him. That is a unilateral obligation imposed upon X which is binding if and only if the home is painted. If unpainted, X had no right to sue the painter. But if the painter does the work and is unpaid, he can sue X.
LIMITED PROMISE EXCEPTION:
Any commitment or promise made, however limited, constitutes sufficient obligation for the purposes of mutuality. As an example, if I have the right to terminate an agreement for any or not reason but only upon thirty days’ notice and you are required to give me three years’ notice to terminate, that still is valid for mutuality purposes. (Insufficient consideration may be another defense raised, but here we speak of mutuality requirements.
VOIDABLE CONTRACTS EXCEPTION:
Any contract that exists that may be voidable for any number of reasons is not invalidated based on mutuality. As an example, a contract with a minor is voidable at the discretion of the minor on grounds of his age. But it is still binding on the party on the other side should the minor so decide.
CONDITIONAL CONTRACT EXCEPTION:
A conditional promise is a promise that the promisor must perform but only if a specified condition occurs. This is considered a binding promise because, if the condition does occur, the promisor must perform his promise and has thus limited his future options.
Oddly enough, such conditional promises are valid even if the fulfillment or frustration of the specified condition is within the promisor’s control.
As an example, I may promise to hire you as a manager if I purchase a building. Whether I purchase the building or not is within my control, but that is still a binding contract upon me since if I do purchase it, I must hire you. Mutuality is achieved.
ALTERNATIVE PROMISE EXCEPTION:
If the promisor can fulfill the obligation by choosing between two or more alternatives, that meets the mutuality requirement. Thus, if I promise to either paint your house or mow your lawn for X dollars, and you agree, that is a binding agreement since I must choose one or the other. The fifth exception to the mutuality rule is for alternative promises. But note that both or all options must be valid options or the entire agreement is void. Thus, if I promise to break the law or paint your house, the contract is void.
MATERIAL TERM CHOICE EXCEPTION:
Even if one party can still elect critical (material) terms the contract can still be valid under mutuality doctrine if one of the two conditions below are met:
- If one party has the power to determine a material term but must determine that term in relation to an objective measure (ex: market price) then the contract will be held valid.
- Where material terms are set in the contract but one party has the power to either alter or modify the material terms, the contract will still be valid if the modifications are made in good faith.
IMPLIED PROMISE EXCEPTION:
An implied promise is a promise that is never actually expressed by the promisor, but can be implied based on what the contract and representations of the promisor and the promisee. As an example, if X and Y enter into a sales agreement which describes commission and warranty matters but nowhere does it state X must actually sell the product, the courts will impute that X must do so using best efforts and mutuality is satisfied.
OUTPUT-REQUIREMENT CONTRACTS EXCEPTION:
In a requirement contract, the buyer agrees to buy all of what it needs of a certain product or service from the seller.
In an output contract, the seller agrees to sell all its production of a specific product or service to the buyer.
Under the common law, requirement and output contracts were invalid as illusory and were held not to have mutuality. Recently, requirement and output contracts are enforceable because the parties to the contracts do, in fact, limit their options. If the buyer in a requirement contract wants to buy any of the product in the contract, he must buy it from the seller, etc.
The Uniform Commercial Code specifically upholds such agreements. According to the U.C.C. 2-306 (1), output and requirement contracts are enforceable. However, the U.C.C. does lay out three requirements that control the validity of these contracts.
- The U.C.C. sets down an obligation of good faith which requires the party who has the right to determine the quantity under a requirements or output contract to do so in good faith and according to commercial standards of fair dealing in that particular area of business.
- Where one party has the right to set the quantity in a requirement or output contract, the U.C.C. says that the quantity offered under the contract cannot be unreasonably disproportionate to any estimate that has been made, and, where estimates have not been made, the output or requirement cannot be unreasonably disproportionate to any comparable previous requirement or output contract.
- The U.C.C. establishes that, where parties enter an output or requirements contract, there is an implied promise that the party who is bound by the contract will remain in business. The U.C.C. establishes that if a buyer or seller goes out of business specifically to avoid their requirements under an output or requirements contract they are in breach of the contract. However, if the party goes out of business for reasons that are unrelated with the particular output or requirements contract they made, they are not in breach.
It is important to recall that mutuality of obligation is only one criteria of many that must be fulfilled to have a binding agreement between the parties. As described above, the courts have sought to increasingly minimize the lack of mutuality as a defense to enforcement of an agreement and while not a “disfavored” defense, it is certainly not a defense beloved by the judiciary. As one commentator wrote, “If the court can maneuver to find mutuality, it often will.” Yes.