Today, we're going to introduce the concepts of material breach and substantial performance by exploring Jacob and Young's verses Kent. The opinion was written by Benjamin Cardozo while he was a judge on the New York State Court of Appeals. As some of you may know, Cardozo went on to become a Supreme Court justice and like Justice Scalia and Marshall, Cardozo has a law school named after him. He also wrote the famous torts decision in Palsgraf versus Long Island Railroad. The plaintiff in this case is a building company, Jacob and Young's, which contracted to build a summer home for the defendant, a home owner George Kent. The contracts specified that all wrought iron pipe must be of Reading manufacturer. The building company however ended up installing some pipe made by other manufacturers. After building was completed the defendant, George Kent, discovered the error and demanded that the plumbing be re-done because most of the plumbing was at that point encased in the walls. The cost to the building company of replacing the plumbing would have been quite high. So, they refused to do the replacement. Kent responded by refusing to pay $3,483 balance that was due out of $77,000 for the overall construction contract. The procedural of the history of the case was like this. The plaintiff builders sued for this $3,400, some odd balance. The trial judge excluded evidence that the pipe used was the same in quality, appearance and market value and cost as the Reading pipe that had been promised. The court directed a verdict for the defendant. The appellate court reversed and granted a new trial and the instant court affirmed the appellate court and again found for the plaintiff. This case is often taught in introductory contracts courses because it touches on several important issues. There are two main issues in the case. Number one was the installation of Reading pipe a constructive condition, a condition precedent to the owner's duty to pay the last installment. If it is a condition precedent, then the defendant would have no duty to pay any money. The second issue is the measure of damages for a breach by the builder of promising to put in Reading pipe and not putting it in. Should that measure of damages be the cost of performance or merely diminution in value? In essence, judge Cardozo helps determine both the extent of the buyer's defensive right to lawfully withhold payment, as well as the extent of the buyer's offensive right to sue for damages. A party to a contract can help secure her right to the other side's performance by either withholding her own performance or by affirmatively suing the other side for damages. These are the core defensive and offensive protections of contract law. Let's examine these two issues in turn. First, the defensive protection issue that the court considered was whether the installation of Reading pipe is a constructive condition to the owner's duty to pay the last installment. In other words, can the defendant withhold payment just because the pipe was not from the right manufacturer? The defendant argued that the installation of Reading pipe and only Reading pipe it was a condition that must be satisfied before the buyer had a contractual duty to pay. In essence, the defendant wanted the court to apply what's called the perfect tender rule. If the perfect tender rule had been applied, the buyer would have no duty to pay unless the builders performance was perfect. Cardozo rejected the perfect tender rule in part because he wanted to avoid builder forfeiture for innocent or trivial construction breaches. If a builder even makes a minuscule breach, a minuscule mistake in construction under the perfect tender rule, the buyer can refuse to pay for any of the work. The alternative to the perfect tender rule is the independent promises rule. If the buyers promise to pay is deemed to be an independent promise of the builders promise to build, then the buyer has an unconditional contractual duty to pay regardless of the builders performance. The Independent promised rule eliminates the buyer's defensive protection especially under the very old common law. If a buyer had agreed to buy a cart for a certain amount of money, the buyer might have an obligation to pay even if the seller didn't show up with the cart at the designated time. Under the independent promises rule, the buyer's only legal recourse for seller breach would be to affirmatively sue the seller for damages. So, how do we decide if promises are independent or dependent. The opinion is somewhat vague on this question. Cardozo does tell us that some promises are so plainly independent that they can never by fair construction be conditioned on one another. Cardozo refuses to ply the independent promises rule possibly because it would encourage builders to commit gross breaches. You could not build the house well and still the person would have to pay you and their only recourse who would be going to court, which a lot of buyers don't want to do. So, instead of applying either the perfect tender rule or the independent promises rule, Cardozo crafts an intermediate standard. He tells us that some promises quote, though dependent and thus conditions when there is a departure in point of substance will be viewed as independent and collateral when departure is insignificant. So, here's a quiz, was the defendant's right to Reading pipe protected by a defensive right not to pay, an offensive right to sue for damages, or both? Well apparently, only an offensive right. The court wrote, in a mission both trivial and innocent, will sometimes be atoned for by allowance of the resulting damage, and will not always be the breach of a condition to be followed by a forfeiture. This is a statement of what is called the Substantial Performance Rule. This Substantial Performance Rule has two prongs. Kent has no duty to pay if there is a willful breach, or if there is less than substantial performance. In this case, the court found that the plaintiffs substantially performed its side of the contract, by installing another pipe brand that was similar in quality. Where a breach is trivial and innocent, a breach may be atoned for by allowance of just resulting damages. What counts as substantial performance? It is determined by considerations partly of justice and partly of presumed intention. The factors listed by the courts are reflected in section 241 of the restatement second. They go to the issue of whether the breach is sufficiently material, such as whether the injured party will be deprived of the benefit which he or she reasonably expected, and the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing. Note that the substantial performance rule is a middle ground between perfect tender and unconditional duties to perform, minimizing both seller and buyer opportunism. The willful breach prong helps assure that the builder will not intentionally chisel on her promise to build, while the substantial performance prong helps assure that the buyer will not refuse to pay for trivial build or breaches. The rule established in the case, the substantial performance rule, is an outcome that is likely to be preferred by both future sellers and future buyers. Future sellers are aware of the myriad of small breaches that are bound to occur in a complex construction contract. Future buyers realize that the defendant victory would cause future sellers to take dramatic inefficient precautions, creating time and expense, and raise the price unreasonably, or the sellers might demand payment in advance to assure against loss in a similar suit. Here's another quiz. Can future parties contract around the substantial performance rule? You bet. Yes, they can contract around it. The court says that, intense not otherwise revealed may be presumed to hold in contemplation of the reasonable and probable. In other words, a buyer with idiosyncratic preferences, who really wants Reading Pipe because grandparents say started the company, can request perfect tender by revealing their preference explicitly in the contract. Putting the onus on the buyer makes sense from an economic perspective, because the idiosyncratic buyer is the least cost avoider. It's cheaper for the buyer to speak up than for the seller to speculate about all the possible idiosyncrasies. This substantial performance rule resolves the defensive rights issue in favor of the builder. But, what about the offensive rights question? The second question is what kind of remedies are appropriate for the builder's breach. The court held that when breaches not willful and the cost to replace the pipe is high, the defendant is only entitled to diminution in value damages, which in this case is nothing. Recall that the diminution in value is nothing because the pipes actually installed are equal in quality and value to the Reading Pipe that was promised. So, in this case with the cost of performant damages mean that construction company would have had to tear out the wall and replace the pipes? No. The construction company can pay the buyer money to be let out of its duty to perform. The incentive to modify the contract in the presence of cost or performance damages, is an example of Coasian bargaining. The Coase theorem is a highly influential, legal, and economic theory. It states that where transaction costs are low, an efficient allocation of resources will take place regardless of how entitlements are allocated. Here, there's a Coasian incentive for the seller to buy her way out of her duty to sell to the original buyer. So there's also an interesting issue in this case involving the architect, and what's called the Certificate of Completion. The contract explicitly said that the final payment was only due after plaintiff's architect gave a certificate of completion, certifying that the work had been done. Except for noting that the architect failed to notice the discrepancy in the pipe until after the house was completed. The court did not consider the effect of substantial performance upon the express condition, that the issuance of the certificate was to proceed the duty to pay. One reason for this may be the case of Nolan versus Whitney. Where the court held that when a contractor has substantially performed the contract, the architect is bound to issue a certificate. An unreasonable and wrongful refusal excuses the necessity that the certificate be issued. Most states however have followed the principle of reviews set forth in Section 303 of the first restatement, which excuses the certificate of an architect as a condition precedent to the duty of the immediate payment. Only in limited circumstances such as the deaths of the architect, or failure of the architect to properly examine the work. An assumption here is that the architect as a professional should have more room for the exercise of honest judgment, then that permitted if the decision were reviewable under standards of reasonableness. A second interesting issue is the seller's duty to sell. As we just discussed outside the UCC, a buyer's duty to pay is nominally conditioned on the seller substantial performance. On the other hand, a seller's duty to sell is normally conditioned on perfect tender or full payment. Should there be exceptions to this perfect tender rule where the buyer is a day late or a dollar short? The Jacob and Young's case illustrates many important principles in contract law. It touches on important issues such as material breach, substantial performance, and remedies. The court adopted a substantial performance rule regarding a buyer's duty to pay, instead of a perfect tender rule, or an independent promises rule. Because the plaintiff installed a pipe equal in price and quality to Reading Pipe, the court found that the plaintiff substantially performed his side of the contract, and was not in material breach. As for damages, the defendant is only entitled to diminution in value and not the cost of performance.
