BILL ANALYSIS
SENATE JUDICIARY COMMITTEE
John L. Burton, Chairman
1997-98 Regular Session
SB 1865 S
Senator Maddy B
As Introduced
Hearing Date: April 28, 1998 1
Civil Code 8
DLM:lgp 6
5
SUBJECT
Contracts: Statute of Frauds: Exception for specified
institutional agreements
DESCRIPTION
This bill would allow the enforcement of certain financial
transaction agreements entered into between business
institutions (and not individuals) without the necessity of
a written contract, if sufficient evidence of the agreement
is produced.
BACKGROUND
In contract law there is a principle known as the Statute
of Frauds (SOF) which holds that no contract for sale of
goods over the amount of $500, or one which will take
longer than a year to complete, may be enforced unless
there is a written contract. The concept behind the SOF is
to create certainty as to the terms and conditions of
agreements so that the courts have a sufficient basis to
rule in disputes. There are exceptions to this rule for
agreements which have some other indicia of reliability,
such as when both parties perform their respective
obligations.
In the field of modern financial transactions, many
agreements are made over the telephone or internet, via
facsimile and e-mail. Due to the nature of these
agreements, there is no contemporaneous writing which
memorializes the terms. As a result, these agreements may
be unenforceable under the SOF. While the Uniform
Commercial Code has exempted "securities" transactions from
the writing requirements of the SOF, there is some doubt as
to whether other classes of transactions such as
commodities trading and money exchanges are also exempt
from the SOF writing requirement.
CHANGES TO EXISTING LAW
Existing law declares (among other provisions not herein
relevant) that an agreement is unenforceable unless it is
in writing and signed by the party to be charged or by the
party's agent, if the agreement:
by its terms is not to be performed within a year from
the making thereof;
involves the sale of goods over $500, or;
involves the sale of personal property over $5,000.
This bill would declare that notwithstanding the above, an
agreement or contract that is valid in other respects and
is otherwise enforceable is not invalid for lack of a note,
memorandum, or other writing and is enforceable provided:
that the agreement or contract is a qualified financial
contract and there is sufficient evidence to indicate
that a contract has been made, or;
the parties thereto by means of a prior or subsequent
written contract, have
agreed to be bound by the terms of the qualified
financial contract from the time they reached agreement
(by telephone, by exchange of electronic messages, or
otherwise) on those terms.
This bill would define qualified financial contract as an
agreement as to which each party thereto is other than a
natural person, e.g. a business entity and not individual,
and that is within a specified list of transactions
(outlined in their entirety in Comment 2 below).
COMMENT
1. Statement of need for bill
According to the sponsor, this bill is needed to
bring California's law into conformity with modern
business reality. The type of contracts intended to be
covered by this bill are used by financial institutions,
investment banking firms, institutional investors,
dealers and other California entities for hedging risks
arising in the course of their business. California's
statute of frauds contemplates a pen-and-ink world of
paper contracts, they say, but today highly sophisticated
institutions more typically memorializing their
agreements by electronic writings and recordings.
The sponsor stresses that the bill would only cover
businesses, and would expressly not cover individuals.
This is meant to keep the scope of the proposed new
exception to the SOF within the sophisticated world of
banking and financial business dealers, and not bind
mom-and-pop to agreements which they do not have in
writing to reflect, and therefore may not be able to
enforce.
2. Contracts which could be enforced without a written
contract; proof required
a) Qualified financial contract
This bill creates a new exception to the requirement
that contracts be in writing. It defines qualified
financial contract as an agreement as to which each
party thereto is other than a natural person, meaning
individuals would not be covered by the proposal. The
covered transactions are any of the following:
For the purchase and sale of foreign exchange, foreign
currency, bullion, coin or precious metals on a
forward, spot, next-day value or other basis.
A contract (other than a contract for the purchase of
a commodity for future delivery on, or subject to the
rules of, a contract market or board of trade) for the
purchase, sale, or transfer of any commodity or any
similar good, article, service, right, or interest
that is presently or in the future becomes the subject
of a dealing in the forward contract trade, or any
product or byproduct thereof, with a maturity date
more than two days after the date the contract is
entered into.
For the purchase and sale of currency, or interbank
deposits denominated in United States dollars.
For a currency option, currency swap, or
cross-currency rate swap.
For a commodity swap or a commodity option (other than
an option contract traded on, or subject to the rules
of a contract market or board of trade).
For a rate swap, basis swap, forward rate transaction,
or an interest rate option.
For a security-index swap or option, or a security or
securities price swap or option.
An agreement that involves any other similar
transaction relating to a price or index (including,
without limitation, any transaction or agreement
involving any combination of the foregoing, any cap,
floor, collar, or similar transaction with respect to
a rate, commodity price, commodity index, security or
securities price, security index, other price index,
or loan price).
An option with respect to any of the foregoing.
b) Sufficient evidence to allow enforcement without
writing
The bill would declare that there is sufficient
evidence that a contract has been made despite the
absence of a written contract--and therefore could be
enforced by the courts--in any of the following
circumstances:
There is evidence of an electronic communication
(including, without limitation, the recording of a
telephone call or the tangible written text produced
by computer retrieval), admissible in evidence under
the laws of this state, sufficient to indicate that in
the communication, a contract was made between the
parties.
A confirmation in writing received no later than the
fifth business day after the contract is made and the
sender does not receive written objection to a
material term of the confirmation on or before the
third business day after receipt.
The party against whom enforcement is sought admits in
its pleading, testimony, or otherwise in court that a
contract was made.
There is a note, memorandum, or other writing
sufficient to indicate that a contract has been made,
signed by the party against whom enforcement is sought
or by its authorized agent or broker.
The bill would allow evidence of an electronic
communication indicating the making of a contract, even
if it omits or incorrectly states one or more material
terms agreed upon, as long as the evidence provides a
reasonable basis for concluding that a contract was made.
3. UCC treatment of securities has changed consistently
with this bill
In a very similar arena, securities trading, the law has
changed to reflect the modern realities of telephonic,
fax, and computer business transactions, to no longer
require a writing in order to enforce a contract. Under
the Uniform Commercial Code (UCC) 8-113, "A contract or
modification of a contract for the sale or purchase of a
security is enforceable whether or not there is a writing
signed or record authenticated by a party against whom
enforcement is sought, even if the contract or
modification is not capable of performance within one
year of its making.
The Official Comment to the section states that the law
changed to recognize, that "With the increasing use of
electronic means of communication, the Statute of Frauds
is unsuited to the realities of the securities business.
For securities transactions, whatever benefits a statute
of frauds may play in filtering out fraudulent claims are
outweighed by the obstacles it places in the development
of modern commercial practices in the securities
business."
4. Current industry practice: master agreements
Currently, the prevailing practice is for businesses
to enter into "master agreements" within which they
establish the general respective rights and
responsibilities to which parties will adhere during
their course of trading. Often the master agreement will
recite that any subsequent transaction entered under the
master agreement is defined independently; with separate
terms, rates, and responsibilities attaching to each
transaction. These subsequent individual trades, swaps,
or sales are subject to separate confirmation agreements.
5. The law allows subsequent writings to be used to
interpret contracts
Contracts jurisprudence contains another principle of law
known as the Parole Evidence Rule. What this rule holds
is that a contract should contain all of the terms sought
to be enforced within itself (Civil Code 1639). This
rule generally does not allow the presentation of
evidence of other, or prior agreements, based upon the
notion that an agreement will reference all of the terms
which the parties agree to. This bill contemplates what
would be parole evidence, when it states that, "An
agreement or contract that is valid in other respects and
is otherwise enforceable is not invalid for lack of a
writing provided that the agreement or contract is a
qualified financial contract and ... the parties thereto
by means of a prior or subsequent written contract, have
agreed to be bound by the terms of the qualified
financial contract from the time they reached agreement
(by telephone, by exchange of electronic messages, or
otherwise) on those terms." The sponsor asserts that
this provision of the bill supports and encourages
"master agreements," while maintaining the flexibility
financial businesses need to react in volatile markets
such as rate swapping.
Civil Code 1642 creates an exception to the Parole
Evidence Rule, declaring that "several contracts relating
to the same matters, between the same parties, and made
as part of substantially one transaction, are to be taken
together." Id. This law had been broadened by the courts
to include "instruments" "papers" and "contracts" whether
or not they expressly refer to each other or not. (see
Lucas v. Quigley Motor Co., (1961) 191 C.A.2nd 152;
Goodman v. Community Savings and Loan, (1966) 246 C.A.2nd
13.) The courts have also held that the several
instruments need not themselves be "contracts," nor need
they be executed on the same day or within any particular
period of time. (See for instance Cadigan v. American
Trust Co., (1955) 131 C.A. 2nd 786.)
These sections of the Civil Code seem to suggest that
for companies which enter into a "master agreement,"
this bill is unnecessary.
Support: None Known
Opposition: None Known
HISTORY
Source: California Bankers Association
Related Pending Legislation: None Known
Prior Legislation: None Known
**************