BILL ANALYSIS
SB 1865
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Date of Hearing: June 9, 1998
ASSEMBLY COMMITTEE ON JUDICIARY
Martha Escutia, Chair
SB 1865 (Maddy) - As Introduced: February 19, 1998
SUBJECT : CONTRACTS: EXCEPTION TO STATUTE OF FRAUDS FOR SPECIFIED
FINANCIAL INSTITUTIONAL AGREEMENTS
KEY ISSUE : SHOULD CERTAIN FINANCIAL TRANSACTION AGREEMENTS
ENTERED INTO BETWEEN BUSINESS INSTITUTIONS BE ENFORCEABLE WITHOUT
THE NEED FOR A WRITTEN CONTACT?
SUMMARY : Allows the enforcement of certain business-to-business
(not individual) financial transaction agreements without the
necessity of a written contract, if sufficient evidence of the
agreement is produced. Specifically, this bill :
1) Provides that 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 if:
a) the agreement or contract is a "qualified financial
contract" and there is sufficient evidence to indicate that
a contract has been made; or,
b) the parties 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.
2) Defines "qualified financial contract" as an agreement where
each party thereto is other than a natural person (i.e., a
business entity and not an individual), and that is within a
specified list of transactions (outlined below).
EXISTING LAW : Provides, under the Statute of Frauds, 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 its making.
(Civil Code Section 1624.) Certain classes of contracts
traditionally subject to the Statute of Frauds are now governed by
the Statute of Frauds Provisions of the Uniform Commercial Code
(UCC), including contracts which involve the sale of goods over
$500, or the sale of personal property over $5,000. (UCC Sections
2201 and 1206(1), respectively.)
FISCAL EFFECT : Unknown
COMMENTS : 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
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arising in the course of their telephonic business. California's
statute of frauds contemplates a pen-and-ink world of paper
contracts, they say, but today highly sophisticated
institutions more typically are 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" businesses or individuals to agreements
which they do not have in writing to reflect, and therefore may
not be able to enforce.
Background : In contract law there is a principle known as the
Statute of Frauds (SOF) which provides that no contract for the
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 inherently 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.
Contracts which could be enforced without a written contract;
proof required:
Qualified financial contract : As noted above, 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:
1) An agreement 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.
2) An agreement (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,
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or any product or byproduct thereof, with a maturity date more
than two days after the date the contract is entered into.
3) An agreement for the purchase and sale of currency, or
interbank deposits denominated in United States dollars.
4) An agreement for a currency option, currency swap, or
cross-currency rate swap.
5) An agreement 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).
6) An agreement for a rate swap, basis swap, forward rate
transaction, or an interest rate option.
7) An agreement for a security-index swap or option, or a security
or securities price swap or option.
8) 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).
9) An option with respect to any of the foregoing.
Sufficient evidence to allow enforcement without writing : The
bill would provide 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:
1) 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.
2) 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.
3) The party against whom enforcement is sought admits in its
pleading, testimony, or otherwise in court that a contract was
made.
4) 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.
SB 1865
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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.
UCC treatment of securities has changed consistent 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 UCC Section 8113, "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 this 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."
Current industry practice, Master Areements : 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.
The law allows subsequent writings to be used to interpret
contracts : The law governing contracts contains another principle
known as the Parole Evidence Rule. Under this rule, a contract
should contain all of the terms sought to be enforced within
itself. (Civil Code Section 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
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such as rate swapping.
Civil Code Section 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." 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
Cal.App.2d 152; Goodman v. Community Savings and Loan (1966) 246
Cal.App.2d 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 e.g., Cadigan v. American Trust Co . (1955) 131 Cal.App.2d
786.) These sections of the Civil Code seem to suggest that for
companies which enter into a "master agreement," this bill may be
unnecessary.
REGISTERED SUPPORT / OPPOSITION :
Support Opposition
CA Bankers Association (sponsor)None on file
Analysis prepared by : Dan Pone / ajud / (916) 445-4560