Indiana Law Review 1976] SURVEY—CONTRACTS 161 VII. Contracts and Commercial Laiv Gerald L. Bepko* During the past year there were several significant develop- ments in commercial law, including state court decisions, federal court decisions, and federal trade regulation. The following dis- cussion is a cursory review of some of the most interesting of those developments; it begins with a description of the develop- ment and application of the Federal Trade Commission's (FTC's) rule on preservation of defenses. A. FTC Rule on Preservation of Consumer Defenses The legal system has provided various mechanisms by which consumers can be prevented from raising claims or defenses against the party which finances a consumer sale transaction. First, the doctrine of holder in due course can prevent the maker of a prom- issory note from raising defenses against the holder, such as fraud or breach of warranty, which he would have been able to assert against a seller in whose favor the note was originally drawn.' Secondly, waiver of defense clauses have been enforced.^ These clauses generally stipulate that the consumer understands that the retail credit contract right will be assigned by the seller to a financer and that the consumer will not raise any claims or de- fenses based on the underlying sale in any action brought by the assignee. Finally, consumer defenses have been cut off in related loan transactions, in which the consumer borrows money directly from the financer and uses the proceeds of the loan to purchase the goods or services. If the lender and seller are related by agreement or ownership and combine to finance consumer purchases on a regular basis, the transaction is functionally similar to one in which a negotiable instrument or a waiver of defense provision is used. Only the formalities differ. Of course, if the financer simply lends money, and does not sell goods or services, claims or * Professor of Law, Indiana University School of Law—Indianapolis; B.S., Northern Illinois University, 1962; J.D., IIT/Chicago-Kent College of Law, 1965; LL.M., Yale University, 1972. The author extends his appreciation to J. Randall Aikman for his assist- ance in preparation of this article. 'IND. Code §26-1-3-305 (Burns 1974). =/d. §26-1-9-206. 1^2 INDIANA LAW REVIEW [Vol. 10:151 defenses which might arise in the sale transaction would be irrel- evant in a suit to collect the proceeds of the loan.' There has been dissatisfaction with the result produced by these mechanisms. Consumers who are forced to pay for goods or services which prove to be defective or which have been mis- represented to them are the object of much sympathy. It is argued that consumers should not be required to pay unless they obtain the goods or services for which they bargained, and that consumers often do not understand that they will bear the risk of seller mis- conduct and will be unable to withhold payment if the seller defaults."* In addition, the consumer is not in a good position to estimate the risks he bears when he purchases on credit by a contract that cuts off his defenses against a third party financer. Consumers cannot accurately estimate the likelihood of seller default or unavailability, or the costs involved in the event of a default; these costs, in general, can be estimated more readily by the financer.^ Also, the financer is in a better position to prevent seller misconduct by policing the system through which it finances consumer transactions. Finally, there have been cases in which fraudulent schemes may have been furthered by cutoff mechanisms and it is argued that the mechanisms should be eliminated or modified to prevent that possibility. Dissatisfaction with cutoff mechanisms has stimulated activ- ity on at least two fronts. First, there are judicial decisions in some states which deny enforcement of some of these mechanisms.* For example, courts have refused to apply the holder in due course doctrine where there is a "close connection" between the financer ^ There is a fourth common method by which a consumer's claims or defenses can be cut off by a financing device—the credit card transaction. In this transaction the credit card issuer (the financer) issues a credit card to a consumer. In the contract by which this credit card is issued the con- sumer agrees to seek redress for any grievances directly against the merchant from whom he purchased goods or services and not to raise these grievances in any suit brought by the credit card issuer. This device has been restricted by the 1974 amendments to the Consumer Credit Protection Act. The contract provision limiting the consumer's right to raise defenses is now enforceable only if a purchase takes place more than 100 miles away and in a state other than the one in which the consumer has his mailing address, or if the trans- action is for less than $50. 15 U.S.C. § 1666i(a) (Supp V. 1975). *See Federal Trade Commission Statement of Basis and Purpose, 40 Fed. Reg. 53,506, 53,523 (1975) [hereinafter cited as FTC Statement]. ^For an excellent discussion of this subject, see Schwartz, Optimality and the Cutoff of Defenses Against Financers of Consumer Sales, 15 B.C. Ind. & Com. L. Rev. 499 (1974). *The most heralded and widely read case on this subject is Unico v. Owen, 50 N.J. 101, 232 A.2d 405 (1967). 1976] SURVEY—CONTRACTS 153 and seller/ In doctrinal terms, this is based on a finding that there is no good faith transfer of the note, or that the consumer has actually dealt with the financer through its agent, the seller. In addition, courts have held that waiver of defense clauses are unconscionable and have refused to enforce them where there is this "close connection."^ Secondly, there have been legislative responses in some states to the consumer's plight. For example, in Indiana, the Uniform Consumer Credit Code (UCCC)' has been adopted; it deals with cutoff mechanisms in two ways. Section 2- 403'° provides that in a consumer credit sale a seller "may not take a negotiable instrument other than a check." If, in violation of this provision, a negotiable instrument is taken in a consumer credit transaction, it is unlikely that the instrument could be transferred to a person who qualifies as a holder in due course, since a holder with notice that the instrument has been issued in violation of the section cannot be a holder in good faith." The version of sec- tion 2-404'^ of the UCCC adopted in Indiana places substantial restrictions on the use of waiver of defense clauses. It requires the financer which seeks to employ a waiver of defense provision to give notice of an assignment to the consumer. The notice must state, among other things, that the consumer will lose the right to raise defenses if he does not notify the financer of any defense within sixty days of the mailing of the notice of assignment. With respect to defenses which arise during this sixty-day period and which the consumer does not report to the financer the waiver of defense clause can be enforced. Defenses which arise after the sixty-day notice period has expired are preserved for the consumer. The waiver of defense clause is completely unenforceable in cases in which retailer and financer are "related."'^ Unlike the doctrine of holder in due course and waiver of defense clauses, the third cutoff device—the related loan—has not been the subject of much reform activity.'^ In fact there is some evidence that there has been an increase in volume of related loans where the other two devices have been restricted.'^ ^Id, See also J. White & R. Summers, Handbook of the Law Under the Uniform Commercial Code 479-84 (1972). ^Id. 'IND. Code §§ 24-4.5-1-101 to -6-203 (Burns 1974). '°/<£. § 24-4.5-2-403. '=^/d. §24-4.5-2-404. '^One such reform took place in Massachusetts. See Mass. Ann. Laws ch. 255, §12F (Michie/Law. Co-op Supp. 1975). '^FTC Statement, supra note 4, 40 Fed. Reg. at 53,514-15. 154 INDIANA LAW REVIEW [Vol. 10:151 Against this backdrop, in 1971 the Federal Trade Commission began the process of promulgating a rule to preserve consumer defenses. The original proposed rule was published January 21, 1971, and a revised version of the rule was published January 5, 1973.'* During the process of developing the final rule, which was published November 14, 1975, the commission produced some 2,250 pages of hearing transcripts and recorded 7,362 pages of written comment. The rule became effective May 14, 1976.'^ The rule is divided into two parts.'® The first part deals with the holder in due course doctrine and waiver of defense clauses. It requires sellers to include specified language in consumer credit contract documents which will preserve consumers' defenses. The required language must be printed in the contract in at least ten point boldface type. Failure to include this language constitutes an unfair or deceptive act within the meaning of section 5 of the Federal Trade Commission Act." The presence of this language will have only slight impact on the rights of consumers in Indiana, since taking negotiable instru- '"Id. at 53,506. ^®The rule provides: In connection with any sale or lease of goods or services to con- sumers, in or affecting commerce as "commerce" is defined in the Federal Trade Commission Act, it is an unfair or deceptive act or practice within the meaning of Section 5 of that Act for a seller, directly or indirectly, to: (a) Take or receive a consumer credit contract which fails to contain the following provision in at least ten point, hold face, type: NOTICE ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT AGAINST THE SELLER OF GOODS OR SERVICES OBTAINED PURSUANT HERETO OR WITH THE PROCEEDS HEREOF. RECOVERY HEREUNDER BY THE DEBTOR SHALL NOT EXCEED AMOUNTS PAID BY THE DEBTOR HEREUNDER. or, (b) Accept, as full or partial payment for such sale or lease, the proceeds of any purchase money loan (as purchase money loan is defined herein), unless any consumer credit contract, made in con- nection with such purchase money loan contains the following provi- sion in at least ten point, bold face, type: NOTICE ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT AGAINST THE SELLER OF GOODS OR SERVICE OBTAINED WITH THE PROCEEDS HEREOF. RECOVERY HEREUNDER BY THE DEBTOR SHALL NOT EXCEED AMOUNTS PAID BY THE DEBTOR HEREUNDER. 40 Fed. Reg. 53,506 (1975). ''15 U.S.C. §46 (1970). 1976] SURVEY—CONTRACTS 165 ments in consumer transactions has been proscribed by section 2-403 of the UCCC. However, with respect to the use of waiver of defense clauses there may be some impact since waiver of defense clauses seem incompatible with the language mandated by the rule. As a result, those financers and sellers who used waiver of defense clauses despite their limited efficacy in Indiana, will probably have to change their practices. The second part of the rule, subsection (b),^^ deals with the related loan transaction. The rule makes it an unfair and deceptive trade practice for a seller to receive the proceeds of a consumer loan made by a related lender unless the contract documents recording the loan transaction include specified language causing the lender to be subject to all the consumer's defenses. Since the related loan device does not appear to have been restricted in Indiana, this part of the rule may have significant impact on consumer rights. Subsection (b) of the rule applies to loans made by lenders to whom the retailer has referred customers or which are affiliated with the retailer by common control, contract or bitsiness arrange- ment. Common control includes circumstances in which one hold- ing company owns both seller and financer, one shareholder owns both, or there is a parent-subsidiary relationship between financer and seller.^' The expressions "contract" and "business arrange- ment" are both defined in the rule.^^ These somewhat overlapping definitions suggest that any continuing relationship between financer and seller which relates to the financing of consumer transactions will create an affiliation. In its guidelines on the rule ^°Subsection (b) of the rule applies to purchase money loans, which are defined as follows: Purchase money loan. A cash advance which is received by a con- sumer in return for a "Finance Charge" within the meaning of the Truth in Lending Act and Regulation Z, which is applied, in whole or substantial part, to a purchase of goods or services from a seller who (1) refers consumers to the creditor or (2) is affiliated with the creditor by common control, contract, or business arrangement. 40 Fed. Reg. 53,506 (1975). '^Preservation of Consumers* Claims and Defenses; Statement of En- forcement Policy, Invitation to Comment, 41 Fed. Reg. 34,594 (1976). ^^The rule provides the following definitions: Contract. Any oral or written agreement, formal or informal, between a creditor and a seller, which contemplates or provides for cooperative or concerted activity in connection with the sale of goods or services to consumers or the financing thereof. Business arrangement. Any understanding, procedure, course of dealing, or arrangement, formal or informal, between a creditor and a seller, in connection with the sale of goods or services to consumers or the financing thereof. 40 Fed, Reg. 53,506 (1975). 156 INDIANA LAW REVIEW [Vol. 10:151 the FTC has specified several relationships that will constitute a contract or business arrangment. Among these are: (1) main- taining loan application forms in the seller's place of business; (2) an agreement by the seller to prepare loan forms for the financer; (3) an agreement by the financer to refer customers to the seller's place of business; (4) an agreement by the financer to pay the seller for referrals; (5) an agreement by which the seller agrees to pay the financer for referrals; and (6) participa- tion by the financer in a sales program of the seller." Situations which will not constitute an affiliation are: (1) a relationship created by credit card plan whereby the seller is a member of the plan and the financer is the credit card issuing company; (2) main- tenance by seller of a checking account with the financer; (3) a general loan by a financer to seller; (4) commercial lease in which the financer and seller are both parties; and (5) discussion between seller and financer regarding security agreements.^'' The second basis for imposing the notice requirement occurs when the retailer "refers customers to the creditor." The word "refer" means a continuing pattern of sending customers to the lender; simply suggesting that the lender might lend money to the con- sumer is not a referral which would require notice.^^ If an affiliation exists between financer and seller, the FTC has indicated that the notice must be included, whether or not that particular consumer was actually sent to the lender by the seller.^* For example, suppose a consumer borrowed money from a financer and then went to an affiliated seller to make a cash purchase with the loan proceeds. The seller could be acting in violation of the rule, unknowingly, by accepting proceeds of the loan made without the required protective language. In its state- ment on enforcement policy the FTC has announced that a seller cannot be held responsible if he has no reason to know that the consumer is using purchase money loan proceeds; the seller is under no duty to inquire of every person who makes a cash pur- chase.^' However, some circumstances should alert the seller to the possibility that the source of the consumer's funds was a loan from an affiliated lender. For example, if the consumer presented a cashier's check drawn by an affiliated financer the seller would be on notice that the cash payment for goods or services might have been generated by a purchase money loan. Also a jointly ^^Preservation of Consumers' Claims and Defenses; Statement of En- forcement Policy, Invitation to Comment, 41 Fed. Reg. 34,594 (1976). 2^/d. at 34,595. «/d. at 34,596. 1976] SURVEY—CONTRACTS 167 payable cashier's check drawn by an affiliated financer might give actual knowledge to a seller that the payment constituted proceeds of a purchase money loan. If the seller is put on notice by receipt of a cashier's check from an affiliated financer the seller must determine directly from the financer whether the loan arrangement contained the requisite language. The seller cannot satisfy the rule's requirements by making an inquiry only of the consumer.^® It is clear that if the required language is included in a retail installment sales contract the consumer will have a right to refuse to pay the financer to the extent that there are defenses against the seller. In addition, the required language provides that the financer will be subject to any claim which the consumer may have. This means that the financer could be responsible for consequential losses suffered by the consumer. For example, if the consumer was injured because of a defect in the product, he could make a claim against the financing entity for his injuries. However, the required language clearly states that the maximum recovery against the financer will be equal to the amount paid under the agreement. In its staff guidelines the FTC has indicated that this amount includes all moneys paid to the financer and, in a case involving a retail installment sales contract, any down payment made to the seller." A down payment could not be recovered from the financer if the purchase was made, in part, with the proceeds of a purchase money loan. Finally, problems might arise if financers or sellers fail to incorporate the required language in contract documents. Of course, parties who fail to protect the consumer with the required language will be in violation of the rule and the Federal Trade Commission, armed with new powers under the Federal Trade Commission Improvement Act,'° may take action against them. This enforcement effort may have a decisive impact on recalci- trant creditors, but some instances of failure to include the required language could raise difficult questions with respect to consumers' rights. For example, assume that a related financer loaned money to a consumer who in turn purchased goods or services from seller. Assume further that, because of a proceeds check made payable jointly to consumer and seller, seller knew that purchase money loan proceeds were being furnished. It is obvious that this seller has violated the rule. But what of the con- sumer who seeks at a later time to raise defenses against the __ ^'Guidelines on Trade Reflation Rule CJoncerning Preservation of Con- sumers' Claims and Defenses, 41 Fed. Reg. 20,022 (1976). '°Magnuson-Moss Warranty—Federal Trade Commission Improvement Act, 15 U.S.C. §§2301-12 (Supp. V 1975). 158 INDIANA LAW REVIEW [Vol. 10:161 financer ? Since the required language is not present, it is unlikely that the consumer would be able to raise claims or defenses. If the consumer attempted to raise the violation of the FTC rule in this context he would be confronted with two problems. First, the fi- nancer has not violated the rule as it is presently written, since the rule applies only to the seller and not to the related financer.^' Secondly, even if the related financer were directly affected by the rule the consumer would probably be unable to assert a violation, since the courts have uniformly held that there is no private rem- edy for violation of Federal Trade Commission rules.^^ The only exception to this principle seems to be Guernsey v. Rich Plan of the Midwest,^^ a recent case in the Federal District Court for the Northern District of Indiana, discussed elsewhere in this review.^"^ However, in that case, the plaintiff alleged not only that the de- fendant's conduct violated an FTC rule but that the FTC had earlier entered a cease and desist order with respect to the same conduct. On that basis the district court found that the plaintiff had stated a cause of action by alleging a violation of an FTC rule. Guernsey might be distinguishable from cases in which consumers attempt to raise violations of the rule in a lawsuit brought by a financer. This problem would seem to be less significant in the case of use of a negotiable instrument or a waiver of defense clause. As mentioned earlier, Indiana has, by statute, proscribed the use of negotiable instruments in consumer credit sales.^^ With respect to waiver of defense clauses, a consumer may be able to establish that a financer who became an assignee of a retail installment contract vnthout the required language was not an assignee in good faith, and lack of good faith would prevent enforcement of the waiver of defense clause. B. Remedies For Breach of Contract 1. Liquidated Damages In Handle v. Owens^^ the court of appeals had an opportunity to address a problem which may occur with some frequency in real estate contracts. In that case, a written agreement between ^'The FTC has proposed an amendment to the rule which would make it applicable to lenders and other financers as well as sellers. See 40 Fed. Reg. 53,530. ^^See, e.g., Holloway v. Bristol-Meyers Corp., 485 F.2d 986 (D.C. Cir. 1973). 3^408 F. Supp. 582 (N.D. Ind. 1976). ^'*'See Gray, Consumer Law, supra at 147. ^^IND. Code §24-4.5-2-404 (Burns 1974). 3*330 N.E.2d 362 (Ind. Ct App. 1975). 1^76] SURVEY—CONTRACTS 169 buyer and seller provided for a $300 earnest money deposit. The agreement also provided: "If [the] offer is accepted and if we fail to complete the purchase of the real estate herein mentioned aa provided herein, the amount of three hundred ($300) dollars will be forfeited to you/"' The earnest money was furnished by check which was cashed a few days after receipt. One week later the buyer repudiated the contract and the seller was forced to incur expenses of more than $2,000 in reselling the property to another buyer. Seller sued buyer for these expenses and buyer defended on the ground that seller was limited to recovery of the $300 earnest money. He urged that the quoted clause constituted a liquidated damages agreement, and existed in lieu of all other remedies. After a bench trial the court held for the defendant, concluding that the clause was a liquidated damages agreement since it was a "good faith attempt on the part of the parties to estimate the damages which would probably flow from a breach and is fair and reasonable and was intended by the parties to be the sole remedy in the event of the buyers' breach under the contract.'"® Also, the trial court held that the plaintiffs were estopped from claiming additional damages "by reason of the defendants' failure to perform the contract by accepting and retaining the earnest money deposit and proceeding to enter into a contract of sale for said premises with a third party."" The court of appeals reversed this decision and held that the clause was a penalty and not a liquidated damages agreement. It was thus unenforceable and the plaintiff was entitled, on remand, to prove and recover all damages caused by the breach. The court seems to have based its decision on an inability to determine whether the agreed remedy provision in the writing was to be considered as a penalty or as liquidated damages. Since the written agreement was prepared by the attorney for the buyer, the doubt was resolved against the buyer and the clause was con- strued as a penalty which was unenforceable. The court found reinforcement for this view in the fact that the damages were not uncertain in this case. The seller proved that the property was resold at a price $500 lower than the contract price and that he had incurred a broker's fee of $2,065 in the resale transaction. This proof clearly showed a specific figure which represented the sell- er's losses and highlighted the arbitrary nature of the $300 for- feiture clause.'*° ^Ud. at 363. "/d. at 364. ^Hd. ^''Id. at 366. 160 INDIANA LAW REVIEW [Vol. 10:161 Although there are various formulations, courts have gener- ally listed two criteria to distinguish a liquidated damages agree- ment from a penalty. To be an enforceable agreed remedy it must appear (1) that the injury which might result from a breach is uncertain or speculative, and (2) that the liquidated amount is a reasonable estimate of the possible loss. The latter of these two criteria seems to be the one most heavily emphasized.^' Historically, the test of reasonableness was applied as of the time the contract was formed, and actual injury caused by the breach was not con- sidered. Thus a liquidated damages clause could be enforced even though, in light of actual harm, it provided an unreasonably large recovery and had the effect of a penalty.'*^ However, more recently there has been a tendency to test the reasonableness of the esti- mate both in terms of conditions extant at the time the contract was formed and actual harm suffered by the non-breaching party.^^ The draftsmen of the Uniform Commercial Code (UCC) seemed to adopt this approach ; the Code's focus is on "anticipated or actual harm" and it provides that a "term fixing unreasonably large liquidated damages is void as a penalty."^^ In Handle v. Owens the court seems to follow this trend, testing the provision in light of actual harm and the certainty with which that harm was proved. It should be noted, however, that the court in this case was dealing with a liquidated figure which was very small compared with actual losses, not an unreasonably large figure.^^ 2. Punitive Damages Indiana courts this year handed down three opinions on the subject of availability of punitive damages in contract actions. In two of these cases a consumer was suing a vendor of goods or services and in one case a small businessman was suing insurance ^ij. Calamari & J. Perillo, The Law of Contracts § 232, at 367 (1970). The authors also note that intent of the parties to create a liquidated damages clause will be considered. ^"^See, e.g., Bethlehem Steel Corp. v. City of Chicago, 350 F.2d 649 (7th Cir. 1965). ""^E.g., Priebe & Sons, Inc. v. United States, 332 U.S. 407 (1947) ; Norwalk Door Closer Co. v. Eagle Block & Screw Co., 153 Conn. 681, 220 A.2d 263 (1966). -^IND. Code § 26-1-2-718(1) (Bums 1974). For a recent case interpreting this section of the Uniform Commercial Code, see Equitable Lumber Corp. v. I.P.A. Land Development Corp., 38 N.Y.2d 516, 344 N,E.2d 391, 381 N.Y.S.2d 459 (1976). "^^ There may be another basis for invalidating liquidated damages provi- sions that are unreasonably small. U.C.C. § 2-718, Comment 1, provides that an unreasonably small amount might be invalidated under the section on unconscionable contracts or clauses. See Ind. Code § 26-1-2-302 (Burns 1974) ; R. Nordstrom, Handbook op the Law op Sales § 154, at 272-73 (1970). 1976] SURVEY—CONTRACTS 161 companies/* In each case the trial court awarded punitive damages. Two of these awards were affirmed on appeal and one was over- turned. In Vernon Fire & Casualty Insurance Co. v. Sharp,^^ the Indiana Supreme Court affirmed an award of punitive damages against two insurance companies who were accused of refusing to pay an insured's claim in an "intentional and wanton" manner. In Janes v. Abriani^^ the court of appeals upheld a punitive damage award against the seller of a mobile home who was accused of mis- leading the consumer with respect to the consumer's right to reject the home, failing to deliver a warranty booklet on demand which caused a forfeiture of a manufacturer's warranty, and will- fully and fraudulently refusing to acknowledge and repair defects in the mobile home. In the third case, Hihschman Pontiac, Inc. v. Batchelor^'^ the court of appeals overturned an award of punitive damages against an auto dealer who was accused of misconduct in failing to make warranty repairs. The Hihschman opinion may be in conflict with the supreme court decision in VerTion'y a peti- tion for transfer of Hihschman is pending, which may result in the supreme court addressing that conflict.^° In the Vernon case the supreme court found three separate grounds for upholding the award of punitive damages. First, the court found that the trial court's award of punitive damages could have been based on a finding that the insurance companies were guilty of fraud, an independent tort. Many Indiana courts have stated that if the plaintiff establishes an independent intentional tort, such as fraud, a punitive damages award is justified.^' The fraud in this case was based on the companies' promise to pay the proceeds of the policy, knowing at the time that they had no in- tention of doing so.^^ This representation was undoubtedly relied upon by the plaintiff. The court stated that "[vjiewed in this manner, plaintiff's evidence establishes the elements of fraud ^*A small businessman has been treated as a consumer. See, e.g., Weaver V. American Oil Co., 257 Ind. 458, 276 N.E.2d 144 (1971). '»^349 N.E.2d 173 (Ind. 1976), aff'g 316 N.E.2d 381 (Ind. Ct. App. 1974). This case is also discussed in Gray, Consumer Law, supra, and Frandaen, Insurance, infra. *°350 N.E.2d 635 (Ind. Ct. App. 1976), also discussed in Gray, Consumer Law, supra, and Frandsen, In,surance, infra. A petition to transfer this case to the Indiana Supreme Court is j)ending. ^'340 N.E.2d 377 (Ind. Ct. App. 1976) (rehearing denied). "^ ^'E.g., Rex Ins. Ck). v. Baldwin, 323 N.E.2d 270 (Ind. Ct. App. 1975) ; Vernon Fire & Cas. Ins. Co. v. Sharp, 316 N.E.2d 381 (Ind. Ct. App. 1974) ; Jerry Alderman Ford Sales, Inc. v. Baiiey, 164 Ind. App. 632, 291 N.E.2d 92 (1972). "349 N.E.2d at 184. 162 INDIANA LAW REVIEW [Vol. 10:1«&1 . . . /"^ Secondly, plaintiff's complaint charged that the insurance companies acted in an intentional and wanton manner in refusing to pay plaintiff the proceeds of the policies. This allegation was based on the fact that the insurance carriers refused to pay plaintiff's claim until an unrelated claim, filed by plaintiff's plant manager, was settled. Implicit in the insurance companies' refusal to pay was a demand that the plaintiff obtain a settlement agree- ment from his plant manager in the unrelated claim. The court stated that this evidence was sufficient to justify a finding by the jury that there was "intentional and wanton" conduct, that the insurers dealt with plaintiff's claim "with an ^interested motive' and wrongfully attempted by virtue of their superior position to exact additional consideration from the plaintiff before perform- ing their obligations . . . J'^* Although this evidence did not prove an independent tort, it was held sufficient to establish "a serious intentional wrong" which justified the award of punitive dam- ages." Finally, the court stated that punitive damages were justi- fied because the insurance carriers' attempt to force the plaintiff to settle an unrelated claim before the carriers would pay plain- tiff's claim constituted a violation of the statutory scheme in Indiana providing for fixed premium rates and prohibiting carriers from altering the rates by demanding premiums in excess of those established by law.^* In the second case upholding a punitive damage award, Jones V, Abriani/^ the trial court found that the seller delivered a sub- stantially defective mobile home to the plaintiff. When plaintiff attempted to reject the mobile home defendant threatened that, despite the defects, plaintiff would lose his $1,000 deposit if he refused to accept the mobile home. In addition, although plaintiff made repeated demands, the defendant did not deliver the manu- facturer's warranty booklet which resulted in forfeiture of the ^^Id. In his dissent, Justice Prentice criticized this finding of fraud on the ground that the plaintiff did not rely on the alleged misrepresentation of intent. 349 N.E.2d at 193-94. In addition, the court's conclusion that the evidence supported a finding that the insurance companies did not intend to fulfill their promises at the time they made them is subject to some criti- cism. Generally, promissory fraud is not established simply by showing a breach of the contract. If a promise is followed by an immediate breach, the timing of the breach can be evidence of the promissor's fraudulent state of mind. However, in this case, the breach took place long after the promise had been made and no evidence of the state of mind of the party accused of fraud is apparent in the opinion. ^^349 N.E.2d at 184. ^*7d. at 185. See Ind. Code § 27-1-22-18 (Burns 1975). "350 N.E.2d 636 (Ind. Ct. App. 1976). 1976] SURVEY—CONTRACTS 163 warranty protection provided by the manufacturer, since a war- ranty registration had to be returned by the consumer within five days of purchase in order to be effective. Finally, the de- fendant refused to acknowledge defects, and refused to repair acknowledged defects, while at the same time making assurances that the defects would be cured/' In sustaining the award of punitive damages the court of appeals emphasized that it is not necessary to prove all the elements of an independent tort in order to establish a basis for punitive damages. Heavy reliance was placed on the second ground in the Vernon case, which empha- sized the same point. When the defendant's conduct is tortious in nature, but does not fit all the elements of a tort, it nevertheless may be the basis for a punitive damage award if "the public interest will be served by the deterrent effect punitive damages will have upon future conduct of the wrongdoer . . . ."^' The court of appeals found the defendant's conduct in the Jones case tortious in nature and held that the public interest would be served by the punitive damage award.*° In Hibschman Pontiac, Inc. v. Batchelor,^^ the first of the three cases involving this issue decided during the survey year, the court of appeals overturned a punitive damage award. In this case the plaintiff was the purchaser of a lemon automobile which was returned on repeated occasions to the dealer for repair without satisfactory results. In his suit for breach of warranty the plaintiff alleged that certain statements and acts of the defendant auto dealer were made willfully, maliciously, and in wanton disregard of plaintiff's rights. Those statements were attributed to a service manager at Hibschman Pontiac, who apparently informed Batch- elor on several occasions that the car was repaired. In each case the car had not been repaired.*^ The court of appeals held that in order to support a punitive damage award the plaintiff must establish all the elements of an independent tort,*^ and that in "7d. at 639-40. ^'/d. at 650, quoting Vernon Fire & Cas. Ins. Co. v. Sharp, 349 N.E.2d 173, 180 (Ind. 1976) (emphasis omitted). •^In the Jones case there may have been proof of actual fraud. When the defendant said that the plaintiff had no right to reject the defective mobile home there may have been a misrepresentation of the law. Generally, a mis- representation of law is not actionable as fraud. See Restatement (First) OF Contracts § 474, comment d(1932). However, this may be a ease in which the person making the misrepresentation has expert knowledge and is com- municating with a person who is entitled to rely on that knowledge. See id. § 474(b). *'340 N.E.2d 377 (Ind. Ct. App. 1976). "/d. at 379, 383. "/d. at 380-81. 164 INDIANA LAW REVIEW [Vol. 10:151 this case no independent tort was proved. There was no proof of fraud because there was no reliance by plaintiff on the false state- ment of the service manager. In this connection, the court quoted testimony in which Batchelor admitted that he knew that all the de- fects had not been repaired when he drove his automobile out of Hibschman's service department."^^ The court's focus in this case on the necessity of showing reliance, and all the elements of an independent tort, not only is inconsistent with the supreme court's views expressed in Vemorif but raises other questions as well. In Hibschman the court acknowl- edged that the principal purpose of a punitive damage award is to deter and punish, rather than to compensate for loss.*^ In light of this purpose, reliance and injury to the plaintiff would seem to be less important than the culpability of the defendant. In addi- tion, it may be that there was proof of reliance on the misrepre- sentations in the Hibschman case. In testimony quoted by the court, the plaintiff stated that he had called the service manager from Bethel (presumably Bethel College in Mishawaka) and asked if his car was ready. The service manager said, "[T]he car is all ready to go. We want you to come pick it up."'* This seems to be one of the misrepresentations proved and Batchelor apparently went to pick up the car thereafter in reliance on it. To the extent that plaintiff traveled from Bethel to defendant's place of busi- ness there would seem to be reliance sufficient to complete the elements of the independent tort. S. Rejection and Revocation of Acceptance In the Jones case, discussed in the previous section, the Indiana Court of Appeals offered some guidelines on rejection and revoca- tion of acceptance under the Uniform Commercial Code.*^ In Jones the defects in the mobile home sold to the plaintiff consti- tuted breaches of express warranties and the implied warranty of merchantability. The court pointed out that, based on these defects, the plaintiff had a right to reject the home under UCC *^7d. at 383. **id. at 380. "/d. at 383. *^The buyer's right to reject for defects in the seller's performance is found in Ind. Code § 26-1-2-601 (Burns 1974). The buyer may cancel the contract after rejection; id. § 26-1-2-711. The buyer must furnish notice of his rejection; id. § 26-1-2-602. The buyer has responsibilities with respect to goods which have been rejected; tcJ. §§ 26-1-2-603, -604. Buyer's conduct may constitute acceptance of the goods, which prevents rejection; id. § 26-1-2-606. However, the buyer still may cancel the contract by revoking his acceptance; id. § 26-1-2-608. 1976] SURVEY—CONTRACTS 166 section 2-601** and, presumably, to cancel the contract under UCC section 2-711/' The plaintiff was not obligated to make the decision to reject immediately upon discovery of the defects. Instead, a buyer in these circumstances is entitled to "try out" the goods to discover defects for a reasonable time before his retention of the goods will constitute acceptance, and this per- iod may be extended when the seller makes assurances of cure/° Generally, after the buyer gives notice of rejection, use of the goods can negate the rejection, constitute an acceptance, and prevent the buyer from cancelling the contract/' In the Jones case the buyer continued to use the mobile home after notice of rejection had been given, but the court held that this continued use was provoked by the seller's oppressive conduct, including the representation that rejection would result in forfeiture of buyer's down payment/^ The seller's conduct thus justified the buyer's continued use and the use did not negate buyer's earlier rejection. In addition, the court noted that a buyer who rightfully rejects or revokes acceptance is entitled to control the goods in further- ance of a security interest for the amount of the purchase price paid and any incidental damages incurred.^^ In this case the plain- tiff had given a negotiable promissory note for the mobile home''* and, according to the court, was entitled to control the mobile home until that note was returned. However, use of the mobile home during this period above and beyond simple custody might not be justified by the buyer's security interest.^^ Such use would only be justified, if at all, on the ground that it was necessary to preserve the collateral.'* Even if the buyer's conduct after notice of rejection in this case constituted an acceptance of the goods, and negated his re- jection, the buyer was still entitled to cancel by revoking his "/d. § 26-1-2-601. *'/d. §26-1-2-711(1). ^^350 N.E.2d at 643. This is consistent with the buyer's right of inspec- tion. See IND. Code §26-1-2-513 (Burns 1974). ^'See Whaley, Tender, Acceptance, Rejection and Revocation—The UCC's *'TARR"-Baby, 24 Drake L. Rev. 52, 66-66 (1974). ^=350 N.E.2d at 644. ^^Id. The buyer's security interest under these circumstances is defined in iND. Code §26-1-2-711(3) (Burns 1974). '''*It should be noted that under present law acceptance of a negotiable promissory note in this transaction would be prohibited by iND. Code §24-4.5-2-403 (Bums 1974). ^^350 N.E.2d at 644. ^<'See Jorgensen v. Pressnall, 274 Ore. 285, 546 P.2d 1382 (1976), in which the court held that continued occupancy of a mobile home was the most feasible method of protecting the mobile home from continuing water damage caused by a leaky roof. 166 INDIANA LAW REVIEW [Vol. 10:151 acceptance, since all requirements for revocation seem to have been met/^ The buyer's acts of acceptance were probably induced hy the seller's assurances that cure v^ould be forthcoming, and the court found that the nonconformities in the mobile home substan- tially impaired the value of the home to the plaintiff. Finally, there had been no substantial change in the condition of the mobile home other than changes which resulted from defects present in the home at the time of tender.^' One interesting aspect of the Jones case is the court's con- clusion that the trial court decision on monetary damages could be supported by use of the formula found in UCC section 2-714.^' This section applies when the buyer has accepted and kept the goods, and clearly is not to be used when the buyer has rightfully rejected or revoked acceptance.®^ The court's decision presumed that the buyer, although he was entitled to do so, did not cancel pursuant to a valid rejection or revocation of acceptance. There- fore, the court's discussion of rejection and revocation of accept- ance was either voluntary or primarily related to questions of monetary recovery. There is some indication that it was the latter. In its opinion the court suggests that "grounds for relief were made out on at least four different theories : refusal to recognize a valid rejection; refusal to recognize a rightful revocation of acceptance; breach of express warranty; and breach of implied warranty of merchantability."®' To the extent the court's decision creates a separate and independent basis for damages based on the seller's refusal to recognize a rejection or revocation of ac- ceptance, the court may have broken new ground. It does not ap- pear that the Uniform Commercial Code drafters provided ex- plicitly for monetary liability under these circumstances. The principal danger for a seller in refusing to recognize a rejection or revocation of acceptance appears in the risk of loss sections of the UCC which shift the risk of loss back to the seller."^ ^. Proof of Damages Under UCC Section 2-71 A The court of appeals in Jones also provided some standards for proving damages under UCC section 2-714." That section pro- vides that, in general, the measure of recovery is the difference ^''The requirements for a revocation of acceptance are found in Ind. Code §26-1-2-608 (Bums 1974). ^«350 N.E.2d at 644. 79IND. Code §26-1-2-714 (Bums 1974). «°/d. § 26-1-2-711. 8'a50 N.E.2d at 645. 82See Ind. Code §26-1-2-510 (Bums 1974). "Ind. Code §26-1-2-714 (Bums 1974). 1976] SURVEY—CONTRACTS 167 between the value of the goods accepted and the value they would have had if they had been as warranted "unless special circum- stances show proximate damages of a different amount." In JoneSy the only evidence to support the trial court's award of $5,000 dam- ages was evidence that the cost of repair of the mobile home would be $3,000 to $4,000. The court stated that since one of the breached express warranties was a warranty of repair, the proof on the cost of repair would be adequate to support the trial court's judg- ment, at least to the extent of $4,000. In addition, the court focused on the language which indicates that in special circumstances proximate damages of a different amount may be shown. In this case the seller's refusal to recognize a rightful rejection or revo- cation of acceptance and continued assurances of cure were spe- cial circumstances which justified using the cost of repair as a measure of recovery for any of the breached warranties.'^ C, Employee Termination During the survey year the Indiana Court of Appeals con- sidered four suits by dismissed employees claiming wrongful dis- charge against former employers." In Shaw v. S.S. Kresge Co.y^" the plaintiff was an employee who had worked for Kresge for about three years. After he was dismissed because of chronic absenteeism and tardiness, Shaw brought suit for breach of the employment agreement. Shaw alleged that Kresge had published a handbook which incorporated the conditions of employment and that the handbook contained a provision which required Kresge to utilize a system of formal warnings and a hearing before dis- missing an employee. Shaw claimed that he was not accorded this procedure. In its answer, Kresge admitted that it had furnished the handbook with the provision cited, and that the handbook set forth terms and conditions of the emplojonent relationship. How- ever, Kresge denied that it was obligated to furnish warnings prior to discharging the plaintiff for chronic absenteeism and tardiness since there were other provisions in the handbook which authorized Kresge to terminate an employee without warnings or a hearing and since the relationship was terminable at will. Both «^350 N.E.2d at 646. *^Iii a fifth case, an appeal by an employee whose complaint against the East Chicago School Board had been dismissed, the court of appeals found that the complaint stated a cause of action and reversed. Emphasizing that it did not appear from the complaint itself that plaintiff was precluded from recovery, the court held that a missing allegation would not serve as a basis for dismissal. Soltes v. School City, 344 N.E.2d 865 (Ind. Ct. App. 1976). ^ "328 N.E.2d 775 (Ind. Ct. App. 1975). ~" 168 INDIANA LAW REVIEW [Vol. 10:161 parties moved for summary judgment and the trial court granted the defendant's motion and entered judgment for Kresge. The court of appeals affirmed the trial court's decision and held that the employment relationship was terminable at will by either employer or employee, despite the provision in the hand- book cited by the plaintiff. Since the employment agreement was terminable at will, the court found a want of mutuality of obliga- tion or consideration and therefore any arrangement between the parties was held unenforceable "in respect of that which remains executory."*^ In addition, the court concluded that there was no basis for a cause of action under the principle found in section 90 of the Restatement (First) of Contracts,^^ since the defendant made no promise of employment for any ascertainable period. Since Kresge admitted that the handbook set forth terms and conditions of Shaw's employment, it constituted part of the con- tractual relation between the parties. Therefore, the court was required to interpret this writing to determine if it established a contract for permanent employment or was sufficient to cause reliance for which plaintiff might have sued under the principle found in section 90 of the Restatement. This interpretation ques- tion could be viewed as a question of fact. Moreover, plaintiff sub- mitted an affidavit in which he recited his understanding of lan- guage in the handbook and the fact that he had remained in Kresge's employ on the basis of these understandings. This might be viewed as evidence of the commercial setting in which the con- tract was formed and course of performance, both of which would be relevant in interpreting the writing. To the extent that the interpretation of the writing involved weighing evidence of com- mercial setting and course of performance, a further fact question is brought into focus, one which would normally be decided by a jury.®' The existence of these fact questions may have made sum- mary judgment inappropriate. In a second case. Town of Highland v. Powell,''^ the court of appeals was confronted with a question concerning the measure of recovery for a police officer who was dismissed from employ- —————— "^Restatement (First) op Contracts §90 (1932) provides: "A promise which the promissor should reasonably expect to induce action or forbear- ance of a definite and substantial character on the part of the promisee and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise." "'If the meaning of words in a writing depends on the credibility of ex- trinsic evidence or on a choice among reasonable inferences to be drawn from extrinsic evidence, it is a question for the trier of fact. See Restatement (Second) op Contracts §238(2) (1973). 9°341 N.E.2d 804 (Ind. Ct. App. 1976). 19761 SURVEY—CONTRACTS 108 ment without regard for the proper dismissal procedure. The trial court had ordered the officer's reinstatement and directed that the Highland Police Department pay all wages and salary with- held during the period between his termination and reinstatement. On appeal, the town argued that the award should be modified to reflect income which the officer had earned in other employment during his dismissal period. Generally, the measure of recovery for a wrongfully dismissed employee is the salary which would have been paid under the employment contract less any earnings actually generated during the employment period. However, the court of appeals refused to apply this formula and affirmed the award of the trial court, relying on cases decided under a provi- sion of the Cities and Towns Act.'' That statute provides a proce- dure for disciplining police or fire department employees of cities and towns covered by the Act, and specifies various grounds for dismissal.'^ If a police officer or fireman is dismissed under this law the officer has a statutory right to appeal to the circuit or superior court of the county in which the city is located within thirty days from the date of decision of the Board of Metropolitan Police Commissioners. If the decision of the board is reversed, the statute requires the city to "pay to the party entitled thereto any salary or wages withheld from such party pending such appeal and to which he or she may be entitled under the judgment of said court.'''^ On the basis of this language courts have permitted a recovery of back wages without an offset for money earned in other employment.'^ The court of appeals in Powell followed these cases and, finding that the statutory provisions were applicable to the officer's dismissal and that the appeal to the circuit court was effected in a timely manner, the court determined that an offset for wages earned by Powell during his dismissal period was not required. In Seco Chemicals v. Stewart,'^^ another question was raised concerning wages earned in substitute employment. In that case the employment agreement provided: Any violation of the terms of this contract by em- ployer shall render the contract voidable by employee, in which event employee shall have the option to continue working under the terms of the contract or terminate said working relationship and receive as liquidated dam- '^ND. Code §§18-1-1-1 to -24-1 (Burns 1974). "/d. § 18-1-11-3. '^Bole V. Civil City of Ligonier, 242 Ind. 627, 181 N.E.2d 236 (1962) ; City of Lebanon v. DeBard, 110 Ind. App. 79, 37 N.E.2d 718 (1941). '^349 N.E.2d 733 (Ind. Ct. App. 1976). 170 INDIANA LAW REVIEW [Vol. 10:1W ages the balance due under the remainder of the term of the contract as set out in Section 3(a) of this contract. After the employee, Stewart, was wrongfully discharged, he worked at three different jobs in other communities during the remainder of the twenty-three-month period covered by the employment agreement. Salary earned in these other jobs was deducted from the total salary remaining due under the breached employment agreement to compute Stewart's recovery in the trial court. This award was based on the principle mentioned above that an em- ployee should recover total salary for the emplojmient period less any amount he could have earned in comparable employment at a similar compensation rate in the same community or less what the employee actually earned in any substitute employment.'* The latter amount is deducted for the following reason: when a wrongfully discharged employee fails to find work during the em- ployment period the measure of recovery is simple and direct; he can be put in the position he would have been in had the contract been performed by being given the full salary due under the agreement. However, to the extent that the employee uses the free time made available by the breach to earn money, he has not suffered a loss and can be put in the full performance position by being given the difference between what he earned and what he would have earned under the breached agreement. In either case the employee ends up with the full salary for the employment period.'^ On appeal the court reversed on the issue of damages. It held that the quoted language constituted a liquidated damages agree- ment. Since damages were fixed in the agreement, the trial court "should not have included a consideration of what Stewart earned —or could have earned"'* during the employment period. However, the court did not consider whether the failure of the agreed dam- age clause to take account of actual earnings in substitute em- ployment prevented it from being a reasonable estimate of antici- pated losses, and thus void as a penalty." In Kiyose v. Trustees of Indiana University^ °° the court of appeals was asked to address a question concerning the enforce- ability of an oral contract for lifetime emplosnnent. The plaintiff, '6J. Calamari & J. Perillo, The Law op Contracts 351 (1970). '^'The court of appeals quoted from 5 CORBiN, Contracts § 1039, at 242 (1963), on this subject. 349 N.E.2d at 740. 's/d. at 741. '^The court showed less sympathy for agreed remedies in Handle v. Owens, discussed at text accompanying notes 36-45 supra. '°°333 N.E.2d 886 (Ind. Ct. App. 1975). 1^6] SURVEY—CONTRACTS 171 a lecturer and student at Indiana University, was told by univer- sity officials that if he obtained a Doctor of Philosophy degree in East Asian languages he would be given a permanent faculty ap- pointment. After obtaining the degree in April 1973, he was ap- p>ointed to the rank of assistant professor. When he was notified that he would not be reappointed for the 1974-75 academic year, plaintiff initiated this action alleging breach of an oral agreement for permanent employment. The trial court sustained defendant's motion to dismiss based on the fifth section of the Statute of Frauds, which provides that no action shall be brought " [u] pon any agreement that is not to be performed within one [1] year . . . un- less the promise . . . shall be in writing . . . ."'°' The court of appeals reversed on this issue, acknowledging numerous authorities hold- ing that a contract for lifetime employment need not be in writing to be enforceable. The fifth section of the Statute of Frauds has been interpreted to require a writing only if the contract cotdd not be performed within one year.'^^ In Kiyose the plaintiff could have died within one year, which would have constituted complete per- formance of the lifetime employment contract. Since the contract coiUd have been performed within one year, it did not have to be in writing to be enforceable. This suggests the somewhat anomalous situation in which a thirteen-month employment contract for an octogenarian might have to be in writing to be enforceable because it could not be performed within one year, while an oral agree- ment to hire a healthy young employee for life would be enforce- able. D. Broad Form Indemnity The court of appeals recently heard two cases in which a party was seeking indemnity for injuries caused by its own negli- gence. '°^ In Vertwn Fire & Casvxilty Insurance Co. v. GraJiam,^'^'^ '°'IND. Code §32-2-1-1 (Burns 1973). '°=333 N.E.2d at 889. The court cited Frost v. Tarr, 53 Ind. 390 (1876); Hurd V. Ball, 128 Ind. App. 278, 143 N.E.2d 458 (1967) ; Holcomb & Hoke Mfg. Co. V. Younge, 103 Ind. App. 439, 8 N.E.2d 426 (1937). '°^The 1975 Indiana Greneral Assembly enacted a law declaring broad form indemnity clauses to be void and unenforceable in construction con- tracts. Ind. Code §26-2-5-1 (Burns Supp. 1976). However, since the law does not affect agreements which were made before July 1, 1975, it would not affect either of the cases discussed in this section. In addition, the law does not apply to highway construction contracts and thus the Thomas case, dis- cussed at text accompanying notes 105-08 infra, would not be governed by this new law even though it is a construction contract. And, since the Graham case, discussed at text accompanying note 104 infra, involved a lease it would not be covered by the new law. See Bepko, Contracts and Commercial Law, 1975 Survey of Recent Developments in Indiana Law, 9 Ind. L. Rev. 132, 136-38 (1975). '°^336 N.E.2d 829 (Ind. Ct. App. 1976). 172 INDIANA LAW REVIEW [Vol. 10:151 a lessor who had incurred liability for negligence to a third party on leased premises was attempting to obtain indemnification from the lessee. In Indiana State Highway Commission v. Thomas,^^ the State of Indiana, which had incurred liability to a worker for negligence on a construction job, was attempting to obtain indem- nification from the contractors. In both cases the court affirmed trial court opinions which refused to interpret indemnity agree- ments to protect against negligence on the part of the party seek- ing indemnification. In the Graham, case the court repeated the often-stated principle that contracts which provide indemnification for one's own negligence may be valid, but the agreement must be knowingly and willingly made in order to be enforced. In addition, these provisions are strictly construed and will not be held to re- quire indemnity for loss caused by the negligence of the party seeking indemnification unless the requirement is expressed in clear and unequivocal terms. '°* In the Thomas case, which was decided after Graham, the court went one step further and held not only that such a clause will be strictly construed, but that general language will never be sufficient to require indemnifica- tion for negligence of the party seeking indemnification. The lan- guage must specifically mention indemnity against the indemnitee's own negligence.'^' This is justified since "lawyers who specialize in this field are well aware that clauses such as those under con- sideration in this case demand laborious judicial parsing . . . [and] it is not too much to require them to stop waging verbal duels and to state unmistakably whether or not a contract purports to burden the indemnitor with another's negligence." '°® E. Conditional Payment Terms in Subcontracts In written agreements between general contractors and sub- contractors for construction work there is often a conditional pay- ment clause. The clause may provide, for example, that the con- tractor will pay the subcontractor for the subcontract work "after completion of the work, certification by the architect, and pay- ment by the owner." '°' General contractors have urged that such '°^346 N.E.2d 252 (Ind. Ct. App. 1976). '°*336 N.E.2d at 831. i°''346 N.E.2d at 260. '°°/d. at 263-64, quoting from Jordan v. City of New York, 3 App. Div. 2d 507, 514, 162 N.Y.S.2d 145, 152 (1957), aff'd, 5 N.Y.2d 723, 152 N.E.2d 667, 177 N.Y.S.2d 709 (1958). '°'Handbook for Subcontractors E-6 (1973). In this handbook, compiled by the Indiana Subcontractors Association, Inc., 4755 Kingsway Drive, Indi- anapolis, Indiana 46205, the association warns against the use of this clause and suggests that it might result in a contingent right to payment. 1976] SURVEY—CONTRACTS 178 clauses create express conditions precedent to the general con- tractor's obligation to pay. Therefore, if the owner failed to pay the general contractor, or delayed payment for a substantial period, the general would not have to pay the subcontractor, at least until the end of that period of delay. The subcontractor's right to pay- ment would thus be contingent on a variety of circumstances which may be beyond his control and he would bear the risk of the own- er's insolvency. Some courts have applied conditional payment clauses in this manner."° This year, however, in Midland Engi- neering Co. V. John A. Hall Construction Co.y'^^ the United States District Court for the Northern District of Indiana joined other courts in restricting this type of clause. In this case the conditional payment clause provided that the contractor was to make "pay- ment, which the said contractor shall pay to said subcontractor immediately after said material and labor installed by said sub- contractor to have been completed, approved by said architect, and final pa^Tnent received by the contractor . . . .""^ The owner did not pay the general contractor and no payment was made to the subcontractor for approximately three years. The court held that this provision did not create a perpetual excuse for nonpayment, but simply provided the general contractor with a reasonable time within which to obtain payment from the owner before making payment to the subcontractor."^ The three-year delay was beyond this reasonable period and payment was due. In reaching this conclusion the court expressed concern about the effect of a different rule in circumstances such as those pre- sented in the Midland Engineering case. In Midland Engineering the owner kept a five percent retainage from the general contractor until final payment was due while the general contractor kept a ten percent retainage from the subcontractor. In this situation the general contractor is in the position of holding some of the sub- contractor's money until final payment becomes due and, therefore, it may be in the interest of the general contractor to delay pay- ment. The court said that "it would not be inconceivable that a malefic general contractor might intentionally maintain a dispute with the owner which would cause the owner to refuse to make payment; the general contractor could thereby avail himself for several years of funds to which he has no right.'*"'* ''°See, e.g., Mascioni v. I.B. Miller, Inc., 261 N.Y. 1, 184 N.E. 473 (1933). '"398 F. Supp. 981 (N.D. Ind. 1975). "=/d. at 993. ''^The language of the standard form for subcontracts distributed by the American Institute of Architects produces a similar result. See AIA Document A401, Standard Form of Agreement Between Contractor and Sub- contractor, art. 12.5 (American Institute of Architects, Jan. 1972). ''^398 F. Supp. at 994.