U.S. Supreme Court Describes "Ordinary Principles of Contract Law"
Michael W. Mitchell, Smith Anderson, LLP
In a contract governed by federal law, does “The End” really mean “The End”? Some federal courts have said “no,” but the U.S. Supreme Court has just said “yes.”
Most contract cases in federal court involve the application of state substantive law and so it is uncommon for the U.S. Supreme Court to expound on what it considers to be the contract principles to be applied in federal cases where no state’s substantive law applies. But in a recent unanimous decision, M&G Polymers USA, LLC v. Tackett, 135 S.Ct. 926 (2015) (four justices concurring in a separate opinion), the Court took the opportunity to do just that when it vacated a Sixth Circuit decision because that court had failed to apply “ordinary principles of contract law” to a collective bargaining agreement.
The issue in M&G Polymers USA was whether the agreement, governed by The Employee Retirement Income Security Act of 1974 (ERISA), granted lifetime health benefits to employees even in the face of the agreement’s three-year term. In a prior case, International Union, et al v. Yard-Man, Inc., 716 F.2d 1476 (6th Cir. 1983), the Sixth Circuit had adopted its “Yard-Man” inference, pursuant to which courts could construe the grant of health care benefits in a collective bargaining agreement as vested and interminable despite express language setting an expiration date on the entire agreement itself.
In M&G Polymers USA, the collective bargaining agreement provided a durational clause, stating that the employer would provide health benefits for the duration of the agreement. The agreement provided for renegotiation of its terms in three years. Despite this explicit language, the Sixth Circuit applied its Yard-Man inference and held that the health care benefits were vested for the life of all retirees. In other words, health benefits would continue after the agreement’s expiration and for the remaining life of the retirees.
But the Supreme Court rejected the Yard-Man inference in M&G Polymers USA. As the Court explained, “[w]e interpret collective-bargaining agreements, including those establishing ERISA plans, according to ordinary principles of contract law, at least when those principles are not inconsistent with federal labor policy.” Below are the four basic principles the Court applied in reaching its decision:
- Intention of the parties should be determined by case-specific evidence.
Courts should use case-specific evidence to determine the intentions of the contracting parties and not the court’s own general suppositions regarding their intentions. The Supreme Court noted that the Yard-Man inference distorted the attempt to ascertain the intention of the parties because its “assessment of likely behavior…is too speculative and too far removed from the context of any particular contract to be useful in discerning the parties’ intentions.” The Court also explained that courts may look to known industry customs or usages to determine the meaning of a contract. But, the parties first must prove that those particular customs and usages apply to the contract and do so with specific evidence in each case.
- General durational clauses should be construed as part of the whole agreement.
According to the Court, a written agreement is presumed to encompass the whole agreement of the parties. Therefore, it is not necessary for parties to include a separate durational clause in a contract in order to terminate any specific provision when the contract already contains a general durational clause.
- The “illusory promises” doctrine does not apply where the promise is only partly illusory.
The Court also described the proper application of the “illusory promises” doctrine. The doctrine discourages an interpretation of a contract that would render a promise illusory because an illusory promise cannot serve as consideration. And without consideration, a contract is invalid. The Sixth Circuit had held that the collective bargaining agreement would be illusory if the health care benefits did not vest for the life of the employee, because some employees would not get the benefit of the promise. But the Supreme Court explained that, if a promise is only partly illusory, then it is necessarily partly real. And a real promise can serve as consideration.
- Contractual obligations generally cease upon termination of the contract.
Finally, the Court recognized the “traditional principle that courts should not construe ambiguous writings to create lifetime promises.” The Court held that, generally, contractual obligations will cease upon termination of the contract. And when a contract is silent as to the duration of the term, a court may not infer that the parties intended it to last indefinitely.
While most commentators have focused on the importance of M&G Polymers USA in relation to collective bargaining agreements and health care benefits, the case also provides valuable insight into the Supreme Court’s view of those contract principles that federal courts should apply in the absence of applicable state law.
Reprinted with Permission.