What Is an Adhesion Contract?

An adhesion contract is an agreement where one party has substantially more power than the other in setting the terms of the contract. For a contract of adhesion to exist, the offeror must supply a customer with standard terms and conditions that are identical to those offered to other customers. Those terms and conditions are non-negotiable, meaning the weaker party in the contract must agree to the contract as it is rather than requesting clauses be added, removed, or changed. Adhesion contracts may also be referred to as boilerplate contracts or standard contracts.

Understanding Adhesion Contracts

Adhesion contracts are often used for insurance, leases, vehicle purchases, mortgages, and other transactions where there will be a high volume of customers who will all fall under some standard form of agreement. In an insurance contract, the company and its agent have the power to draft the contract, while the potential policyholder only has the right of refusal; the customer cannot counter the offer or create a new contract to which the insurer can agree. It is important to read over an adhesion contract carefully, as all the information and rules have been written by the other party.

Adhesion contracts are usually enforceable in the United States thanks to the Uniform Commercial Code (UCC). The UCC helps to ensure that commercial transactions are taking place under a similar set of laws across the country. Although the UCC is followed by most American states, it has not been fully adopted by some jurisdictions like American Samoa and Puerto Rico. Louisiana stands alone among the 50 states in that it has only adopted parts of the UCC. The UCC has specific provisions relating to adhesion contracts for the sale or lease of goods. Contracts of adhesion are, however, subject additional scrutiny and interpretation under state law.

History of Adhesion Contracts

Adhesion contracts originated as a concept in French civil law, but did not enter American jurisprudence until the Harvard Law Review published an influential article on the subject by Edwin W. Patterson in 1919. Subsequently, most American courts adopted the concept, helped in large part by a Supreme Court of California case that endorsed adhesion analysis in 1962. 

As with most aspects of contract law, the legality and enforceability of adhesion contracts has been formed over time. The case law and interpretation may vary from state to state, but it is generally agreed that adhesion contracts are an efficient way to handle standardized transactions. Using adhesion contracts saves companies and customers time and money in terms of legal counsel when they are done properly. However, the law around adhesion contracts is always evolving. For example, digital adhesion contracts signed online have been challenged in court for burying clauses or making it difficult to read certain clauses, so a digital adhesion contract must now be as close to a paper contract as possible.

Enforceability of Adhesion Contracts

For a contract to be treated as an adhesion contract, it must be presented as a “take it or leave it” deal, giving one party no ability to negotiate because of their unequal bargaining position. Adhesion contracts are subject to scrutiny, though, and that scrutiny usually comes in one of two forms.

Courts have traditionally used the doctrine of reasonable expectations to test whether an adhesion contract is enforceable. Under this doctrine, specific parts of an adhesion contract or the whole contract may be deemed unenforceable if the contract terms go beyond what the weaker party would have reasonably expected. Whether a contract is reasonable in its expectations depends on the prominence of the terms, the purpose of the terms, and the circumstances surrounding acceptance of the contract.

The doctrine of unconscionability has also been used in contract law to challenge certain adhesion contracts. Unconscionability is a fact-specific doctrine arising from the same equitable principles—specifically the idea of bargaining in good faith. Unconscionability in adhesion contracts usually comes up if there is an absence of meaningful choice on the part of one party due to one-sided contract provisions combined with unreasonably oppressive terms that no one would or should accept. Simply put, if the contract is exceptionally unfair to the signing party, it can be declared unenforceable in court.

The doctrine of unconscionability shifts the focus from what the customer might reasonably expect to the motive of the supplier. Unconscionability is easier to argue if the supplier is making a significant profit from the agreement, especially if the amount of profit is in some way tied to the weaker party’s lack of bargaining power. Some legal experts have pushed back on this approach as it has implications in terms of the freedom of contract—the legal concept that people can freely determine the provisions of a contract without government interference.

What Is an Allowance for Bad Debt?

An allowance for bad debt is a valuation account used to estimate the amount of a firm’s receivables that may ultimately be uncollectible. It is also known as an allowance for doubtful accounts. When a borrower defaults on a loan, the allowance for bad debt account and the loan receivable balance are both reduced for the book value of the loan.

How an Allowance for Bad Debt Works

Lenders use an allowance for bad debt because the face value of a firm’s total accounts receivable is not the actual balance that is ultimately collected. Ultimately, a portion of the receivables will not be paid. When a customer never pays the principal or interest amount due on a receivable, the business must eventually write it off entirely.

Methods of Estimating an Allowance for Bad Debt

There are two primary ways to calculate the allowance for bad debt. One method is based on sales, while the other is based on accounts receivable.

Sales Method

The sales method estimates the bad debt allowance as a percentage of credit sales as they occur. Suppose that a firm makes $1,000,000 in credit sales but knows from experience that 1.5% never pay. Then, the sales method estimate of the allowance for bad debt would be $15,000.

Accounts Receivable Method

The accounts receivable method is considerably more sophisticated and takes advantage of the aging of receivables to provide better estimates of the allowance for bad debts. The basic idea is that the longer a debt goes unpaid, the more likely it is that the debt will never pay. In this case, perhaps only 1% of initial sales would be added to the allowance for bad debt.

However, 10% of receivables that had not paid after 30 days might be added to the allowance for bad debt. After 90 days, it could rise to 50%. Finally, the debts might be written off after one year.

Requirements for an Allowance for Bad Debt

According to generally accepted accounting principles (GAAP), the main requirement for an allowance for bad debt is that it accurately reflects the firm’s collections history. If $2,100 out of $100,000 in credit sales did not pay last year, then 2.1% is a suitable sales method estimate of the allowance for bad debt this year. This estimation process is easy when the firm has been operating for a few years. New businesses must use industry averages, rules of thumb, or numbers from another business.

Default Considerations

When a lender confirms that a specific loan balance is in default, the company reduces the allowance for doubtful accounts balance. It also reduces the loan receivable balance, because the loan default is no longer simply part of a bad debt estimate.

Adjustment Considerations

The allowance for bad debt always reflects the current balance of loans that are expected to default, and the balance is adjusted over time to show that balance. Suppose that a lender estimates $2 million of the loan balance is at risk of default, and the allowance account already has a $1 million balance. Then, the adjusting entry to bad debt expense and the increase to the allowance account is an additional $1 million.

What Is an Accidental Death Benefit?

Accidental death benefit is a payment due to the beneficiary of an accidental death insurance policy, which is often a clause or rider connected to a life insurance policy. The accidental death benefit (ADB) life insurance policy usually pays in addition to the standard benefit payable if the insured died of natural causes.

Depending on the policy’s issuer, an accidental death benefit may extend up to a year after the initial accident occurs, provided the accident led to the insured’s death.

Understanding Accidental Death Benefits

Accidental death benefits are riders or provisions that may be added to basic life insurance policies at the request of the insured party. Some people add accidental death benefit riders to their policies to protect their beneficiaries if an accident occurs. This is important as accidents are hard to predict and can lead to financial struggles if a sudden death occurs.

Accidental death benefits are important for people who work in or around potentially hazardous environments. Even those who drive more than average—either professionally or as a commuter—should consider accidental death benefit riders.

As an optional feature, the insured party must pay an additional fee on top of their regular premiums to purchase this benefit. Then, the accidental death benefit increases the payout to a policy’s beneficiary. So essentially the beneficiary receives the death benefit paid by the policy itself plus any additional accidental death benefit covered by the rider. These riders typically end once the insured person reaches a certain age, such as 60, 70, or 80.

What Is Considered Accidental Death?

Insurance companies define accidental death as an event that strictly occurs as a result of an accident. Deaths from car crashes, slips, choking, drowning, machinery, and any other situations that can’t be controlled are deemed accidental. In the case of a fatal accident, death usually must occur within a period specified in the policy.

Some policies’ accidental death benefits may also cover dismemberment—total or partial loss of limbs—burns, instances of paralysis, and other similar cases. These riders are called accidental death and dismemberment (AD&D) insurance.

Types of Accidental Death Benefit Plans

Group Life Supplement

With a group life supplement, the accidental death benefit plan is included as part of a group life insurance contract, such as those offered by your employer. The benefit amount is usually the same as that of the group life benefit.

Voluntary

A voluntary accidental death benefit plan is offered to members of a group as a separate, elective benefit. Offered by your employer, premiums are your responsibility. You generally pay these premiums through regular payroll deductions. Employees are covered for accidents that occur while on the job. Policies pay out benefits for voluntary accident insurance even if the insured party isn’t at work.

Travel Accident

The accidental death benefit plan with travel accident insurance is provided through an employee benefit plan and provides supplemental accident protection to workers while they are traveling on company business. Unlike voluntary accident insurance, the employer usually pays the entire premium for this coverage.

Dependents

Some group accidental death benefit plans also provide coverage for dependents. If you have a spouse or partner, or children who depend on your salary to pay bills and other costs, it may be a good idea to enroll in an accidental death benefit.

This additional insurance could help them out by providing money to pay bills, pay off a mortgage, or provide money to your children for future events, like college. In addition, if you co-own a business, your business partner could be listed on your insurance policy to cover any outstanding debts, in the event of your death.

Example of Accidental Death Benefit

As a hypothetical example, assume you have a $500,000 life insurance policy with a $1 million accidental death benefit rider. If you die due to a heart attack—a natural cause—the insurance company will pay your beneficiary $500,000. If you die as a result of a car accident, your beneficiary will receive the $500,000 life insurance benefit plus the $1 million accidental death benefit for a total payout of $1.5 million.