Jim Whitney Economics 495
 

    III. Contracts
    D. Interpreting contracts (cont'd.)

Per Greenfiel v. Kolea: [A]n allocation of risk can be accomplished in one of two ways. First, the parties could specifically provide for risk assumption with respect to certain possible contingencies. In the absence of an express recognition and assumption by the parties, the court is left with the task of determining what the parties would have done had the issue arisen in the contract negotiations.

    Efficiency guidelines: assign risk to the party who can
    (i) best spread (pool) the risk
    (ii) best control the risk (F)

    "an efficient contract will usually assign the loss associated with something going wrong to the party with control over that particular something."  (F162)
    Commonly, that means the seller: Moral hazard and adverse selection push in same direction: the promisor usually knows risks better and can prevent them better

    Ex: risks best controlled by the producer: Risk of strike, factory burning down
    Contractors building houses: assigning risk to supplier is logical since supplier can spread risk more easily and prevent fires  (F161)

    But not always:
    Ex: risks best controlled by the consumer due to moral hazard: Himalayan photographer. If he doesn't tell the photo labs that his six rolls of film cost thirty thousand dollars to get, they don't owe him thirty thousand when they lose the film.
    Without moral hazard, risk spreading considerations would => make photo lab liable.

 

    Ex: landlords and tenants: Assignment of risk from hazards has shifted over time.
    Early days, tenants: most of value was land, not buildings
        Buildings were simple and hazards best prevented by conduct of tenant

    Nowadays: landlords: buildings more valuable relative to land
        Many hazards are structural
        Consequence--tenants pay higher rent

    stare decisis provides guidance but is not binding

    In general: "If it is clear that the parties intend the seller to bear the risk...; contract law will...read..a warranty ino the contract of sale." (P113)

    Some implicit contract terms are nonwaivable
    Ex: nonwaivable warranty of habitability for apartments

    Disadvantage: Raises product price and reduces choice
        A consumer can shop for a guarantee, etc.
    Advantage: More predictable
        Lowers shopping costs and perhaps litigation costs

 

    2. interpreting and modifying contract language

    Morin Building Products (p) v. Baystone Construction (d,app), 717 F. 2d 413 (1983) -- acceptable paint job (P95n3)

  1. What are the facts of the case? "artistic effect" and "acceptability" are strictly decided by the owner. Another contractor was brought in to re-do the job.
  2. What did the court decide? ruled for plaintiff that payment was due; accepted the propriety of a jury trial instruction that jurors use a "reasonable person" standard for commercial buildings
  3. You install aluminum siding
    Situation 1: You sign a contract for a commercial building.
    Form contract. Specifies that the quality is subject to the "final approval of the owner." Consultants agree that your product is "first class," but the owner does not and refuses to pay.
        Will the court award you the contract price? yes--reasonable person standard
        Why would you agree to sign a form contract like this?
  4. Situation 2: You sign a similar contract with a homeowner.
        Will the court award you the contract price?     --no, aesthetics matter
  5. Situation 3: A commercial contract adds a special provision highlighting that expectation.
        Will the court award you the contract price? --no, it would not then be just a clause in a form contract
        Would you charge a different price than in situation 1?
  6. Did you find this court opinion to be relatively well written or poorly written? (Posner opinion)

    Illustrates interpretation of contract performance standards:
    "reasonable person" when functionality matters
    vs. "good faith" when aesthetics matter
    So "the reasonable person standard" is employed when the contract involves commercial quality, operative fitness, or mechanical utility which other knowledgeable persons can judge . . . The standard of good faith is employed when the contract involves personal aesthetics or fancy.... 

 

    Contracts can contain ambiguous, conflicting or mistaken terms

    Some general rules:

    Ambiguity: interpreted according to trade practice.

    Mistake: the party in the best position to avoid it is responsible.
    Ex: a problem in transmission, the party that chose the communication medium