Jim Whitney Economics 495

Monday, January 07, 2013

III. Contracts
C. Enforcing contracts (cont'd.)

    c. situational monopoly

    exercise of ordinary monopoly power does not void a contract
    but abuse of monopoly circumstances linked to the bargaining situation can

    Alaska Packers Assn. (p) v. Domenico (d,app), 117 F. 99 (1902)

  1. What are the facts of the case?
    You are the superintendent.... 
  2. Before leaving San Francisco, the workers seek twice the negotiated wage. You agree but refuse to pay the extra after you return. 
        Which wage would the court enforce?     higher wage--competitive contracting
  3. The workers insist on the higher wage only after reaching Alaska. After arguing briefly, you agree but later refuse to pay the extra.
        Which wage would the court enforce? lower wage--duress
  4. The workers insist on the 100% wage increase in exchange for an extra 15 minutes of work per day.
        Would the court enforce the revised contract?     lower wage--duress despite consideration
  5. On the return trip after the season, a storm threatens to wash away the entire catch. You ask the workers to help preserve the catch. They insist on double their season's wages to help, and you agree.
        Would the court enforce the salvage contract? yes--dire straits
  6. The contract you offer the workers has several pre-specified conditions. The workers complain about the unfair terms but you refuse to negotiate them, claiming that the terms are standard for the industry. After the season, the workers sue for extra compensation because of the contract terms.
        Would the court support the suit?     no--competitive contracting
  7. Did the court enforce the revised contract? no - reversed lower court and demanded decision in favor of defendant

 

    Notes re Alaska Packers:
    Famous case
    Defense based on lack of consideration, but illustrates duress
    Duress:
        (1) dire straits
        (2) caused by the opportunistic conduct of your contract partner
    Contracts negotiated under duress are not enforceable

    related case: Austin Instrument Inc. v. Loral Corp., 29 N.Y.2d 124, 272 N.E.2d 253 (1971): a firm obtained refund of a price increase, which it had agreed to pay under pressure, on grounds of economic duress. The "emergency" was the result of the supplier threatening to breach its contract if it did not get the higher price.

    Related situation:
    Necessity: dire straits, but not caused by the conduct of your contract partner
    Ex: saving a sinking ship (bilateral monopoly)

    Efficiency =>
    Charge ship owners the expected cost of rescue
    Pay the rescuer the value of the cargo (F154-5)
    --insurance schemes can do this
    the present legal rule "permits an admiralty court to rewrite a contract that is too favorable to one side." Lowers chance of sinking while bargaining. (F156)
    Posner gets this wrong--worries about "excessive" efforts when the efforts to rescue due to getting the full value are efficient. This is not like the patent race or the sunk treasure case, because if another rescuer is expected in ten minutes, the first one isn't going to be able to get a very high price. (F)

 

    Seemingly related to duress: form contracts
    contracts of adhesion - "take it or leave it contracts"
    Not actually duress because it's offered up front while consumers can still choose between competing suppliers
    Form contracts reduce drafting costs, eliminate the problem of the firm having to control the employee who negotiates the individual contracts.
    The argument for freedom of contract holds in this case since the firm, in drafting the contract, will take account of benefits and losses to its customers. Anything that makes the terms of the deal more attractive to the customer will also increase the amount he is willing to pay.
    Even for a monopolist: The more unfavorable the contract is to the consumer, the lower the price the monopolist will be able to charge. Customers still have the alternative of not buying the good.
    Courts sometimes refuse to enforce the terms of form contracts on the grounds that they represent a sort of duress. These arguments suggest the courts are wrong.

 

    Williams (d,app) v. Walker-Thomas Furniture Co. (p), 350 E2d 445 (1965)

  1. What are the facts of the case? installment payments were applied pro-rata across all items leased (in default on $514 stereo, but p sued to repossess $1,800 of items purchased since 1957)
  2. Did the court decide to enforce the contract? lower courts sided with p, appeals court remanded case with instructions to consider whether contract is unconscionable  
  3. Suppose that the clause was standard in a form contract. Would you then consider it enforceable?
  4. Suppose that the clause had been highlighted in the contract.
     Would you then consider it enforceable?
  5. Suppose that Williams had acknowledged awareness and understanding of the clause.
    Would you then consider it enforceable?
  6. Regarding equity: Why do you think Williams might have considered it worthwhile to sign the contract even with a full understanding of its terms?

    Points out that contracts with unconscionable terms are not enforceable

 

    Unconscionable => an absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party.

    it's another case of "unequal bargaining power" but not in the context of temporary circumstances => it should be possible to shop around for a better deal

    related case: Weaver v. American Oil Co., 257 Ind. 458, 276 N.E.2d 144 (1971) a contract was found unenforceable in part on the basis of unequal bargaining power

    Controversial:
    From Walker v. Williams opinion: Ordinarily, one who signs an agreement without full knowledge of its terms might be held to assume the risk that he has entered a one-sided bargain.
    "Intrinsic fraud": fraud inferred from the grossly unfair terms of a contract

    What economic purpose could stringent repossession terms serve?
    (multiple items and no distribution to buyer of net proceeds from resale)
    Facilitates sales to consumers with bad credit and insufficient funds for a down payment
    If repossession "occurs early the seller sustains a windfall loss; he has received only a small part of the price, too little to cover both the depreciation of the good and the costs of repossession. (This assumes, but realistically, that the seller will not be able to collect the unpaid balance directly from the buyer, by suing him.) As long as competition among sellers of consumer goods is sufficiently vigorous to eliminate supracompetitive profits, limiting the windfall gains of late defaults would lead sellers to require larger down payments or higher initial installment payments, or charge higher prices, in order to protect themselves against windfall losses from early defaults." (P117)

    => Posner suggests that "the broad interpretation of unconscionability... makes it more difficult for poor people to borrow, thus harming them ex ante though benefiting some of them ex post." (P117)

 

    D. Interpreting contracts

    Progress so far:
    --The parties have made a contract--offer, acceptance, consideration
    --The contract is a valid one, enforceable by the courts--the contract has acceptable parties, purpose and conditions

    Concern now:
    The parties have a dispute about the details of the contract and turn to the court to resolve a dispute about its interpretation

   Fundamental question: Why not just enforce the contract as it is written?

    Presumption: freedom of contract --> Pareto improving exchange
    --contract terms are presumably efficient since that creates the largest potential gain for the contracting parties to divide up
    --the contract price is presumably tailored to the contract's terms--including quality of performance, allocation of risks, etc.

    Sources of litigation regarding interpretation of contracts:
    1. filling gaps in contracts -- some relevant clauses is omitted
    2. interpreting and modifying contract language -- some included clause is misspecified

    Should efficiency or intentions govern how the court interprets contracts?
    --Ordinarily, intentions, since parties likely knew what they wanted better than the courts do. (P96)
    --Court interference with intentions will make parties write longer contracts, which is costly. (F)

 

    1. filling gaps in contracts -- missing clauses

    There is never enough fine print to cover all aspects of a bargain, so we need some rules for filling in the gaps
    Parties omit clauses if cost of contracting exceeds benefits

    This gives a role for the court in contract disputes:
    filling out the parties' agreement by interpolating missing clauses. (P96)
    goal of courts is to try to fill in terms the parties would have come up with (F160)
    --efficient; and
    --cuts contract costs since parties know that court will play a mutually beneficial back-up role

 

    (1) implicit understandings

    Wood (p) v. Duff-Gordon (d), 222 N.E. 88 (1917) "contract for an exclusive dealership contains an implied condition that the dealer shall use his best efforts to sell the supplier's product." -- good example of implied terms; designer (P95n4) P=agent/distributor; D=creator of fashions

  1. What are the facts of the case?
  2. Does plaintiff believe that there is a contract?
  3. Does defendant agree that there is a contract? Why not? no explicit promise of effort
  4. If there is a contract, why would it restrict what defendant has been doing? plaintiff was given exclusive rights to attach her endorsement
  5. Why does plaintiff claim that there is a contract despite the absence of any clause committing the plaintiff to actually perform any duties? promised to share profits 50/50 and to take steps to protect the creations (filings, etc.)
  6. Why do you think the plaintiff didn't enumerate in the contract the specific duties that the plaintiff would perform? excessive costs
  7. Did Court of Appeals for the state of NY (NY's supreme court) award damages to Wood? Wood; lost at appellate level; appealed to state supreme court--received damages
  8. What will the damages consist of? 50% of profits from items marketed separately

    illustrates implicit understandings in contracts -- courts will interpolate missing clauses based on their understanding of the intent of the parties

    some gaps in contractual protection may be deliberate--the product of a tradeoff between the dangers of opportunism  and the direct and indirect costs (including the risk of error) of litigation on the one hand vs. the contracting costs on the other." (P95)

 

    (2) unspecified adversities (P96)
    --allocation of risk

    2 options for allocating risk:
    (i) specify in contract
    (ii) let court determine intent

    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.

Under common law, tenants bore implicit liability for unspecified adversities

    Early days, tenants: most of value was land, not buildings
        Buildings were simple and hazards best prevented by conduct of tenant
    Suydam (p,landlord) v. Jacskon (d,tenant,app) 54 N.Y. 450 (1873) illustrates initial rental agreements, with tenants liable

    Nowadays: landlords: buildings more valuable relative to land
        Many hazards are structural
        Consequence--tenants pay higher rent
    Greenfield (p,lessor) v. Kolea (d,app,lessee) 475 Pa. 351 (1977) -- in this case, the appellant is listed second; the order remains the same as at the trial court level

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.

    In general: "If it is clear that the parties intend the seller to bear the risk...; contract law will...read..a warranty into 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

    Contracts can contain ambiguous, conflicting or mistaken terms

    Some general rules:

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

    Ambiguity: interpreted according to trade practice.

 

    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 of appeals 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
        How would the price you would charge compare to 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....