Risk, Uncertainty and Profit

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George Mason School of Law
Contracts II
Relational Contracts II
F.H. Buckley
[email protected]
1
Next day’s assignment
 Up to Scott 541-56
2
Relational Contracts
 Relational contracts as different in
kind from one-shot transactions
3
Relational contracts as different in
kind from one-shot transactions
1. Relations are seen as semi-permanent
4
Relational contracts as different in
kind from one-shot transactions
1. Relations are seen as semi-permanent
 They promote norms of solidarity more
than of autonomy???
 Macneil, The New Social Contract (1980)
5
Relational contracts as different in
kind from one-shot transactions
1. Relations are seen as semi-permanent
2. A lengthier process of negotiation where it
may be difficult to identity the moment at
which contractual duties arise
 Hoffman: promissory estoppel
6
Relational contracts as different in
kind from one-shot transactions
1. Relations are seen as semi-permanent
2. A lengthier process of negotiation where it
may be difficult to identity the moment at
which contractual duties arise
3. The object of exchange is not easily
quantified
 Varney: “a fair share of the profits”
7
Relational contracts as different in
kind from one-shot transactions
1. Relations are seen as semi-permanent
2. A lengthier process of negotiation where it
may be difficult to identity the moment at
which contractual duties arise
3. The object of exchange is not easily
quantified
4. Future cooperation is anticipated
8
Relational contracts as different in
kind from one-shot transactions
1. Relations are seen as semi-permanent
2. A lengthier process of negotiation where it
may be difficult to identity the moment at
which contractual duties arise
3. The object of exchange is not easily
quantified
4. Future cooperation is anticipated
5. Trust becomes more important
9
Relational contracts as different in
kind from one-shot transactions
1. Relations are seen as semi-permanent
2. A lengthier process of negotiation where it
may be difficult to identity the moment at
which contractual duties arise
3. Future cooperation is anticipated
4. The object of exchange is not easily
quantified
5. Trust becomes more important
 A special concern for strategic behavior
10
Forms of Strategic Behavior
 Post-contractual opportunism
Armen Alchian et al.
21 J.L.E. 297(1978)
11
Relational Contracts and Strategic
Behavior
 Post-contractual opportunism
Armen Alchian et al.
21 J.L.E. 297(1978)
12
Relational Contracts and Strategic
Behavior
 Post-contractual opportunism
 Bilateral Monopolies and relation-specific
assets
Oliver Williamson (Nobel 2009)
Markets and Hierarchies (1975)
13
No opportunism where no
relation-specific assets
 In some relationships, no one invests
anything
Jean-Paul Belmondo,
Jean Seberg,
Breathless (1960)
Jean-Luc Godard
14
But where asymmetric investments are
made, opportunism is possible
 In others, one
person only invests
Ford Maddox Brown,
Stages of Cruelty
15
But where asymmetric investments are
made, opportunism is possible
 Giving the other
person a threat
advantage
16
Which results in the
underinvestment problem
17
Curing Underinvestment
 Ex ante, planners should seek to
reinforce long-term stability
 Minimize the possibility of post-contractual
opportunism
 Cure the underinvestment problem
18
What if both parties invest equally?
Brangelina
19
What if both parties invest equally?
Hamburger U. as a risk-sharing strategy
20
What if both parties invest equally?
Mutually Assured Destruction
Dr Strangelove
21
The Schwartz-Scott Proposal
 Can you think of other applications?
22
The Schwartz-Scott Proposal
 Security deposits
23
The Schwartz-Scott Proposal
 Joint investments
24
Relational Contracts
 Should they be treated differently
than one-shot transactions?
25
Relational Contracts
 Should they be treated differently
than one-shot transactions?
 They may be relational, but the relation
is invariably over when they sue each
other
26
Relational Contracts
 Should they be treated differently
than one-shot transactions?
 Should courts worry less about certainty
of terms, if the parties seem to want a
binding agreement?
27
Indefinite Agreements
 When should a court gap-fill and
when not?
28
Indefinite Agreements
 When should a court gap-fill and
when not?
 The court’s informational problem
29
Indefinite Agreements
 When should a court gap-fill and
when not?
 The court’s informational problem
 The parties’ transaction cost problem
30
Indefinite Agreements
 If a court gap-fills, can you suggest
the criterion it should apply?
31
Indefinite Agreements
 If a court gap-fills, can you suggest
the criterion it should apply?
 Mimicking the intention of the parties?
32
Indefinite Agreements
 If a court gap-fills, can you suggest
the criterion it should apply?
 Ex ante and ex post
33
Indefinite Agreements
 If a court gap-fills, can you suggest
the criterion it should apply?
 Tailored and untailored
34
Agreements to Agree
 Shepard v. Carpenter (p.300)
 An agreement to cut all logs in a
specified area, resell them, and pay
owner 1/3 of resale price
35
Agreements to Agree
 Shepard v. Carpenter (p.300)
 An agreement to cut all logs in a
specified area, resell them, and pay
owner 1/3 of resale price
 But an agreement to agree negatives an
agreement
36
Open Price Terms
 Joseph Martin p. 38
 Renew “at annual rentals to be agreed
on”
37
Open Price Terms
 Joseph Martin p. 38
 Renew “at annual rentals to be agreed
on”
 Held: an “agreement to agree”
38
Open Price Terms
 United Press case at p. 301
 Weekly payments not to exceed $300 for
news service
39
Open Price Terms
 United Press case at p. 301
 Weekly payments not to exceed $300 for
news service
 Price an “essential element”
40
Open Price Terms
 Lee v. Seagram p. 40
 What was left out?
41
Open Price Terms
 Lee v. Seagram p. 40
 What was left out?
 “a price roughly equal to that of their
current distributorships”
 A location “acceptable to plaintiffs”
42
Open Price Terms
 Lee v. Seagram p. 40
 What was left out?
 Court thought acceptable a price
at book + 3 times net profits
43
Open Price Terms and Sales of Goods
 D.R. Curtis p. 36
44
Indefinite Agreements
 Is a forward grain contract a sale of
goods?
45
Indefinite Agreements
 Is a forward grain contract a sale of
goods?
 UCC 2-105(1)
46
Indefinite Agreements
 What was left out of the contract?
47
Indefinite Agreements
 What was left out of the contract?
1. The actual protein content of the grain
(which won’t be known until the grain is
harvested)
48
Indefinite Agreements
 What was left out of the contract?
1. The actual protein content of the grain
2. Protein basis figure
(standard protein content: which is what the case
is about)
49
Indefinite Agreements
 What was left out of the contract?
1. The actual protein content of the grain
2. Protein basis figure
3. “Scale”: $ times divergence of (1) from
(2) and is usually fixed on delivery by the
export company
50
Indefinite Agreements
 What was left out of the contract?
 Does the omission to specify the basis
render the contract void for uncertainty?
51
Indefinite Agreements
 Can you think of any evidence that
you want to have introduced as the
Mathews lawyer?
52
Indefinite Agreements
 Suppose I told you that the average
% of protein in hard red spring is
12.6%?
53
The UCC
 Cf Kleinschmidt on p. 301
 What is the intent of the parties
 UCC 2-204(3)
54
The UCC
 What is the intent of the parties
 UCC 2-204(3)
55
The UCC and Open Price Terms
 Gap-filling price: UCC 2-305
56
The UCC
 Why should there be a different
standard in sales law?
57
The UCC
 Why should there be a different
standard in sales law?
 More standardized?
58
The UCC
 Why should there be a different
standard in sales law?
 More standardized?
 Market prices?
59
The UCC
 Why should there be a different
standard in sales law?
 More standardized?
 Market prices?
 Historical accident?
Karl Llewellyn
60
The UCC
 Alter p. 302
 Anything unusual about this case?
61
The UCC
 Alter p. 302: a rush order for pumps
Three Mile Island 1979
62
The UCC
 Alter p. 302: a rush order for pumps
 Ex ante, would the purchaser have
wanted a binding contract?
63
The UCC
 Alter p. 302: a rush order for pumps
 Ex ante, would the purchaser have
wanted a binding contract?
 Seller’s “belated concern with the lack of
agreement as to sale price…”
64
Preliminary Agreements
 You are contemplating a joint venture
with a social acquaintance, Mr. Gold.
He’s a dot.com person, made his
bundle, got out, now wants to get
back in the game. His idea is
synchronous virtual meetings. To
bring this to market he needs to work
on the software and create platforms
to support it.
65
Preliminary Agreements
 You have the business contracts and
network to provide users
66
Preliminary Agreements
 Would you want to memorialize your
understandings with an agreement at
this point?
 Why might you not want to do so?
67
Preliminary Agreements
 Would you want to memorialize your
understandings with an agreement at
this point?
 Why might you not want to do so?
 Transaction costs
68
Preliminary Agreements
 Would you want to memorialize your
understandings with an agreement at
this point?
 Why might you not want to do so?
 Transaction costs
 Informational uncertanties
 Will the product find a market?
 How do we divide up the equity?
 Do we have enough players in our venture?
69
Risk and Uncertainty
Frank Knight, Risk, Uncertainty and Profit
Risk and Uncertainty
[
There are known knowns; there are
things we know we know.
We also know there are known
unknowns; that is to say we know
there are some things we do not
know.
But there are also unknown unknowns
– the ones we don't know we don't
know.
Risk and Uncertainty
[
Unfortunately, there are also unknown
knowns – the ones we don't know but
think we know
Preliminary Agreements
 Would you want to memorialize your
understandings with an agreement at
this point?
73
Preliminary Agreements
 Would you want to memorialize your
understandings with an agreement at
this point?
 Why might you not want to do so?
 Transaction costs
74
Preliminary Agreements
 Would you want to memorialize your
understandings with an agreement at
this point?
 Why might you not want to do so?
 Transaction costs
 Informational uncertanties
75
Preliminary Agreements
 Would you want to memorialize your
understandings with an agreement at
this point?
 Why might you not want to do so?
 Transaction costs
 Informational uncertanties
 Might the negotiations get in the way of
progress on the venture?
76
Brown v. Cara 304
 Was the MOU a binding agreement?
 What was missing?
77
Brown v. Cara
 Was the MOU a binding agreement?
 What was missing?




78
Financing and construction contracts
Architectural plans
Equity stakes
What happened after the $175,000
Brown v. Cara
 Was the MOU a binding agreement?
 What was missing?




Financing and construction contracts
Equity stakes
What happened after the $175,000
Obligation to erect building
 A “formal agreement” to follow
79
Brown v. Cara
 Was the MOU a binding agreement?
 What was missing?




Financing and construction contracts
Equity stakes
What happened after the $175,000
Obligation to erect building
 Why didn’t they negotiate all terms then
and there?
80
Brown v. Cara
 What is the difference between
Leval’s Type I and II agreements?
81
Brown v. Cara
 Badges of Type I agreements?
82
Brown v. Cara
 Badges of Type I agreements?
 Express denial of an agreement means
no agreement
83
Brown v. Cara
 Badges of Type I agreements?
 Express denial of an agreement means
no agreement
 Partial performance evidence of
agreement
84
Brown v. Cara
 Badges of Type I agreements?
 Express denial of an agreement
 Partial performance
 All material terms agreed to evidences
an agreement
85
Brown v. Cara
 Badges of Type I agreements?




86
Express denial of an agreement
Partial performance
All material terms agreed to
Agreement of a kind usually committed
to writing: otherwise an agreement
Brown v. Cara
 Badges of a Type II agreement?
87
Brown v. Cara
 Badges of a Type II agreement?
 An intention to be bound
 Too uncertain for a Type I agreement
 Partial performance
88
Brown v. Cara
 What duties arise under a Type II
agreement?
89
Brown v. Cara
 What duties arise under a Type II
agreement?
 What does a good faith negotiation
mean?
90
Brown v. Cara
 What duties arise under a Type II
agreement?
 What does a good faith negotiation
mean?
 Give examples of bad faith?
 What questions would you want answered on
remand?
91
Brown v. Cara:
What happened to 100 Jay?
Rising 33 stories alongside the Manhattan Bridge, J Condo is Brooklyn’s
premiere luxury residential building.
As the tallest building in Dumbo, J Condo adds an easily recognizable icon
to the Brooklyn skyline with its dramatic curved, sail-like façade of floor to
ceiling windows that maximizes the building’s abundant natural light and
offers magnificent panoramic views of Manhattan, Brooklyn, the East
River, and New York Harbor.
92
Brown v. Cara:
What happened to 100 Jay?
Does this suggest why the deal didn’t
happen?
Does this look like
“Light Bridges at J Street”?
93
If it’s not a Type I agreement, is it
necessarily a Type II agreement?
 Arcadian Phosphate at 309
94
Arcadian Phosphate
 The agreement specified:
 the timing and amounts of the payments
 the fixed assets to be purchased,
 and a closing date of not later than May
31, 1987.
95
Arcadian Phosphate
 The agreement specified:
 a framework of negotiation for the purchase
of Arcadian's finished product inventory at
closing at a "mutually agreeable market
value," with phosphate stores to be
purchased at closing at Arcadian's book
value.
96
Arcadian Phosphate
 [a] binding sales agreement will be
completed by December 31, 1986.
97
Arcadian Phosphate
 Both parties agreed to the memorandum
"to cooperate fully and work judiciously
in order to expedite the closing date and
consummate the sale of the business.
98
Arcadian Phosphate
 Why did the defendant back out?
99
Arcadian Phosphate
 If negotiations for the sale failed,
Arcadian would repay any capital
expenditures agreed to thereafter and
made by API, and if the negotiations
failed through no fault of API, Arcadian
would refund API's deposit.
100
George Mason School of Law
Contracts II
Relational Contracts III
F.H. Buckley
[email protected]
101
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