April 1, 2006
Umbrella Policies and Multiple Moral Hazard
Few areas of contract law require so much complex drafting as insurance. Designing insurance policies is difficult enough when the event is beyond the insured's control. But when the insured has some substantial control over whether the payout occurs -- as by deliberately engaging in risky conduct or ignoring safety precautions ("moral hazard") -- the problem gets worse. In a new article, Multiple Losses, Ex Ante Moral Hazard, and the Implications for Umbrella Policies, forthcoming in the Journal of Risk and Insurance, Michael Breuer of the Socioeconomic Institute at the University of Zurich looks at the issues involved in classic umbrella policies.
Under certain cost conditions the optimal insurance policy offers full coverage above a deductible, as Arrow and others have shown. However, many insurance policies currently provide coverage against several losses although the possibilities for the insured to affect the loss probabilities by several prevention activities (multiple moral hazard) are substantially different. This article shows that optimal contracts under multiple moral hazard generally call for complex reimbursement schedules. It also examines the conditions under which different types of risks can optimally be covered by a single insurance policy and argues that the case for umbrella policies under multiple moral hazard is limited in practice.
March 31, 2006
To Protect and to Serve, But Somewhere Else
Recruits who train at the Los Angeles Police Department's police academy are required to sign contracts that require them to repay all or part of their $60,000 training costs if they leave the department before five years are up. Turns out some leave anyway -- and now the City is going after them. It's suing 53 former officers for $1.6 million in breach of contract.
The office of City Attorney Rocky Delgadillo (left) says it will work with the officers to arrange a payback that doesn't bankrupt them, but the officers' lawyer says it's a breach of the Fair Labor Standards Act to get money back from former employees. (Photo: Delgadillo City Attorney Website).
Contractual Allocation of Uncertainty in Employment
Contractual arrangements in the modern workplace are getting more complex, with more employees working on a temporary or on-call basis instead of in long-term fixed employment. The benefits to employers seem obvious, but are there any benefits to employees who find themselves in a situation of greater uncertainty?
Economist Marloes De Graaf-Zijl of the University of Amsterdam, in a recent study, finds one: higher wages for employees who are in on-call positions. The paper is Compensation of On-Call and Fixed-Term Employment: The Role of Uncertainty. Here's the abstract:
In this paper I analyse the use and compensation of fixed-term and on-call employment contracts in the Netherlands. I use an analytical framework in which wage differentials result from two types of uncertainty. Quantity uncertainty originates from imperfect foresight in future product demand. I argue that workers who take over part of the quantity uncertainty from the employer get higher payments. Quality uncertainty on the other hand originates from the fact that employers are ex-ante unable to fully observe a worker's ability and results in lower wages.
Using a combination of propensity score and Mahalanobis matching I analyse wage differentials and find that on-call workers receive compensation for providing quantity flexibility. Compensation of fixed-term contracts on the other hand is dominated by the negative wage effect of quality uncertainty. I investigate whether this relation still holds after the 1999 policy change that had a substantial impact on the attractiveness of on-call and fixed-term workers from the employers' perspective. I find that the policy change has not only influenced the use of on-call and fixed-term contracts, but unintentionally also their compensation.
Drennan v. Star Paving
One of Justice Traynor's most famous contracts decisions is Drennan v. Star Paving, in which the court rewrote the economics of the contracting industry by holding that, in effect, subcontractor bids created option contracts even where the prime didn't pay for the option. I recently ran across this picture of what appears to be the school that was the subject of the contract, Monte Vista Elementary School in Lancaster, California.
March 30, 2006
Outsourcing and Contract
One of the most interesting trends in recent years is "outsourcing" -- the practice of replacing activities governed within the firm with contractual relationships. In Hierarchies, Relational Contracts and New Forms of Outsourcing, Ulrike Muehlberger of the International Centre for Economic Research at the Vienna University of Economics and Business Administration, uses a study of the Austrian insurance industry to look at the evolving relationships. It's not, she finds, all that simple. Here's the abstract:
We observe that economic restructuring is significantly changing organizational governance. On the one hand, we witness an increase in mergers & acquisitions, which substitutes markets for hierarchies and, on the other hand, we see an increase in outsourcing and subcontracting activities, appearing to replace hierarchies by markets. However, there is evidence that an increasing part of outsourcing activities mix hierarchies with market forms of governance. The key argument of this paper is that firms have established governance structures based on markets, hierarchies and self-enforcing relational contracts so that they are able to keep a substantial amount of control despite of sourcing out labour. Furthermore, we argue that such hierarchical forms of outsourcing produce dependency. Using empirical evidence of the Austrian insurance industry, it is demonstrated that dependency is created, firstly, by the contractual restriction of alternative uses of resources, secondly, by support measures that bind the upstream party closely to the downstream party, thirdly, by relationship-specific investments made by the upstream party, and fourthly, by authority elements.
Hawai'i's Conway-Jones Gets Fulbright
Conway-Jones, who earned her J.D. at Howard and an LL.M. at George Washington, has taught at UH since 2000, where she also serves as Director of the Hawai'i Procurement Institute . She previously taught at the University of Memphis and at Georgetown.
March 29, 2006
Photos: Lucy v. Zehmer
It was a little over fifty years ago, a little after seven p.m. on a Saturday night before Christmas, that Welford Ordway Lucy pulled up at Ye Olde Virginnie Restaurant, Service Station, and Guest Cabins in McKenney, Virginia. He pulled a half-full bottle of whiskey out of the glove box and went in to visit with Adrian Hardy Zehmer, the owner of Ye Olde Virginnie.
The rest, of course, is casebook legend. Turns out that Ye Olde Virginnie is still there -- not a restaurant any more, but a home for disabled adults. The Ferguson farm is still around, too. I was out there in January, collecting pictures and details for an article. You can find a number of the photographs over on the AALS Contracts Section Website, aalscontracts.com. The photos are here.
Don't Prosecute, Renegotiate
There are no contract relationships more "relational," perhaps, than those between the U.S. military and the contractors who supply it. The parties collaborate at every stage of the contracting process, from drawing up specifications to making modifications in the field. An elaborate array of regulations specifies the obligations and duties of each party in ways that depart significantly from classical contract law.
Yet it's that very closeness and interdependence that -- many people believe -- can lead to waste, fraud, and abuse by contractors. So one of the parties, the Government, spends vast amounts of time and effort policing the other, using not merely contract law but criminal sanctions. In A Modest Proposal to Enhance Civil/Military Integration: Rethinking the Renegotiation Regime as a Regulatory Mechanism to Decriminalize Cost, Pricing, and Profit Policy, William E. Kovacic and Steven L. Schooner (Geo. Washington) suggest that fewer criminal actions and more renegotiation -- a hallmark of relational dealing -- might be in everyone's interest. Here's the abstract:
Neither Congress, the procuring agencies, the media, nor the public will condone government contractors reaping what are perceived as excessive profits. Accordingly, the procurement process employs an unduly complex, burdensome, risk-laden, and ineffective mechanism that erects significant barriers to civil/military integration. The paper examines certain policy implications associated with the Truth In Negotiations Act (TINA), the existing audit regime, and the use of criminal and civil anti-fraud measures to scrutinize deviations from these complex cost, pricing, and profit policies and controls. It re-visits the long-extinct Renegotiation Act and finds it less troubling than the existing quagmire. It analogizes to recent experience in the public utilities industry, which employs a sharing mechanism as an explicit, transparent means for addressing excessive profits. The paper proposes to simplify and decriminalize Federal procurement pricing and profit policy by drawing from the historical renegotiation experience. A transparent renegotiation regime (1) could be one less burdensome or complex element of a regulatory scheme that presents suppliers with a menu of regulatory options; (2) would allow contractors to select the approach that best corresponds to their own assessment of which contractual rules will minimize their costs; and (3) could permit the Government to share, directly or indirectly, in these increased efficiencies and savings.
Revised Article 1 Update
Revised UCC Article 1 appears to be on the verge of adoption in Colorado (HB 1247), Kentucky (SB 154), New Hampshire (HB 719), and West Virginia (SB 742), where it has passed both houses, as amended to replace uniform R1-301 with language tracking pre-Revised 1-105. All four bills opt for the definition of good faith in uniform R1-201(b)(20).
A Revised Article 1 bill has also passed one house in Arizona (SB 1250) and appears destined to pass as both minority and majority caucuses in the second house have recommended adoption. Like the Colorado, Kentucky, New Hampshire, and West Virginia bills, the Arizona bill replaces uniform R1-301 with language tracking pre-Revised 1-105. Unlike its counterparts in 9 of the states in which Revised Article 1 is in effect, and the four states where bills adopting Revised Article 1 await gubernatorial action, Arizona SB 1250 retains the pre-Revised Article 1 definition of good faith -- joining Alabama, Hawaii, Idaho, Nebraska, and Virginia in perpetuating different standards of good faith for merchants and non-merchants.
One unexpected development is that Oklahoma's bill to adopt the 2003 amendments to Article 2A (HB 3084) -- not Article 2, too, just Article 2A -- has passed one house and appears to be progressing through the other.
March 28, 2006
Today in History: Skelly Wright
On this date, March 28, 1962, James Skelly Wright was confirmed by the U.S. Senate to become a judge of the U.S. Court of Appeals for the D.C. Circuit. Wright, a prominent judge during the civil rights movement in the south, is best known in contract circles for his 1965 decision in Williams v. Walker-Thomas Furniture Co., in which he used the new doctrine of "unconscionability" to strike down a cross-collateralization clause in a consumer purchase.
A Lawyer, and Old Enough to Drink, Too
If students seem to be getting younger, you can take some solace that sometimes they are getting younger. Witness Mario Tabone, who is getting his joint JD-MBA from Detroit-Mercy at the age of 21. Apparently after working in his family's fruit orchards, law school was a snap.
NYLS's Gross Honored
New York Law School contracts prof Karen Gross will be honored tomorrow at a Women's History Month luncheon at SUNY Westchester Community College. Gross, who also is an expert in bankruptcy law, is being honored for her longtime work in helping consumers manage money.
Perhaps It Was Delivered by Pickfords
Some may not realize that Sir Edward Hall Alderson, the author of Hadley v. Baxendale (the case of the shaft that got delayed in transit) grew up in the world of Jane Austen, not Charles Dickens. He was, in fact, a contemporary of many of Austen's heroes, including Edmund Bertram of Mansfield Park (left). He may have shared Austen's view of the likelihood of packages going astray:
“Mr. Bertram,” said [Miss Crawford], “I have tidings of my harp at last. I am assured that it is safe at Northampton; and there it has probably been these ten days, in spite of the solemn assurances we have so often received to the contrary.” Edmund expressed his pleasure and surprise. “The truth is, that our inquiries were too direct; we sent a servant, we went ourselves; this will not do seventy miles from London -- but this morning we heard of it in the right way. It was seen by some farmer, and he told the miller, and the miller told the butcher, and the butcher’s son-in-law left word at the shop.”
Ultimately, Henry Crawford must send his coach to Northampton to pick up the harp there.
Nonprofits and Boilerplate
Lots of people use boilerplate contract language that they didn't themselves draft. Lots of that boilerplate is written by nonprofit organizations, including trade associations. Should we treat boilerplate differently when it's been produced by a nonprofit organization instead of the parties? Kevin Davis (NYU) suggests we might want to do that in The Role le of Nonprofits in the Production of Boilerplate. Here's the abstract:
In the United States at least, nonprofits, and in particular trade associations, seem to play a substantial role in producing boilerplate contractual terms. There are at least four reasons to believe that it makes a difference whether boilerplate is produced by a nonprofit such as a trade association rather than a for-profit such as a law firm or a publisher of legal databases. First, because of their distinctive mandates, when making decisions some nonprofits take into account benefits and costs that for-profits treat as externalities. Second, some nonprofits are relatively well placed to stimulate demand for contracts by credibly assuring prospective users of their value. Third, some nonprofits can produce contracts of a given quality at a relatively low cost because they have superior ability to attract volunteers. Fourth, nonprofits may be able to produce contracts at a relatively low cost because they enjoy preferential tax treatment. Understanding the distinctive features of production of boilerplate by nonprofits constitutes an important step towards understanding its implications for social welfare. This understanding can in turn inform analyses of the role the state ought to play in formulating contractual terms and shed light on the question of whether state intervention ought to involve encouraging or discouraging the production of boilerplate by nonprofits. This analysis also sheds light on broader questions surrounding the role of nonprofits such as trade associations in a market economy.
Civil or Criminal, or Both?
The AP is reporting a macabre story: Robert
Winston, an ex-funeral director from
Winston is now charged with the crimes of “abuse of a corpse” and “theft by deception.” His attorney’s response:
“This is a breach of contract, if anything.”
Is this really a compelling defense strategy? Winston’s actions can certainly be both; that is, both criminally improper and a breach of contract. Certainly, the hospital did not receive the benefit of its bargain with Winston. But contract law does not preclude societal punishment of Winston for his outrageous (in)actions -- this is more appropriately tasked to the criminal system. Thus, it seems a weak defense strategy to point to contract law as a scapegoat – it is not an either/or situation.
[Meredith R. Miller]
March 27, 2006
Payee Isn't TPB of Promissory Note
The payee of a promissory note is not a third party beneficiary of an assignment by his promisor, and cannot maintain an action on the note against the assignee, according to a recent decision by the Georgia Court of Appeals.
In the case, NitrOSystems, Inc. issued a promissory note to one of its employees, an inventor, as part of the compensation for one of his inventions. NitrOSystems subsequently entered into an asset purchase agreement under which it transferred certain rights and obligations to Angiogenix, Inc. One of the listed items was this:
Promissory Note from NitrOSystems, Inc. to Wayne H. Kaesemeyer dated January 20, 1998 in the original principal amount of $ 225,000 with interest accruing at the rate of 7% per annum. [T]his note is due and payable one-year after the date of FDA approval of any of Seller products which are or would be covered by any of the Patents included as Initial Assets or Subsequent Assets.
Georgia’s third party beneficiary statute provides, “The beneficiary of a contract made between other parties for his benefit may maintain an action against the promisor on the contract.” Kaesemeyer argued that this made him a third party beneficiary of the assignment.
Guess again, said the court. The statute doesn’t create third party liability where the contract does not. The asset purchase agreement between NitrOSystems and Angiogenix specifically stated:
This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, and no other person shall have any right, benefit or obligation under this Agreement as a third party beneficiary or otherwise.
It was clear to the court that there was no intent to confer third-party beneficiary status on Kaesemeyer, and thus summary judgment on his claim was appropriate.
Kaesemeyer v. Angiogenix, Inc., 2006 Ga. App. LEXIS 246 (March 7, 2006).
Negotiating Now, Negotiating Later
It goes without saying (although we'll say it) that parties to contract do not provide in their agreements against all contingencies that might occur. Everyone knows that contracting parties make decisions about how much time and effort to invest in negotiations and which contingencies to address specifically. In a new paper, Determinants of the Optimal Degree of Pro-activeness in Contracting, Henrik Lando of the Copenhagen Business School's Department of Industrial Economics and strategy, explores the issues. Here's the brief abstract:
The paper explores the extent to which contracting parties should include future contingencies in their contract rather than leave them for future (re-)negotiation. It is argued that whether or not to include a contingency or specific clause in a contract depends on three factors:
-- how important any deviation from the fully elaborate contract is in terms of the essential functions served by the contract, including securing efficient risk-allocation, incentives, and reliance investments;
-- whether the contingency is sufficiently likely and important for it to be worthwhile to spend time on drafting a clause concerning it; and
-- whether something approaching the clause may come about as the result of renegotiation of the contract under the shadow of default rules and contract interpretation by the court (including the possibility of invalidation of unfair contract terms) as well as under the shadow of the parties' concern for their reputation.
Weekly Top 10
There’s a new Number One this time, as we take our regular look at the Weekly Top Ten. Following are the most-downloaded new papers from the SSRN Journal of Contract and Commercial Law for the 60 days ending March 26, 3006.
1 (4) Contract as Statute, Stephen J. Choi (NYU) & G. Mitu Gulati (Georgetown).
2 (6) The Best Puffery Article Ever, David A. Hoffman (Temple).
3 (5) Bundling and Consumer Misperception, Oren Bar-Gill (NYU).
4 (7) Reading Wood v. Lucy, Lady Duff-Gordon with Help from the Kewpie Dolls, Victor P. Goldberg (Columbia).
5 (8) The Moral Impossibility of Contract, Peter A. Alces (Wm. & Mary).
6 (9-t) Contract Formation Issues in Employment Arbitration, Richard A. Bales (Northern Kentucky).
7 (9-t) Modularity in Contracts: Boilerplate and Information Flow, Henry E. Smith (Yale).
8 (-) Adjusting the Rules: What Bankruptcy Reform Will Mean for Financial Market Contracts, Michael Krimminger (FDIC).
9 (-) Reputations, Relationships and the Enforcement of Incomplete Contracts, W. Bentley MacLeod (Columbia-Economics).
10 (-) Legal Default Rules: The Case of Wrongful Discharge Laws, W. Bentley MacLeod (Columbia-Economics) & Voraprapa Nakavachara (Southern Cal-Economics).