Wednesday, July 11, 2007
Victor Goldberg, Framing Contract Law: An Economic Perspective(Harvard Univ. Press 2006)
by Joseph M. Perillo (Fordham)
Economists and lawyers trained in economics invaded what had been the relatively autonomous discipline of law in the 1970's. They have taken over many classrooms, preaching that rules of law are, or ought to be, rooted in economics. Law review articles employing economic analysis make up a sizable chunk of legal literature. Yet, economic analysts of law lament that they have had little impact on court decisions. When such lamentations are addressed to me, I reply that there are two basic reasons why economic analysts are usually ignored outside the academy. For one thing, rather than employ language and jargon that lawyers comprehend, their articles are overrun with the jargon of economics. Second, economic analysts are typically wrong about, or have a superficial acquaintance with, the legal rules they analyze. Victor Goldberg’s book suffers from neither of these infirmities. His prose is clear, and despite his lack of a law degree, he has a good handle on contract law. While most economic analyses of contract law tend to agree that from an economic perspective the legal system has got contract law basically right, this book analyzes a number of contract cases and finds them either wrong or, if right, wrongly reasoned. The skewering of some of these cases is, in his opinion "like shooting fish in a barrel" (p. 123).
One of his strong beliefs is that a court should take into account the business background -- the context -- of any contract. His first chapter shows the economic justification of Hollywood accounting, a system of bookkeeping that almost always shows that a blockbuster film produced no profits. This often shocks talent who sometimes agree to a small fee plus a share of the profits. It shocked the conscience of one trial court. But Goldberg demonstrates that the accounting system is embedded in the rational method by which a producer step by step puts together the talent and financing for a film. His knowledge of the film business serves him in good stead when he analyzes Hollywood’s "pay-or-play" contracts in chapters 15 & 16. However, I wish he had taken the trouble to explain why a Hollywood pay-or-play contract is a valid option in law and economics while a take-or-pay clause outside of certain specialized fields is an invalid penalty in law.
The context of the business, he urges, is of prime importance. His chapter 7, however, excoriates the decision in Columbia Nitrogen v. Royster, where the court attempted to understand the business context of a contract between fertilizer companies. The court got the context and the decision wrong, Goldberg complains. But interestingly, he employs legal, rather than economic, arguments to show that the court had an insufficient record to understand the business context and that the negotiating history, involving 21 negotiators, showed that the parties had crafted a tailor-made contract that trumped the alleged trade usage. Goldberg argues that the document should have been enforced as written and evidence of trade usage should not have been allowed to undermine the written agreement. In Chapter 6 he explains why another casebook favorite, Bloor v. Falstaff Brewing Corp., was wrongly decided, but places the blame on the lawyers who failed to have their witnesses sufficiently explain why an express "best efforts" clause had been included.
There is much in this book to surprise the reader. Did you know that the contract case that all lawyers read in law school, Wood v. Lucy, Lady Duff Gordon, was wrongly decided? The author makes a persuasive legal case that it was. But the argument is based on evidence that was not in the record. If we limit our analysis to the facts in the record, was it wrongly decided? Goldberg thinks so. His main criticism is not the finding of consideration; he would have found consideration in an unorthodox way that has a basis in economics but not in law. His main objection is that an implied term of best or reasonable efforts is too amorphous when it is argued that the implied term was breached. Indeed, a major theme of the entire volume is that the implication of terms such as "best efforts" or "good faith" undercuts the parties’ agreement. Yet some will believe that human sloth and iniquity are so variegated as to justify such implications. While he faults the implication of those terms, he would readily imply option terms in many agreements sometimes without a sufficient explanation why this should be so. Go figure!
I think that Goldberg is unaware of how his analysis undercuts the parties' agreements as I, and many others, interpret them. Take one of the cases he cites as wrongly decided and its holding absurd; he calls the decision in 407 E. 61st Garage, Inc. v. Savoy Fifth Ave. Corp, "another tail-wags-dog opinion." The Savoy Hilton hotel had entered into a five-year contract with a parking garage, promising to use reasonable efforts to steer its guests to use the garage’s facilities for parking their vehicles. In exchange, the garage promised to pay to the hotel 10 percent of the fees it received from the hotel guests. The hotel decided to go out of business during the five-year term and to use its valuable real property for another commercial use. The garage sued for breach. The court held that the garage had a cause of action unless the hotel could prove, on remand, that a custom existed to allow a hotel to go out of business without making compensation for incidental service contracts.
Goldberg faults the decision, basically by discussing the garage’s and the hotel’s reliance. In doing this, his analysis is hindered by the lack any knowledge of the garage’s opportunity costs. Did it turn down a deal with the nearby Plaza because the Plaza offered somewhat less favorable terms? More importantly, he totally ignores one of the dominant vectors in contract law, the protection of the promisee’s expectations. This is at the core of my disagreement with much in this volume. In his analysis of another decision, authored by fellow economist Richard Posner, he states that "[t]he lost profits remedy provided a ludicrously high level of protection for [plaintiff’s] reliance" (p.128). Although some respectable theorists view expectation damages as a surrogate for lost opportunities -- a reliance interest -- most contract scholars view expectation damages as a free-standing core value that underlies much of contract law. This volume would have been improved by a segment explaining why the author throughout concentrates on the parties’ reliance interests and seemingly disdains the expectation interest of the parties. In the tail-wags-dog opinion that he faults, the promisee is the tail, but has expectations that banks will lend money on. It is a form of property that is protected by the Constitution against interference by the states and protected by tort law against interference by third parties; fortunately, the courts often protect the reasonable expectations of parties in the position of the garage against a breach by parties in the position of the hotel. The mitigation principle assures the hotel that it will not be punished for making a presumably rational business decision to shut down.
The parties had no term in the contract with respect to the hotel’s going out of business. It seems to me and to a unanimous court that the implication of a term that the hotel impliedly promised to stay in business is more rational and more in line with the reasonable expectations of a party in the garage’s position than is a term that would allow the hotel to cease operations the day after signing a contract that purports to have a five-year term.
The author does recognize the expectation interest in two excellent chapters dealing with contracts for the sale of goods. This is followed by a more doubtful chapter on the "lost volume" issue where he comes out against scholars and courts that would grant the seller its lost profits and against those who would limit the seller to the difference (usually none) between the market price and the contract price plus incidental damages. Instead, he would substitute an implied option price -- pure economics with no grounding in law. The argument would place the daunting task of determining the implied option price in the laps of the jury.
I have discussed a few of the themes in this volume. There are many others. Although I have highlighted a few points of disagreement, this is the most stimulating and interesting book on contract law that I have come across in many years. It is full of surprises. Everyone who works with contracts and every law professor who teaches contracts should take a look at it.