Monday, October 19, 2009
There has been a lot of interest on the blog lately in the topic of contracts law and morality, e.g. here and here. Our comments section has been unusually active, which is terrific. A recent comment got me to thinking about Market Street Associates v. Frey.
That case involved a lease agreement between GE Pension Trust (GE) and Market Street Associates (MSA) as the assignee of JC Penny. The lease had a provision that allowed MSA to seek a loan from GE for the purpose of improving the property. If GE refused, MSA had an option to buy the property for the original purchase price plus 6% annual interest.
MSA offered to repurchase the property from GE, but GE demanded $3 million, which MSA thought was too much. MSA then requested financing, and when GE refused on the ground that it was not offering loans in amounts less than $7 million, MSA demanded the sale of the property pursuant to the lease provision. Under the terms of the lease, MSA would have been entitled to buy the property for about $1 million. GE claimed that because MSA had failed to remind it of the option in the lease, MSA had acted in bad faith.
The district court granted summary judgment to GE, finding that under the doctrine of good faith or simply as a matter of contract interpretation, MSA had a duty to remind GE of the option provision. This led Judge Posner to a lengthy rumination on the nature of terms such as “good faith” in contract law. Not surprisingly, Judge Posner does not find these terms very useful. However, he was able to explain the value of the doctrine of good faith in economic terms, and that permitted him to find that in fact MSA's conduct might well have violated the duty to act in good faith.
For Posner, what we call the duty of good faith is really just about reducing transactions costs by creating a disincentive to sharp practices in the course of performance. Sharp practices, says Judge Posner, are perfectly fine when negotiating a deal, but once the parties enter into an agreement, they are now in a “cooperative relationship” in which each lowers her guard. The doctrine of good faith thus protects against opportunistic behavior that can arise in the context of the sort of bilateral monopoly that can develop after the parties have committed themselves to a contractual relationship.
As many commentators on the blog have pointed out, there are many reasons to doubt that the moralizing tone underlying terms such as “good faith” could or should be eliminated from contracts law. But even assuming we were to attempt to understand contracts law entirely in terms of transactions costs, Posner’s position remains highly dubious.
First, at least since the Restatement (2d) and the UCC, contracts law has been sensitive to the difficulty of attempting to pinpoint the moment at which a threshold from a pre-contractual to a post-contractual relationship has been crossed. Parties continue to negotiate and change deals as they go. There is thus little reason to suspect that parties immediately let down their guards once they have entered into a cooperative relationship.
Second, if sharp practices increase transactions costs, then they do so regardless of when they occur. A party that engages in sharp practices will get a reputation for doing so. Other parties dealing with that party will be cautious and will engage in extra diligence that will complicate negotiations and may ultimately prevent many deals from occurring because a fundamental mistrust cannot be overcome satisfactorily.
Finally, if one is really interested in reducing transactions costs, then hold sophisticated, well-resourced parties to the terms of the agreements they sign. If GE wants a provision requiring notice before its contractual partner triggers its option to purchase, it can very easily write that duty to notify into the contract. A party like GE should have no recourse to a doctrine like good faith when it had the means and the ability to protect its own interests in both the pre- and the post-contractual moments.
Still, Posner opinions are always stimulating and thus Limerickworthy:
Market Street Associates v. Frey
“Don’t get moralistic with me,”
Said Judge Posner to trustee, GE.
“Though when I hear ‘good faith,’
I reach for my . . . Wraith.
Opportunists ain’t my cup o’ tea.”