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Wednesday, April 18, 2012

"Good faith" breaches

A recent discussion on the AALS Contracts listserv got me to thinking about the question when a party acts in "good faith" in threatening to breach a contract unless the other (nonbreaching) party agrees to pay more. Take this situation:

A has a contract with B. A is losing money on the transaction and is facing bankruptcy unless it can get more money from B. A threatens to breach unless B pays more. At this point, B could refuse the request, in which case A will breach and B will be left with a lawsuit against a probably judgment-proof debtor. Or B could agree to the price increase. Suppsoe B agrees, and A goes ahead and performs, and then B refuses to pay the higher amount. Is B's subsequent promise enforceable? The answer will often turn on whether we think that A was acting in "good faith" in obtaining the modification.

The fact that the company will go bankrupt if it cannot get a higher price seems to be an important factor for many people who say that the promise should be enforced. They argue that the threatening party is acting in "good faith," in a way it would not if it just wanted more money to pass on to its shareholders.

But I'm not sure I agree. In this situation it seems to me that all A is doing is taking advantage of one of its creditors over whom it has a great deal of leverage (B, to whom it owes a performance), so that it can transfer B's money to creditors over which it has less leverage (landlord, bank, IRS, employees). I don't particularly see why it's more moral to exploit a customer for one's creditors than for one's stockholders. There's a natural tendency to see "taking loss" as different from "not getting a gain," but behavioral economics, I think, teaches us that this is simply fallacious reasoning.

Take this hypothetical:

Airline sells me an advance ticket to fly from DFW to New York for $200. Fuel and other prices rise, and Airline decides it won't make money on me. Moreover, Airline is teetering on the edge of bankruptcy, and unless it can get more revenue it will go under. The day before I am to fly, Airline informs me that it will breach the contract unless I agree to pay $400. A quick check of airlines shows that $400 is still less than what I would have to pay to get a last-minute ticket on the other airline. If I refuse to pay the extra, the airline will sell the seat to someone else. I can either pay the extra $200 and fly, or I can pay $800 to fly on another airline, and file a $600 lawsuit against Airline. If I agree to pay the extra, is my promise binding?

Has Airline acted in good faith? What is the relevance of the fact that Airline is near bankruptcy? Why should a company that has managed itself so incompetently as to face bankruptcy be able to get this kind of price increase, while a well-run company in good financial shape would not? My own tentative view is that a company's motive for exploiting a contracting party ought usually to be irrelevant.

But I'm interested in thoughts on the topic.

FGS

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After spending more time thinking through this hypothetical than I should have I'd make two points. First, it is the essence of our contractual system that when B contracts with A for the provision of a good or service bankruptcy or the threat of bankruptcy by A is a foreseeable risk that B must assume. Whether A is acting in good faith or not is irrelevant. The key issue is that in both hypotheticals the threat of bankruptcy is a credible threat and it's a credible threat because it is a foreseeable risk to a rational actor. That's just the way our system works.

The second point is that there was an offer, there was acceptance, and an exchange hence there was an enforceable contract. In both examples no one forced B to take up the new offer. Assuming that both parties are rational actors the fact that B decides he's better served by accepting the offer modification from A binds him to it. The suggestion that B isn't somehow bound by the offer modification which he accepted because it was made under duress (the threat of a BK) fails because of the first point.

The underlying concern seems to be one of gamesmanship. Namely, that A could agree to a contract knowing it can't perform at that price and then after B is locked in and dependent on A use that leverage to wring more money from B. That's just poker, though: is A bluffing or not? B can chose to call the bluff by not agreeing to the new price, sue for breach of contract, and hope that A doesn't file for BK. On the other hand B can refuse to call A's bluff, pay more money, get specific performance, and live with with that.

What B shouldn't be able to do is to refuse to call the bluff (by paying the new price) and then when he finds out that A was bluffing (A doesn't file for BK) sue to claim the pot. That's not how poker works. You wouldn't have a game if those were the rules; no one would play.

Posted by: Daniel | Apr 20, 2012 8:41:22 PM

No dice. The attempt to charge a higher price was an invitation to set aside the first agreement and create a new one for no additional consideration. It is not sufficient consideration to threaten to do something thing that is illegal, such as breaching the first agreement. The airline already had a duty to offer the ticket for the first price. That said, the buyer should have declined the offer to renegotiate. If not, then the promise to pay more money (although not enforceable as part of a new contract) could create liability on the part of the flier for promissory estoppel, if the airline reasonably relies on the promise to obtain more money and suffers some resulting damage, such as budgeting for money money in its checking account and then suffering shortfall and NSF fee.

Posted by: Pittsburgh Small Claims | Apr 23, 2012 11:28:20 AM

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