Wednesday, April 18, 2012
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.