Monday, May 9, 2022
Now that the semester is behind me (but for the grading), I can take up where I left off. This is the tenth in a series of posts on Victor Goldberg's work. Today's post is about Chapter 14 of his book, Rethinking Contract Law and Contract Design (RCL). Links to related posts follow this one.
In TIAA v. Tribune Co.,670 F. Supp. 491 (S.D.N.Y. 1987), Judge Leval divided the world of preliminary agreements into three categories. Type I agreements are enforceable, with the final, executed agreement considered a mere formality. In Type II agreements, the terms are mostly set, and the parties have a duty to negotiate in good faith. Type III agreements have too many open terms to be enforceable (RCL, 207). But how does a court go about determining what type of preliminary agreement it is dealing with? Brown v. Cara, 420 F.3d 148 (2d Cir. 2005) offered Professor Goldberg an opportunity to demonstrate the difficulties in the task.
The case involved a joint venture through which Brown would develop property owned by Cara. Brown had to first secure a zoning variance and then the parties would jointly manage the property and split the profits. By the time negotiations broke down, Brown alleged that he was out $750,000 and that the rezoning had increased the value of the property from $3 million to $18 million (RCL, 210-11).
The documents relating to this transaction were complex. The draft operating agreement stretched to 70 pages, and the parties differed on how close they were to final agreement. Cara pointed out that Brown's attorneys noted "five significant open business points," but Brown himself claimed that the parties were at the final "wordsmithing stage" (RCL, 213). The trial court sided with Cara, dismissing Brown's contractual claims but allowing a claim for unjust enrichment to survive (RCL, 214-15). Cara then proceeded to build the J Condominium, a luxury residential building in Brooklyn's
awesome Dumbo district, pictured at right (RCL 215-16).
The Second Circuit reversed, finding that the parties had entered into a Type II preliminary agreement, and remanded for further fact-finding necessary to decide whether Cara had breached his duties under a Type II agreement. The court identified five factors and found that all weighed in favor of finding that the parties had a duty to negotiate in good faith. Those factors are:
- whether the language reveals an intent to be bound;
- the context of the negotiations;
- the existence of open terms;
- partial performance; and
- whether custom required that such agreements be put in final form.
The court was of the view that, given all of the contingencies and complexities, the parties could not have put their deal in final form. Professor Goldberg's point is that they could have done so (RCL, 216-17). In prior cases considering Type II agreements, very few terms had been left open; here multiple terms were left open, but the Second Circuit treated that as a factor in favor of finding a Type II agreement, perhaps because of the parties' decision to first pursue the necessary zoning change and worry about other aspects of the transaction later (RCL 217-18). But even if this was a Type II agreement, did Cara breach the duty of good faith by breaking off negotiations after one year? If so, New York law preferred reliance damages as the remedy, while Brown really wanted expectation. Expectation damages arising from the breach of a contract that was never finalized would be very difficult to calculate (RCL 218-19).
Professor Goldberg analyzes the case from his perspective of the operative trade-offs between reliance and flexibility. Both parties are heading down a path together. Both see potential profits and potential pitfalls ahead. Both seek safe exits and promising alternatives for themselves while also watching the other for signs that they might be abandoned with no clear path forward. The solution, according to Professor Goldberg was "a mechanism for pricing Cara's option to unbundle;" that is, for seeking a different partner to construct or manage the project (RCL, 220). Professor Goldberg provides a range of options: Cara could have terminated Brown for cause, subject to a duty to reimburse Brown's reliance expenses; the parties could have agreed in phases, with Brown deriving an advantage over its competitors with each phase of the process because of reimbursement costs Cara would incur; Cara could have agreed to pay a "success fee" to Brown at any point in the process if Cara decided to go it alone; or the parties could have entered into a buy/sell agreement (RCL, 220-21).
Ironically, while other jurisdictions have followed Judge Leval's tripartite approach to preliminary agreement, New York has not done so. The Second Circuit applied a non-existent New York standard. Moreover, if Cara acted in good faith in terminating the Type II agreement, Brown should have lost not only its contracts claims but also its unjust enrichment claims. After all, Brown could have protected itself contractually, but it didn't (RCL 222-23).
And so Professor Goldberg concludes, it is best for the parties to work out a binding contractual agreement, weighing reliance and flexibility interests and pricing the option for exit. That way, the parties can decide for themself the price at which a party can bail on a joint product, rather than leaving that determination to a court (RCL 223-24).
A post on Chapters 12 and 13 (excuse doctrine) is here.
A post on Chapter 11 (an Auseinandersetzung with Mel Eisenberg) is here.
A post on Chapters 8-10 (consequential damages) is here.
A post on Chapter 7 (liquidated damages) is here.
A post on Chapters 5 & 6 (speculative damages) is here.
A post on Chapter 4 (lost-volume damages) is here.
A post on Chapter 3 (timing for assessing damages) is here.
A post on Chapter 2 (the flexibility/reliance trade-off) is here.
The introductory post is here.