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Abstract:
Long-term contracts are designed to manage risk. After a brief discussion of why it is unhelpful to invoke risk aversion for analyzing serious commercial transactions between sophisticated entities, this paper focuses on adaptation to changed circumstances. In particular, it considers the options to abandon and the discretion to change quantity. It then analyzes a poorly designed contract between Alcoa and Essex showing how the parties misframed their problem and designed a long-term contract that was doomed to fail.

Abstract:
By analyzing two American contract law decisions, the paper illustrates the usefulness of economic analysis in framing the inquiry. The cases have a common feature, unrecognized by the courts: they both deal with the production and transfer of information regarding the sale of an asset of uncertain value. One involves the combination of an option and a lockup to encourage the buyer to produce information. The other involves contingent compensation to convey the seller's assurance of the quality of the assets. Once this is recognized, the outcomes are straightforward.

Abstract:
Bloor v. Falstaff has become the standard casebook example of judicial interpretation of a "best efforts" clause. The court held that Falstaff's lackluster promotional efforts for Ballantine beer violated its "best efforts covenant, a result that has met with near universal approval. However, when the problem is properly framed, the decision is clearly wrong. The court's failure to consider the purpose of the transaction led it astray. Falstaff almost certainly did not breach its obligation.

The essential feature of the contract is that Ballantine was exiting the beer business and was making a one-shot sale of some of its assets to Falstaff. Ballantine wanted to receive the highest possible price and, other things equal, the fewer post-sale restrictions on Falstaff's exploitation of the assets, the more Falstaff would be willing to pay. So, any restriction, like the best efforts clause, immediately raises a red flag: how might the particular restriction raise the value of the Ballantine assets, ex ante? The deal included an "earnout" designed to cope with the information asymmetries inherent in the transaction. A significant part of Ballantine's compensation was in the form of a per barrel royalty. The role of the best efforts clause was to guard against the possibility that Falstaff could obtain the value from the Ballantine assets in a manner which bypassed the royalty. The poor performance of Ballantine beer post-acquisition was due not to Falstaff's diversion of revenue, but to the poor quality of the Ballantine assets (and the changing conditions in the beer industry).

Abstract:
The UCC and common law have used "good faith" to interpret long-term, open quantity contracts in a manner which ignores the parties' allocation of discretion. With no theory to guide them, courts have rewritten contracts to say, in effect, that a seller agrees to keep running his factory at a loss in order to generate waste (the waste removal company being the purchaser under the long-term contract) or that a buyer in a long-term requirements contract has promised to never run its facility at full capacity. Commentators have routinely accepted these interpretations without recognizing the peculiar features of this default rule. The simple theoretical point is that a long-term contract will often grant one party discretion with regard to quantity, in the form of output or requirements contracts, to adapt to changed circumstances. That discretion will typically be constrained by the requirements (or output) of a particular facility. To protect the opposite party's reliance, the contract will often impose additional constraints on that discretion so that the first party must take this reliance seriously when making quantity decisions. The paper analyzes a number of cases from this perspective and concludes that, with the possible exception of cases in which the buyer eliminates its requirements by selling the plant, the courts should not use good faith to override the contractual allocation of discretion.

Abstract:
In Wood v. Lucy, Lady Duff-Gordon, Cardozo found consideration in an apparently illusory contract by implying a reasonable effort obligation. Unbeknownst to Cardozo, Wood had agreed to represent Rose O'Neill, the inventory of the kewpie doll in an earlier exclusive contract. Wood sued O'Neill two months prior to entering into the Lucy arrangement. That contract included an explicit best efforts clause. The failure to include such a clause in this contract was, quite likely, deliberate, suggesting that Wood was trying to avoid making a binding commitment to Lucy. The paper examines both the kewpie doll and Lucy contract in some detail. It then goes on to argue that the decision's role in finding consideration is probably minimal - it would be easy enough for the parties to provide an alternative source of consideration if they desired. The mischief of the opinion is its impact on contract interpretation. The UCC and some common law courts have taken to imposing a vague effort standard on promisors, even if there exists an explicit source of consideration.

Abstract:
When warehouse clubs started making inroads into its market, Toys R Us responded with a policy designed to limit the clubs' access to certain toys. The FTC successfully challenged the policy, arguing that TRU had coordinated a horizontal agreement amongst the toy manufacturers to eliminate competition from this new class of competitors. TRU defended itself, invoking the free-rider rationale. This the Commission rejected as pretext. TRU's argument was better than the Commission gave it credit for, but it failed to press its best argument. That failure stems in part from the shortcomings of the standard free rider formulation, and in part from the defendant's need to tailor its arguments to ill-fitting doctrinal constraints. TRU attempted to convince the Commission that its actions were unilateral, within the Colgate exception. Perhaps they were, although the Commission found to the contrary. Regardless, the net result was suppression of an efficiency rationale that emphasized the benefits of cooperation by the toy manufacturers.

In this paper, I will argue that TRU emphasized the wrong free rider problem. Properly framed, the behavior of TRU and the toy companies can be seen as consistent with the efficiency goals of antitrust policy. That a plausible efficiency argument can be constructed does not mean that the outcome itself was wrong. My narrow focus here is on showing that the standard formulation led to asking the wrong question.

Part I provides a brief overview of the market and TRU's behavior. Part II summarizes the defense's rationale and the Commission's rejection of it. Part III provides an alternative explanation. Part IV concludes.

Abstract:
The standard analysis of Parker v. Twentieth Century Fox follows the court in focusing on whether the substitute employment offered Shirley MacLaine was "different and inferior" from that which she had initially contracted for. That, this paper argues, was the wrong question. The court managed to produce the right outcome but through convoluted reasoning that failed to recognize the essential feature of the contract. The contract had a "pay-or-play" provision by which the studio, in effect, purchased an option on her time; they would pay her to be ready to make a particular film, but they made no promise to actually use her in making the film. Cancellation did not entail breach, and, therefore, it was unnecessary to ask whether she had failed to mitigate.

The paper traces the case through the courts, showing how the attention paid the pay-or-play feature declined. It then analyzes the economics of the pay-or-play clause. The clause gives the studio an option, giving it the flexibility to adapt or to abandon a project. The pay-or-play clause is a nuanced balancing of the studio's need for flexibility against the artist's reliance.

Abstract:
The standard analysis of Parker v. Twentieth Century Fox follows the court in focusing on whether the substitute employment offered Shirley MacLaine was "different and inferior" from that which she had initially contracted for. That, this paper argues, was the wrong question. The court managed to produce the right outcome, but through convoluted reasoning that failed to recognize the essential feature of the contract. The contract had a "pay-or-play" provision by which the studio, in effect, purchased an option on her time; they would pay her to be ready to make a particular film, but they made no promise to actually use her in making the film. Cancellation did not entail breach, and, therefore, it was unnecessary to ask whether she had failed to mitigate.

The paper traces the case through the courts, showing how the attention paid the pay-or-play feature declined. It then analyzes the economics of the pay-or-play clause. The clause gives the studio an option, giving it the flexibility to adapt or to abandon a project. The pay-or-play clause is a nuanced balancing of the studio's need for flexibility against the artist's reliance.

Abstract:
In the analysis of vertical integration by contract versus ownership one event has dominated the discussion - General Motors' merger with Fisher Body in 1926. The debates have all been premised on the assumption that the ten-year contract between the parties signed in 1919 was a legally enforceable agreement. However, it was not. Because Fisher's promise was illusory the contract lacked consideration. This note suggests that GM's counsel must have known this. It raises a significant question in transactional engineering: what is the function of an agreement that is not legally enforceable.

Abstract:
In the "Three Tenors" case the FTC found an agreement a violation of the antitrust law despite the fact that there was no way it could be anticompetitive. The Commission failed to heed the lessons of Coase's classic paper on the nature of the firm, making a sharp distinction between activities within a firm (legal) and across firm boundaries (not legal). Analytically, there should be no distinction. The decision to integrate activities by contract rather than ownership is a matter of relative transactions costs. Since the boundaries of the firm are, ultimately, an economic decision reflecting the costs and benefits of the alternative arrangements, there is no economic justification for making the legality of any act contingent upon whether it was on the proper side of that boundary. Nor is there any particular virtue in using antitrust rules to alter the relative costs so as to shift that boundary to favor bringing activities within the firm. The paper proposes a "quick look" approach. The first thing to look for is some indication of market power. If antitrust harm is not credible because there is no market power, stop looking.

Abstract:
In F. Hoffmann-La Roche Ltd. v. Empagran S.A., the Supreme Court interpreted the Foreign Trade Antitrust Improvements Act ("FTAIA") to bar an antitrust suit by foreign plaintiffs against foreign defendants despite the fact that the foreign and domestic markets were interconnected. I identify one narrow class of cases that would satisfy the statutory exception. Rather than focusing on the interrelatedness of the foreign and domestic prices, the inquiry centers on the resale of goods to the domestic market. The argument is a variant on Illinois Brick.

Abstract:
Despite the fact that public corporations ought to be risk neutral, they often carry insurance. This note first considers why insurance (or, more precisely, the package of services provided by insurance companies) might create value, regardless of the risk preferences of managers, shareholders, or other corporate stakeholders. One motive is that their contractual counter parties-buyers, lessors, and lenders - require that they carry insurance. Two explanations for why the requirement might be value enhancing are proposed.

Abstract:
Professor Mel Eisenberg argued in a recent paper for an expansion of the excuse doctrines. He argues that performance should be excused in those instances when parties tacitly assume that a given kind of circumstance will not occur during the contract time (the shared-assumption test). In addition, he argues that there should be a partial excuse when a change in prices would be sufficiently large to leave the promisor with a loss significantly greater than would have reasonably been expected (the bounded-risk test). This paper questions his first proposition by re-examining the Coronation cases and Taylor v Caldwell. His bounded-risk analysis is badly flawed, resting on a dubious proposition, inconsistent with the cases he relies on, and, most importantly, recognizing the wrong set of circumstances in which parties would choose to limit their exposure to large cost changes.

Abstract:
A casebook favorite for exploring the liquidated damage-penalty clause distinction is Lake River v. Carborundum in which Judge Posner found a minimum quantity clause to be an unenforceable penalty clause. In this paper I argue that the case was framed improperly. Had the litigators recognized that the contract afforded one party an option, the result should have been different. The contract was for the provision of a service - setting aside capacity - which was valuable to the buyer and costly to provide for the seller. The primary purpose of the minimum quantity clause was the pricing of that service. The case raised indirectly a significant damages issue: if there is an anticipatory repudiation of a contract that is take-or-pay or has a stipulated damage clause, should the promisee's ability to mitigate be taken into account when reckoning damages?

Abstract:
In the analysis of vertical integration by contract versus ownership, one event has dominated the discussion—General Motors’ (GM) merger with Fisher Body in 1926. The debates have all been premised on the assumption that the 10-year contract between the parties signed in 1919 was a legally enforceable agreement. However, it was not. Because Fisher's promise was illusory the contract lacked consideration. This note suggests that GM's counsel must have known this. It raises a significant question in transactional engineering: what is the function of an agreement that is not legally enforceable?

Abstract:
The "battle of the forms" has long posed a problem for contract law. The common law resolved the problem with the "mirror image" rule. Under the Code there has been a movement away from that rule toward one favoring the Code's default rules. Movement in that direction continues in the latest drafts of the new Code. The mirror image rule, the current Code, and the proposed revisions all fail to address the primary problem: when drafting their forms the parties have insufficient incentive to take their counterparties' concerns into account. What is needed is a mechanism that would bring the counterparties' concerns to the lawyer's attention at the moment at which the standardized form is being produced. This paper proposes such a mechanism, the "best shot rule," which is, in effect, a variant of final offer arbitration.

Abstract:
The paper suggests that the private remedy for securities law violations might be unnecessary. Since the primary movers in the litigation are a small number of plaintiff law firms, the actual plaintiffs are by and large irrelevant; their role is to provide a rationale for damage measurement. But if the damages of the plaintiff class bear no logical relation to the social losses, then it might make sense to simply remove the plaintiffs from the process entirely. Plaintiff law firms are, in a sense, bounty hunters, supplementing the SEC's enforcement effort. The paper suggests that the current situation is similar to an open-access fishery and that a more efficient system might result in more sensible management of that fishery. The supplementary role might be better served if the SEC established a set of fines and then licensed some subset of private lawyers to pursue those fines.

Abstract:
The use of "net profit" clauses in the movie business poses a problem. The standard perception is that Hollywood accounting results in successful films showing no net profits. If that is indeed so, then why have they survived for over four decades? This paper argues that a successful movie will fail to yield net profits only if a "gross participant" (a major star whose compensation is in part a function of the film's gross receipts) becomes associated with the film. Since the net participants typically are associated with a project first, the question becomes: why would net participants be willing to sacrifice some (or all) of their contingent compensation when a gross participant is added to the project. The answer is that the net participants are made better off, ex ante, both directly by increasing their expected earnings, and indirectly because the studio is willing to pay for the increased flexibility. Contingent compensation is endemic in the movie industry. Because the inputs for the commercial success of a movie are not all supplied simultaneously, the compensation schemes will be tailored to induce effort at the appropriate time. If the studio-distributor gives up too much of the back-end, it waters down its incentives to market the film effectively. At the same time, giving the net profit participants a share of the back-end sharpens their incentives, both before and after the completion of production. The net profits clause nicely balances these two effects.