Discretion in Long-Term Open Quantity Contracts: Reining in Good Faith

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.

JEL Classifications: K12

Working Paper Series