Archive for April, 2010

24
Apr

This week we consider another view on the issue of whether some contractual breaches are such that additional remedies should be imposed by the courts, beyond the traditional damages for breach of contract.

In other words, Is some conduct sufficiently wrongful that a court should have the right to impose additional damages to deter such wrongful acts?  The law of fiduciary duties answers “Yes – courts should award additional damages by way of deterrence.”  Does this analysis hold weight in a contractual setting?

Professors Steve Thel and Peter Siegelman state that, in the context of a contractual breach, “Willfulness matters [ ] because it identifies those breaches that should be prevented or deterred – that is, all breaches that could have been avoided at little or no cost to the promisor.”

Bixby Bridge in Big Sur

Now, I agree that wilfulness matters, but I believe that the reason why is tied to the relationship between the parties.  Thel and Siegelman instead posit that “when willfulness [ ] is present, courts rightly award remedies that serve to deprive the promisor of any incentive to breach and to assure the promisee of getting full expectation.”  Thus, they tie “deterrence damages” to the relative ease by which a party could have avoided breach.

Professors Thel and Siegelman acknowledge that “contract law generally does not concern itself with the morality of breach in any direct way.  People enter into contracts in hopes that the promises made to them will be kept, and when a promise is broken, the promisee’s injury is typically the same whatever the reason for the breach.  A disappointed promisee ought to be satisfied with full expectation, regardless of what motivated the breach.”

Good point, and an analysis often relied upon by judges.  However, “while contracting parties will agree upon different levels of commitment in different situations, they will almost always agree that some breaches are out of bounds.”

That’s the $64 question.  What kinds of breach fall outside of societal norms?  I think that looking at the conduct inherent in the breach can lead to inconsistent results.  Contract law is, after all, greatly concerned with consistency.  In my view, certain kinds of contractual relationship lead to greater reliance by one of the parties, and therefore the law should impose a higher standard of duty on the breaching party.  This is similar to the concept applied to fiduciaries.

Professors Thel and Siegelman work from a well-known case involving a construction project in which the contractor failed to use the materials specified by the contract.  “Imagine a variant in which the contract calls for Reading pipe, but the builder deliberately substitutes Cohoes, which is cheaper (but just as good), with the intent of keeping the savings.  Should this be treated as a willful breach?  We suggest that it should be.”

Why?  In my view, the reason why is because the property owner placed additional reliance on the contractor and could not defend himself.  According to Thel and Siegelman, ”since the two brands are of identical quality, both builder and owner could be made better off by a breach that substitutes cheaper Cohoes for more-expensive Reading and splits the savings between the two parties . . . That would provide the appropriate party with incentives to look for cheaper materials, and would result in lower contract price.”

Yet, the cost of policing the behavior of the breaching party rises dramatically, and places an undue burden on the property owner.  State Thel and Siegelman, “the problem, of course, is that a builder will have an incentive to substitute not just cheaper but functionally identical materials, but also cheaper inferior ones.”

In a 1906 case, Justice Cardozo wrote that “There is no general license to install whatever, in the builder’s judgment, may be regarded as ‘just as good’.”   Similarly, the court in Groves v. John Wunder Co. explained that “defendant’s breach . . . was wilful.  There was nothing of good faith about it.  Hence, that the decision below handsomely rewards bad faith and deliberate breach of contract is obvious.  That is not allowable.”

Professors Thel and Siegelman conclude that “this is especially true in a construction contract, where such substitute materials are easy to find and substitutions are often difficult to detect.  In the face of this problem, treating the breach as willful and awarding the owner the cost-of-correction measure provides the appropriate incentives for the builder to inform the owner of the opportunity for savings, and to negotiate for consent to deviate from the contract.”

Yet, I think the argument is better cast in terms of the relationship between the parties.  A building owner places substantial reliance on the contractor.  The law should support such reliance, which is the reason why extra-contractual damages should be awarded for wilful breach.

(Steve Thel and Peter Siegelman, Willfulness Versus Expectation: A Promisor-Based Defense of Willful Breach Doctrine, in Michigan Law Review (June 2009), Vol. 107, No. 8, p. 1517.)

Category : Economics | Law Reviews | Blog
16
Apr

Let’s continue the discussion regarding rules of fault in contract law.  This series is from a law review article written by Professor George M. Cohen, who first notes that:

“The economic justification starts from the same premise as the traditionalist justification – that courts should enforce agreements according to the parties’ mutual intentions.  [Thus,] the strict liability paradigm permeates classical contract law.  Usually, however, the explicit label ‘strict liability’ appears only in connection with the doctrines of performance and breach.”

Prof Cohen is absolutely correct on this count.  Considering the three time frames in a contract – formation, performance, and breach – issues of “fault” really make sense only in connection with performance and breach.

Prof. Cohen continues.  “Under these doctrines, failure in any way to perform a contract breaches the contract, and subjects the breaching party to liability, regardless of fault.  The paradigmatic case is a seller who delivers goods that fail in any respect to conform to the contract.”

“An aggrieved party who can prove breach is entitled to compensation, which contract law generally defines as protecting the expectation interest.  In short, the reason for nonperformance does not matter.”

Southern France

Yet, in contract law, sometimes it does.  It can depend on the relationship of the parties.  “A traditionalist justification of strict liability must defend the proposition that the parties generally intend that the reason for nonperformance does not matter.  That proposition is, however, contestable, as discussed below.”

Prof. Cohen wants to look to intent, not to the relationship of the parties.  He explains that, “Under both the traditionalist and economic justifications, the argument for strict liability is stronger if mutual intent is easily determined and clearly distinguishable from fault.”

He warns that, “Adopting a fault-based system of contract law in those circumstances would lead to illegitimate social judgments by courts on the traditionalist view, and result in inefficient contracting around or failures to contract on the economic view.”

When, then should fault be considered?  “Determining disputed mutual intent is inherently uncertain.  Mutual intent is an ideal.  Contracting parties attempt to express mutual intent, often in writing, but do so imperfectly.  Contracts are largely a set of private rules, and all rules require interpretation, stories that explain their meaning in a particular situation.”

Now we return to relationships and their unfair exploitation.  “As unanticipated situations arise, disputes requiring interpretation inevitably occur.  The objective theory presumes that when one party manifests some intent and then later asserts a different intent, either he negligently or intentionally misled the other party originally, or is acting opportunistically now.”

Here follows a tremendous observation.  “Parties generally resolve these disputes on their own, often driven by reputational concerns.  When these efforts fail, they bring their disputes to court.  In litigated cases, the parties typically contest the requirements of mutual intent . . . But the uncertainty of intent blurs this dichotomy.  When intent is uncertain, fault can help inform intent in a variety of ways.  Most obviously, parties may expressly use fault concepts in their contracts, such as best efforts and good faith clauses, which essentially invite courts to make fault-based judgments in the event of a dispute.”

Prof. Cohen concludes by noting that, “With respect to contract damages, I have previously argued that the choice among different measures of damages (expectation, reliance, and restitution), as well as the limitations on expectation damages, are best understood as doctrines enabling courts to make relative fault assessments.  In fact, damages doctrines are best suited to dividing liability when both parties are at fault.  In light of this crucial role of damages in facilitating relative fault assessments, the resistance of courts to ‘penalty clauses,’ which preclude such assessments, is eminently sensible, despite the continued objection of many economic scholars.”

(George M. Cohen, The Fault that Lies Within Our Contract Law, in Michigan Law Review (June 2009), Vol. 107, No. 8, p. 1445.)

Category : Economics | Law Reviews | Blog
11
Apr

Let’s continue with the discussion of fault and breach in contract law.  We are starting to see that the law treat different kinds of contracts differently.  Meaning that, with a “relational contract,” being one in which the duties and obligations extend over time, the law imposes higher standards than in a “one-shot” contract.

Antelope Valley California Poppy ReserveProfessors Oren Bar-Gill and Omri Ben-Shahar comment that “a contractual right entitles a party to the peace of mind that a property right holder enjoys – the right not to be encroached upon.  Deliberate breach is like theft: it undermines this security and diminishes the value of the right.  The problem with the ‘sanctity of contract’ account is that it assumes the conclusion.”

The professors are correct – there are some contracts in which one party establishes sufficient trust in the other side that the law should follow with a higher level of obligation on the breaching party.

Professors Oren Bar-Gill and Omri Ben-Shahar continue.  “To those who regard a contract as a vehicle for promoting the contracting parties’ legitimate commercial interests there remains a puzzle: How is it that willful breach is considered, even by sophisticated parties, to be faulty and wrongful?”

“Why do businessmen reject the notion of efficient breach?  Is there a more subtle reason why a willful breach is perceived to justify supercompensatory damages?”

At this point the discussion takes on a moralistic tone which is lacking in traditional contract theory.  “We argue that willful breach triggers a stronger resentment not because of the harm it causes, but rather because of the harm it reveals.  Willful breach is not any more harmful, nor does it infringe any broader societal interest.  There is no sanctity to contract and no social institution or public good is being violated by willful breach.”

Pause here.  I cannot agree with this premise.  The breach of some kinds of contract causes a societal harm, and there should be additional damages for such wrongful conduct.

Professors Oren Bar-Gill and Omri Ben-Shahar explain that, “Willful breach is a probabilistic indication that the breaching party is the type of transactor who readily chisels and acts in a dishonest way, and has likely exercised such bad faith in other occasions without being sanctioned.”

“An act of willful breach reveals the true nature of the contracting partner: one who would take any opportunity to divert value, if he can get away with it.  This party may act in other self-serving, counterproductive ways that often go undetected and unpunished.  Occasionally, when this party’s opportunistic act is observed and its true nature is revealed, it triggers resentment for what underlies it – for all the other bad things that he likely did, for the choice he made to engage in this pattern of behavior.  That is, when this party is caught in the act of willful breach, he is punished not merely for this act, but for being a nasty type.”

Whatever its attractions, that is not an efficient theory of contracting.  The courts cannot administer justice based on whether a person is a “nasty type.”

abandoned house in the Eastern SierrasGetting back to the discussion.  “Intuitively, this idea tracks a common sentiment experienced by parties who are subject to deliberate breach.  Often, it is not the deprivation resulting from the immediate breach that creates a sense of exploitation for the aggrieved parties, but rather the realization that their partner was not as honest and dependable as they perceived – that he is the type of partner who cares less about their expectations and who would chisel if he can get away with it.”

But a mere moral letdown should not be adequate.  The true disappointment lies in the situational letdown, which is illustrated by the following passage.

“Is this why passengers dislike airlines’ overbooking strategy?  Surely, these passengers do not experience any immediate loss from what is in fact a deliberate booking strategy that leads to occasional nonperformance (indeed, they often line up to receive the offered compensation).  But it is perceived as a symptom of a ruthless strategy of poor service, of skimming off various passenger privileges.  They are angry for what is revealed to be this underlying nonfriendly pattern of treatment.”

Gentlemen, I think you have the right point but the wrong analysis.  The anger and resentment come from misplaced trust.  The passenger was placed in a situation of substantial reliance, and is offended because the airline took advantage of the situation, not because the airline was revealed to be more interested in profits than in its passengers.

(Oren Bar-Gill and Omri Ben-Shahar, An Information Theory of Willful Breach, in Michigan Law Review (June 2009), Vol. 107, No. 8, p. 1479.)

Category : Economics | Law Reviews | Blog
3
Apr

Journalist and attorney Lloyd Carter questions whether the benefits of subsidized water outweigh the social costs.  The undisputable fact is that the west side of Fresno County is one of the poorest regions in all of America.  Does current water policy help or does it simply compound the misery?

The Cost for West Side Agriculture

According to Mr. Carter, “The value of Westlands’ federal water subsidy was calculated at $110 million a year in 2002.”

Carter adds, “One little-noticed subsidy is cheap electricity to pump all that water uphill from the Delta to the Westlands.  EWG estimates the electricity subsidy for the CVP is $100 million a year, with Westlands getting $71 million of that annual power subsidy in 2002-an average of $165,000 per farm.”

What’s the bottom line?  According to a 1985 study, “the average subsidy per acre in the Westlands . . . was $217 per acre while the average net revenue per acre was only $290, meaning the most expensive irrigation project in American history was built so growers could make $73 an acre.”

The Reality

All of this money has not brought wealth to the area.  “The Twentieth Congressional District, encompassing Westlands and a portion of the western San Joaquin Valley down through Kings and Kern counties, has the dubious distinction of being the poorest of the 436 congressional districts in America.”

Pause again.  Rep. Jim Costa’s district is the POOREST in all of America.  This district include the Westlands water district.

Adds Mr. Carter, “While Westlands growers contend that cutbacks in water supplies have devastated the western San Joaquin Valley economy, it should be remembered that many West Side communities were desperately poor decades before the current cutbacks in water to Westlands, back in the days when cheap water flowed freely and Westlands got its full (or nearly full) annual allotment.”

Facts

  • There is no high school inside the boundaries of the 1,000-square-mile Westlands.
  • The Westlands district’s biggest town is Huron.  As of 2007, it’s estimated population of 7,174, which is 98% Hispanic
  • Eighty-two percent of the children at Huron’s continuation high school qualified for the free lunch program.  Of these students, none qualified for gifted and talented programs
  • A 1979 article cited to the fact that nearly two thirds of the Westlands “farmers” did not live within fifty-miles of their “farms,” although the residency requirement was still in effect.  Among the “family farmers” was Southern Pacific Railroad at 106,000 acres, Standard Oil at 10,474 acres, Boston Ranch (owned by cotton billionaire J.G. Boswell) at 26,485 acres, and Harris Ranch, operator of the world’s largest cattle feedlot, at 18,393 acres.

The Pollution Problem

The cost for West Side agriculture is magnified when you consider the environmental problems triggered by the imported water.

As Mr. Carter notes, the soils in the area “include a host of salts, trace elements like selenium, arsenic and boron, and heavy metals, which created an alkali desert on the West Side over eons.”

To further complicate matters, natural drainage is precluded because “several layers of virtually impermeable, thick subterranean clays run below the topsoil and impede the downward percolation of applied irrigation water.”

Growers had known since before World War II that adequate drainage was needed.  Westlands created the Kesterson reservoir in Merced County to hold the runoff, but the waste water created grave pollution problems and harm to wildlife.

Mr. Carter states that, “An estimated 100,000 acres in the Westlands have already gone out of production in the last few years because they salted up for lack of drainage.”

“This includes land covered by a $140 million 2002 Interior Department settlement of a lawsuit against Reclamation and Westlands filed by nineteen old-guard Westlands families who saw 32,400 acres of their farmland ruined by lack of drainage.  That controversial settlement included $70 million for just four prominent farming families.”

Westlands’ “Solution”

Notes Carter, “Because of the enormous cost of completing a federal drainage canal, Westlands has suggested to the government it would take over resolution of the drainage crisis in exchange for debt forgiveness, a guaranteed water supply, and takeover of some federal project plumbing.”

Westlands is seeking:

  • A water-delivery contract in perpetuity
  • Transfer from the federal government to Westlands of title to all pumping and diversion facilities along the San Luis Canal, the Mendota Pool, the Pleasant Valley Pumping Plant, and distribution and drainage-collector systems
  • Subsidized electricity for any drainage-treatment options requiring electrical power

No Disclosure by Westlands

Westlands acts like a governmental agency, and indeed, has the power of condemnation, which is an essential power reserved to sovereign entities.

But Westlands operates without public disclosure.  As Carter notes, “In 1982, the Reclamation Reform Act was passed, eliminating the residency requirement for farms, [and] increasing the acreage limitation to 960 acres.”

That’s the land ownership limitation established by Congress – only 960 acres per farmer is eligible for subsidized water.

There has never been enforcement of this requirement, nor any disclosure by Westlands.  As Mr. Carter points out, “The actual number of “farms” or “farmers” in Westlands is in much dispute, and Westlands has never provided a publicly available list of all of its “farmers,” “farms,” or “water users”; neither has it confirmed whether the “farmers” are people actually involved in farming or merely have their names listed on land deeds or as part of family trusts.”

It’s shocking that Westlands could suggest that it would acquire large portions of the Central Valley Project for irrigation, yet not make basic disclosures so the public could determine whether it was operating lawfully.

Carter’s Conclusion

“Most Westlands growers live far from the bleak and industrialized farmlands of the district; many reside in an exclusive enclave of mansions in north Fresno, in the zip code 93711, which receives more federal farm subsidy money than any other zip code in America.”

“The subsidized factory farm economy, it seems, doesn’t have much of a trickle down effect for the families and communities of workers who bring in the harvest.  In fact, it appears as though this system has helped to foster a culture of unsustainable farming practices, caused large scale environmental degradation, and has created a massive socioeconomic rift between land owners and their primarily Latino workforce.

“Indeed, one cannot help but see two different agricultural worlds among the Eastern and Western flanks of the San Joaquin Valley.  The East Side, where the original irrigation colonies began 130 years ago, is full of orchards and vineyards and farmhouses every quarter of a mile and small towns every few miles.”

“In the Westlands, with a single giant farm sometimes reaching tens of thousands of acres, one can drive for many miles down Interstate 5 through cotton and row-crop fields without ever seeing a farmhouse or the all-but-invisible farm-worker communities. It is a stark contrast indeed.”

Lloyd G. Carter, Reaping Riches in a Wretched Region: Subsidized Industrial Farming and its Link to Perpetual Poverty, in 3 Golden Gate U. Envtl. L.J. (2009) page 5.

Category : Economics | Law Reviews | Blog