Concurring Opinions » Contract Law & Beyond

Symposium Next Week on “A Legal Theory for Autonomous Artificial Agents”

Frank Pasquale — Wed, 08 Feb 2012 15:43:46 +0000

On February 14-16, we will host an online symposium on A Legal Theory for Autonomous Artificial Agents, by Samir Chopra and Laurence White. Given the great discussions at our previous symposiums for Tim Wu’s Master Switch and Jonathan Zittrain’s Future of the Internet, I’m sure this one will be a treat. Participants will include Ken Anderson, Ryan Calo, James Grimmelmann, Sonia Katyal, Ian Kerr, Andrea Matwyshyn, Deborah DeMott, Paul Ohm, Ugo Pagallo, Lawrence Solum, Ramesh Subramanian and Harry Surden. Chopra will be reading their posts and responding here, too. I discussed the book with Chopra and Grimmelmann in Brooklyn a few months ago, and I believe the audience found fascinating the many present and future scenarios raised in it. (If you’re interested in Google’s autonomous cars, drones, robots, or even the annoying little Microsoft paperclip guy, you’ll find something intriguing in the book.)

There is an introduction to the book below the fold. (Chapter 2 of the book was published in the Illinois Journal of Law, Technology and Policy, and can be found online at SSRN). We look forward to hosting the discussion!

Social and economic interactions today increasingly feature a new category of being: the artificial agent. It buys and sells goods; determines eligibility for legal entitlements like healthcare benefits; processes applications for visas and credit cards; collects, acquires and processes financial information; trades on stock markets; and so on. We use language inflected with intentions in describing our interactions with an artificial agent, as when we say “the shopping cart program wants to know my shipping address.” This being’s competence at settling into our lives, in taking on our tasks, leads us to attribute knowledge and motivations, and to delegate responsibility, to it. Its abilities, often approximating human ones and sometimes going beyond them, make it the object of fear and gratitude: it might spy on us, or it might relieve us of tedium and boredom.

The advances in the technical sophistication and autonomous functioning of these systems represent a logical continuation of our social adoption of technologies of automation. Agent programs represent just one end of a spectrum of technologies that automate human capacities and abilities, extend our cognitive apparatus, and become modeled enhancements of ourselves. More than ever before, it is coherent to speak of computer programs and hardware systems as agents working on our behalf. The spelling checker that corrects this page as it is written is a lexicographic agent that aids in our writing, as much an agent as the automated trading system of a major Wall Street brokerage, and the PR2 robot, a prototype personal robotic assistant (Markoff 2009). While some delegations of our work to such agents are the oft-promised ones of alleviating tedious labor, others are ethically problematic, as in robots taking on warfare roles (Singer 2009). Yet others enable a richer, wider set of social and economic interconnections in our networked society, especially evident in e-commerce (Papazoglu 2001).

As we increasingly interact with these artificial agents in unsupervised settings, with no human mediators, their seeming autonomy and increasingly sophisticated functionality and behavior, raises legal and philosophical questions. For as the number of interactions mediated by artificial agents increase, as they become actors in literal, metaphorical and legal senses, it is ever more important to understand, and do justice to, the artificial agent’s role within our networks of social, political and economic relations. What is the standing of these entities in our socio-legal framework? What is the legal status of the commercial transactions they enter into? What legal status should artificial agents have? Should they be mere things, tools, and instrumentalities? Do they have any rights, duties, obligations? What are the legal strategies to make room for these future residents of our polity and society? The increasing sophistication, use, and social embedding of computerized agents makes the coherent answering of older questions raised by mechanical automation ever more necessary.

Carving out a niche for a new category of legal actor is a task rich with legal and philosophical significance. The history of jurisprudence addressing doctrinal changes in the law suggests legal theorizing to accommodate artificial agents will inevitably find its pragmatic deliberations colored by philosophical musings over the nature and being of these agents. Conversely, the accommodation, within legal doctrines, of the artificial agent, will influence future philosophical theorizing about such agents, for such accommodation will invariably include conceptual and empirical assessments of their capacities and abilities. This interplay between law and philosophy is not new: philosophical debates on personhood, for instance, cannot proceed without an acknowledgement of the legal person, just as legal discussions on tort liability are grounded in a philosophical understanding of responsibility and causation.

This book seeks to advance interdisciplinary legal scholarship in answer to the conundrums posed by this new entity in our midst. Drawing upon both contemporary and classical legal and philosophical analysis, we attempt to develop a prescriptive legal theory to guide our interactions with artificial agents, whether as users or operators entering contracts, acquiring knowledge or causing harm through agents, or as persons to whom agents are capable of causing harm in their own right. We seek to apply and extend existing legal and philosophical theories of agency, knowledge attribution, liability, and personhood, to the many roles artificial agents can be expected to play and the legal challenges they will pose while so doing. We emphasize legal continuity, while seeking to refocus on deep existing questions in legal theory.

The artificial agent is here to stay; our task is to accommodate it in a manner that does justice to our interests and its abilities.

The Psychology of Contract Precautions

Dave Hoffman — Tue, 07 Feb 2012 21:29:55 +0000

Tess Wilkinson-Ryan (Penn) and I have a new draft paper up on SSRN: The Psychology of Contract Precautions. From the abstract:

“This research tests the intuition that parties to a contract approach each other differently before the contract is formed than they do once it is finalized. We argue that one of the most important determinants of self-protective behavior is whether the promisee considers herself to be in negotiations or already in an ongoing contract relationship. That shift affects precaution-taking even when it has no practical bearing on the costs and benefits of self-protection: the moment of contracting is a reference point that frames the costs and benefits of taking precautions. We present the results of three questionnaire studies in which respondents indicate that they would be more likely to protect their own interests—by requesting a liquidated damages clause, by purchasing a warranty, or by shopping around to ensure the best deal—when the contract is not yet finalized than they would when they understand the agreement to be finalized. We discuss competing explanations for this phenomenon, including both prospect theory and cognitive dissonance. Finally, we explore some doctrinal implications for work on disclosure, modification, and promissory estoppel.”

The paper is a part of a new literature on the moral psychology of contracting — see, e.g., Suckers, Obligations, Liquidated Damages. That said, it’s been quite a long time in production — I think we first started working on it in 2008 — and I’m thrilled to finally get it out in the open. It’s in draft form, so any comments you might have would be most welcome.

Vassar’s Mistaken Acceptance Letters

Lawrence Cunningham — Sun, 29 Jan 2012 14:17:08 +0000

Six dozen applicants for admission to Vassar College were thrown a boomerang over the weekend, first receiving electronic letters of acceptance only to be followed an hour later by electronic messages of apology saying the first batch were erroneous. At least some of the disappointed hopefuls object that the college is in breach of contract. They say Vassar’s first letter was binding because the deal was described as binding early admissions decision. As a matter of law, this is not a winning argument; but as a matter of public and student relations, the college may wish to do more than send what appear to be mere mass form apologies.

Ordinarily, the school’s letter would not constitute the formation of a contract. Contracts for college matriculation are formed after students first file an application for admission, which has zero contractual significance. The first step in the process with contractual significance is the letter of admission schools send. This would be considered to be an offer of admission. It creates in the student the power to accept, by following stated procedures, such as submitting a deposit by a stated deadline and committing to matriculating.

But offers to form contracts may be revoked at any time until the offeree has accepted or, in limited circumstances when the offeror seeks action in return, begun the requested action in reliance. Accordingly, Vassar’s letters of acceptance had no legal effect unless and until the students accepted, which none of the recipients over the weekend had done. It does not matter that the context involved early admission decisions described as binding. The decisions are binding only once the offer has been made and accepted.

Even if the college’s letters were somehow seen to form a binding contract, another basic contract law doctrine comes into play: mistake. In most cases, excuse from contractual obligation on the basis of mistake is granted only when both parties are mistaken (mutual mistake) and then only when it is evident that some risk existed that the parties did not intend to exchange or allocate. Classic examples are mistakes about the attributes of an animal (such as whether a cow was a breeder or barren) or provenance of a coin or instrument (such as whether a dime was minted in 1916 at Denver or whether a violin was made by Stradivari or not). [I analyzed those in the pending case about a Madoff Ponzi scheme account.]

But there is also a class of cases allowing rescission of a contract based merely on unilateral mistake–mistake by one side only. Excuse based on unilateral mistake requires that the mistake be made honestly not with any whiff of bad faith; involve a clerical matter rather than a matter of judgment; be reported to the other side promptly upon discovery; and not prejudice the other side as a result of its reliance. The case favoring the excuse is strengthened when insisting on enforcement of the contract would result in a windfall to the other party.

All those elements are present in the Vassar case: college officials made an honest computer mistake to which it alerted students within an hour after they had done nothing in reliance. To enforce the letters as contracts would create a windfall–a spot at Vassar that the school’s admissions office had declined to award.

On the other hand, the school’s response to its error seems both glib and insensitive. It sounds as if the school is treating these students as the clinical subjects of the type that appear in the kind of legal analysis I just offered. The school should not forget the human dimension of its error. Perhaps it can could offer something more substantive to these students for its mistake. At minimum, the school should refund any application fee students paid, since the school botched the application process that those fees pay for.

Contracts in the Real World: Ready for Pre-Ordering

Lawrence Cunningham — Sat, 28 Jan 2012 11:08:28 +0000

This new book on contracts, regaling readers with stories ripped from the headlines, will be published soon and can be pre-ordered now on amazon.com and other fine booksellers.

Contracts in the Real World: Stories of Popular Contracts is intended to be a fun, fast, reliable read. It is very useful for 1Ls struggling with the subject, perfect for anyone thinking about going to law school, and designed to entertain devotees of pop culture. It will also captivate experts in contract law by connecting current events with venerable principles and classic cases.

Stories feature such notables as Eminem, Lady Gaga, Charlie Sheen, Donald Trump, and Sandra Bullock, as well as examples such as your cell phone contract, lottery sharing partnership, and on-line privacy policy.

List price is $33. The table of contents follows.

1. Getting In: Contract Formation

A. Gifts, Bargains, Reliance: MLK and BU

A Charitable Pledge, Estopping Aretha Franklin

B. Ads or Offers: Pepsi and Harrier Jets

First Come First Served, Jesting

C. Frolic or Acceptance: Boasts on “Dateline NBC”

The Curious Smokeball, A Hole in One

D. Mutual Assent: Spyware and Secret Clauses

Two Ships Peerless

E. Policies or Pacts: The Cleveland.com Blogger

Employment Handbooks, Promises of Secrecy

2. Facing Limits: Unenforceable Bargains

A.Unconscionability: Gail Waters’ Annuity Swap

Chasing Alaska Gold, Escaping Nazi Germany

B. Blackmail: Michael Jordan’s Paternity

David Letterman and Child Support

C. Palimony: The Rapper 50 Cent

Lee Marvin’s Lover

D. Gambling: Octogenarian Powerball Sisters

E. Making Babies: Baby M, Baby Calvert

3. Getting Out: Excuses and Termination

A. Mistake and Warranty: Madoff’s Ponzi Scheme

Forged Dimes, Fertile Cows and Fake Stradivarius

B. Impossibility and Force Majeure: Donald Trump

C. Infancy: Craig Traylor of “Malcolm in the Middle”

D. Outrage: AIG’s Employee Bonuses

E. Embarrassment: The New York Mets and Citi Field

4. Paying Up: Remedies

A. Interests and Limits: Paris Hilton and “Pledge This!”

Vanessa Redgrave, Jack Dempsey and Robert Reed

B. Compensation: Paris Hilton and Hairtech

The Hairy Hand, The Beatles’ Recordings

C. Markets and Mitigation: Redskins Season Tickets

The Bridge to Nowhere, Lost Volume Sellers, Shirley MacLaine

D. Stated Remedies: Sprint’s Early Termination Fees

The Delayed Mausoleum, Vanderbilt’s Traitorous Football Coach

E. Specific Performance: Tyson Chickens and IBP Pork

A Unique Manhattan Billboard

5. Rewinding: Restitution and Unjust Enrichment

A. Gratuity or Exchange: Caring for Aunt Frances

Bascom’s Folly, Emergency Surgery

B. Mere Volunteers: Battling Alaskan Beetles

C. Trailing Promises: Lena Saves Lee’s Life

The Heroic Lumberman, An Escaped Bull

D. Novel Ideas: The Making of “The Sopranos”

E. Off-Contract Remedies: Rod Stewart at The Rio

6. Writing It Down: Interpretation, Parol, Frauds

A. Plain Meaning I: Eminem’s Digital Records

B. Plain Meaning II: Dan Rather’s Last Broadcast

C. Parol Evidence: The Golden Globes

D. Scrivener’s Error: Who Owns the L. A. Dodgers?

The Fraudulent Architect, The Erroneous Deed

E. Statute of Frauds: Cliff Dumas’s Phantom Radio Deal

Jane Fonda’s Luckless Agent, Elizabeth Arden’s Fortunate Hire

7. Performing: Duties, Modification, Good Faith

A. Implied Terms: Butch Lewis and Maya Angelou

Lucy, Lady Duff-Gordon

B. Express Terms: Clive Cussler’s Movie “Sahara”

C. Unanticipated Circumstances: Deutsche Building

Industrial Detritus, The Salmon Fishermen’s Threat

D. Accord and Satisfaction: Lady Gaga

The Disputed Home Improvements

E. Adjustment: Conan and “The Tonight Show”

8. Hedging: Conditions

A. Interpretation and Effect: Kevin Costner’s Bison

An Aborted Vineyard Sale, A Crop Insurance Caper

B. Order of Performance: Charlie Sheen and Warner

The Country Hotel Sale Bust, The Four-Stage Construction

C. Partial or Total Breach: Sheen and Warner II

An Accidental Bulldozing

D. Waiver: Sheen and Warner III

The Imbibing Professor

E. Substantial Performance: Sandra Bullock’s Lake House

Wrong Plumbing Pipes, Misplaced Walls, Unrestored Farms and Ungraded Gravel Lots

9. Considering Others: Third Parties and Society

A. Beneficiaries: Supply Chain Abuse at Wal-Mart

A Sweatshop in Brooklyn

B. Assignment: JP Morgan’s Cablevisión Loan

C. Interference: New England Patriots and StubHub

D. Torts: Katie Janeway’s Tragic Accident

Amnesty for Ordinary Negligence, A Misleading Authorization

Nondisclosure, Non-disparagement, and Contract Law

Dave Hoffman — Tue, 06 Dec 2011 18:52:15 +0000

In light of some of my previous posts on nondisclosure clauses and their enforceability, I thought readers might enjoy the following story:

“Robert Lee visited a dentist, Stacy Makhnevich, because he was suffering from a severe toothache, caused by a painful infected cavity. She refused to treat him until he signed a so-called “privacy” contract, which included a clause preventing him from posting negative reviews of her online. [The clause read: "Patient will not denigrate, defame, disparage, or cast aspersions upon the Physician; and (ii) will use all reasonable efforts to prevent any member of their immediate family or acquaintance from engaging in any such activity."]

More specifically, the contract stated that Lee would not publish adverse comments about Makhnevich’s performance online, and that he would assign the copyright of any online commentary that he did make to her (presumably so that she could have such commentary quickly and directly taken down if she found it objectionable).

Lee signed the contract. But later—after receiving a hefty bill for service that he viewed as problematic—he posted negative reviews of the dentist on Yelp.com and DoctorBase.com, despite the contract’s ban on such postings.

The Yelp.com review said: “Avoid at all cost! Scamming their customers!” The DoctorBase.com review was similar.

Lee claims that Makhnevich then– in an attempt to enforce the contract—tried to get Lee’s negative reviews taken down from the review sites. He alleges that she also started billing him $100, as a fine, for every day the reviews remained on the Internet. Moreover, Lee alleges, she refused to send copies of his billing records to him so that he could seek reimbursement from his insurer. Makhnevich also sent Lee a notice threatening a lawsuit. In response, Lee filed a lawsuit of his own.

Lee’s lawsuit calls the contract he signed invalid under state law as an unconscionable contract. The lawsuit also alleges that posting one’s own commentary on a website such as Yelp.com or DoctorBase.com constitutes “fair use” under the copyright laws.

In the suit, Lee asks that the agreement that he and other patients signed with his dentist be declared void and unenforceable, and that she be barred from requiring assent to these agreements by future patients.”

So many great issues here — the penalty/liquidated clause damage term; the privacy/nondisclosure nexus; the unenforceability argument coupled with a lurking first amendment claim. The story claims there’s even a consideration defense, though I can’t see how that’s really present on these facts.

As I’ve expressed before, I think these kinds of nondisclosure agreements are more difficult to enforce and obtain damages from than most conventional accounts would have it, and that they often function, like liquidated damages in general, to compel parties to engage in behavior that a court would not actually order. This case seems like a good test of my theory. I’m very glad that the Center for Democracy and Technology has taken up the battle.

(H/T: Reader T.G.)

Does the Secured Transactions Course Make Sense?

Dave Hoffman — Sat, 03 Dec 2011 04:54:32 +0000

I’ve never taught Secured Transactions, so I’ll start by saying that the following is purely speculative and subject to correction.

We had a job candidate come through at some point this Fall who generally is interested in the field of commercial law. That person mentioned in passing that although they were more than willing to teach the traditional secured transactions course, in their opinion it wasn’t well structured. Why? Not, as the navel-gazer might imagine, because the field of commercial law is supposedly intellectually dead. Rather because the traditional secured transaction course is too narrowly conceived — it usually is limited in coverage to personal property security interests under Article 9. But many security interests that matter to lawyers aren’t held on movable property. Since secured is ordinarily the foundational course for the commercial curriculum, students are left starting on too narrow a footing in understanding bankruptcy and bank regulation. It’s even worse than having a corporations course that excludes LLCs. Because of its technicality, ST is traditionally so difficult to teach that many students are turned off to the idea of commercial law practice at all.

Again, I don’t know much about this area of law. I never took ST in law school, I haven’t taught it, and (worse) I haven’t even read a ST syllabus at my current institution. But it struck me as an interesting thought, at least worth airing. It’s related to concerns I have about the general corporate curriculum — is “corporations” really a subject that ought to be taught in a single course, or is it really a merger of too many (or too few) legal principles that have glommed together over time. It’s also related to concerns that one might have about continuing to use the increasingly outdated, purportedly uniform, UCC to teach when States’ adopted versions are moving ever-further-away from that ideal.

“Mentoring” versus “Scamming”

Dave Hoffman — Wed, 23 Nov 2011 04:27:12 +0000

In law school teaching, as in dance competitions, it's important to know when to spin on a dime.

Today in Contracts, I taught Vokes v. Arthur Murray, 212 So. 2d 906 (1968). In Vokes, a “widow of 51 years”¹ sought to be relieved from her obligation to pay for dance lessons purchased from an Arthur Murray franchise. She claimed that the defendant had lied to her about her abilities as a dancer – and, significantly, exaggerated her improvement. She had an account with almost 2,000 hours of unused lessons outstanding, and she owed more than $200,000 (in 2010 dollars). Surprisingly, the court permitted that argument to go to a jury, reasoning that the studio’s superior knowledge, coupled with the defendant’s bad faith as illustrated by the facts, made this the kind of exceptional misleading “opinion” which might be actionable.

It’s a good teaching case. But it got me to wondering about an issue tangentially raised by David Segal’s embarrassingly error-ridden and ideologically charged series in the Times about legal education, and more forcefully by the equally thoughtful Paul Campos. Both argue (ironically) that law schools are contributing to the problems of the legal profession by not raising higher barriers to entry. Those barriers might be incidentally related to other worthy goals — experiential education, a single tenure system, and a more rigorous disclosure regime are all popular reforms that are very, very expensive.²But sometimes reformers make a more direct claim: like the Texas lawyers of the 1930s, they claim that “Our bar, already overcrowded, is held out as an asylum for the lame, and the halt, and the blind from the law schools of this country.” Law schools are failing students by encouraging them to apply (it’s a “scam”), taking their money (it’s really a “scam!”), not preparing them to practice (“scam! scam! scam!”), and then not supporting them in getting jobs (“SCAM!”)

But how far, I mused outloud in class, does this argument run? Let’s say a student comes to your office hours early in the Fall semester. They are lost. Really, desperately, lost. They are working all the time, but they can’t see the forest, the trees, the continent, the planet. Law’s greek to them. What to do? One view – let’s call this the Segal/Campos view – is that the morally right thing to do at that very moment is to 1) recognize that my livelihood depends on the students; 2) this puts me, like every provider of services, in a slightly compromised position when talking to a student about whether they ought to be in school; 3) realizing this, decide pretty quickly if I think that the student is a candidate for Bar passage and employment; 4) if not, tell the student that they’d be better off leaving school and pursuing other opportunities in today’s job market, or to take the Ayes-refund offer if it comes.

I have had this discussion with a handful of students over the last seven years, though always after the first semester and usually after a pretty lengthy exploration of their goals, resources and capabilities. But, to be honest, I am never sure if the talk is a good idea, let alone morally compelled. Putting aside Bar passage – and at Temple, I have that luxury as almost every student passes on their first try – I know that I have very little information early in a student’s career that will meaningfully predict if they can earn a living as a lawyer. I will know something after the first semester about if they’ll get a job at a large law firm. But that’s a narrow slice of jobs for all law school graduates outside of all but 10-15 schools (or, more precisely 5-10% of law school graduates). What I don’t know about students is their motivation; their people skills; their social connections; their ability to bounce back. In short, I know almost nothing about their human capital. And nothing in my training or teaching has made me particularly good at making snap judgments about that really hard to measure set of attributes. In fact, I know that I tend to overvalue a certain set of skills – intellectual, verbal, etc. – and discount social ones. This problem of mis-prediction is particularly acute early in the first semester. Many confused students turn it around. Some don’t. I have never been able to predict which will be which.3

So I encourage most students to persevere, to stick to it, to work super hard, to postpone good times and return again to the books. I tell them that the Law School’s most successful graduates got bad grades. (True, if success means money earned.) I tell them that I felt confused in my first semester. (True, and it’s also true that Contracts was my least favorite, and least understood, class.) I sometimes tell them they are improving though they aren’t – but only if they seem to me to desperately need some solace. (I never tell them that about their practice exams, in case my current students are reading this – you’ll get only criticism from me in the service of better final performance.) I often tell people that hard work and caring more than other lawyers is the path to success, though I know that in life, social connections, being good looking/tall, and luck probably play just as much if not a larger role. In short, I try to be a supportive mentor as much as I can, though I know, in grim probabilistic terms, that some students would be better off cutting their losses.

Should I feel bad that I encourage people who may not succeed? Should I start every conversation with a Vokesian disclaimer that is brutally frank about their current level of skill? I just don’t see it. That’s not, I think, what an educational institution is supposed to be about. We’re selling the possibility of self-improvement, and economic and social momentum. People need to believe in that possibility if they are to realize it: optimism actually makes people better, more competent, and more satisfied with their lives. There’s a corrosive cynicism in the “scamblogs” which would, I think, turn that idea on its head.⁴ We owe our students more.

Notes:

1. Is she a 51 year old widow? Or was she 51 years a widow? It’s not just Cardozo who can write lyrical sentences that are hard to parse.

2. That something is expensive doesn’t mean it’s a bad idea. But I fear that too often reformers in legal education (and elsewhere, of course) don’t think clearly or well about trade-offs. Making law school more expensive would be good for current incumbent lawyers. It would be bad for prospective lawyers and current clients. I’d prefer that law schools be regulated less, and for them to compete on price, disclosure, internal governance, and educational program. For those that say “why don’t they do so now,” the answer is “because the ABA doesn’t let them.”

3. Not knowing whether someone is going to succeed as a lawyer isn’t the same as not knowing how they are doing as a student, or the claim – obviously silly – that we can’t evaluate relative merit at some kinds of lawyer-relevant tasks. Law school sorts students by grades, and I’m committed to making grades pretty good reflections of how well students exercise legal judgment. The point is merely this: we ought to be humble in our predictions of how well our students will do once let loose in the world. We provide a knowledge base. The Bar Exam licenses. Neither guarantees success, happiness or wisdom. Even lawyers with fantastic legal judgment might not rake in cash.

4. Nothing in the above discussion at all approves lying about data. Or increasing tuition above inflation yearly. Or teaching the same thing as we did last year simply because …well…because we did it. Or being a nitwit, a bore, an ideologue, a lazybones, or a sociopath, unable to see the pain of students who can’t find jobs. I’m against being bad at your job, and I think that being good at your job means realizing that we are teaching people to be lawyers, and our students rightly expect that we set them up to succeed.

Headlines for Contracts Book

Lawrence Cunningham — Tue, 22 Nov 2011 11:48:45 +0000

Contracts in the Real World is the title of my next book, which Cambridge University Press will publish in the spring of 2012. It rips stories from the headlines about contracts disputes, showing how old-fashioned cases and doctrines still taught in law schools apply to cases arising every day in this country. (Contra the absurd claim made by David Segal’s infamous NYT piece denigrating the teaching of such old cases as Hadley v. Baxendale.)

I’ve written about the book’s purpose and apppeal elsewhere, including on this blog and at Conglomerate. We are now designing the cover and the creative folks at CUP imagine a headline collage, using actual or adapted headlines to indicate some of the stories and issues in the book. They invited me to make a list for the team to consider as they do this work. A draft follows. I’d welcome suggestions for improvement!

Mistaken Madoff Victim Wants Divorce Contract Do-Over

Donald Trump Says Recession Excuses Bank Loan Deal

Scrivener’s Error in Case of Who Owns the Los Angeles Dodgers

NBC Pays Conan $45M To Go

Charlie Sheen Settles Suit in “Two and a Half Men” Firing

Obama Tells Treasury to Block AIG Bonus Contracts

Paris Hilton Escapes Paying Damages in “Pledge This” Lawsuit

Washington Redskins Take Hard Line on Ticket Contracts

Courts Calls Sprint Fees for Early Contract Terminations Unreasonable

Rod Stewart Owes “Restitution” on Vegas Show Contract

“Sopranos” Creator Wins Contract Case as Jury Says Fuhgeddaboutit

Court Upholds Eminem Royalties Deal

Meaning of Golden Globes Contract Disputed

Boxing Promoter Fights Maya Angelou over Hallmark Cards Pact

Novelist Clive Cussler Breached “Sahara” Movie Contract

Kevin Costner Says Contract Gave Him Buffalo Sculpture

Cost Overruns in Sandra Bullock’s Lake House Contract

Michael Jordan’s Ex Loses Palimony Case

Judge Tosses Suit by 50 Cent’s Ex-Girlfriend

Lady Gaga Smells a Rat in Spat with Ex-Lover

Nondisclosure Agreements and Herman Cain

Dave Hoffman — Fri, 04 Nov 2011 03:32:44 +0000

Five Percent Chance of Being the Nominee. Zero Percent Chance of Recovering Damages in a Breach of Contract Lawsuit for Violation of an NDA.

Let’s pretend for a moment that Herman Cain had a legitimate chance of becoming the Republican nominee for President. Now imagine that he actually engaged in unlawful behavior toward at least one female employee of the National Restaurant Association. That employee would like to talk about what happened, but she is worried that she’ll breach a 1998 severance and nondisclosure agreement if she talks to the press.

Now, let our imagination run wild. The accuser – angered by Cain’s denials of bad conduct- decides to throw caution to the wind and go public. Her allegations are salacious & they portray Cain in the worst possible light. Notwithstanding her claims, Herman Cain actually gets a bump in the polling and becomes the nominee. During the general election campaign, other women come forward – sparked by the original accuser’s courage. Nevertheless, given the dominance of deterministic macro-economic factors over political strategy and common sense, Cain wins a tight election to become the next President of the United States. At that point, emboldened, he decides to sue the woman who released the information about him for breach of contract, on a theory that he was a third-party beneficiary of the nondisclosure agreement. (Let’s pretend that this is a doctrinal possibility.)

Last year, in a discussion with Larry Cunningham and Dan Solove, I argued that it’s exceedingly unlikely that any state court in the Union would award damages for breach of a nondisclosure agreement under circumstances like these, where (i) the information to be protected relates to sexual misconduct; (ii) the information is of immense value to the public at large; and (iii) it’s basically impossible for the promisee to prove damages with any certainty. I am still convinced this is true, and that the media too uncritically reports that parties are “bound” by NDAs that would have almost no effect if tested in Court.

This line of thinking makes me doubt that fear of a breach of contract lawsuit is playing any role at all in the refusal of Cain’s accuser to come forward. Rather, as her lawyer said today, she is afraid of the reputational damage that disclosure would bring, even if she’s entirely in the right.

Public Service Reminder: Baby Selling is Illegal.

Dave Hoffman — Wed, 05 Oct 2011 15:33:31 +0000

Yikes.

For less than the price of a new car, police said, Bridget Wismer, 33, of Brookside Park, Del., sold her month-old son to John Gavaghan, of Old Newtown Road near Tremont in Bustleton.

The transaction is believed to have occurred between Sept. 28 and Sept. 30, when police executed a search warrant on Gavaghan’s home and found him with the child, said Cpl. John Weglarz of the New Castle County, Del., police.

Police there said they began their investigation on Sept. 4, when members of Wismer’s family expressed concerns that she might be trying to sell the newborn to a man from Philadelphia.

Despite investigations and interviews, police were initially unable to confirm the allegations. Then Gavaghan was caught on video filling out papers about the sordid transaction while at Delaware Park and Casino in Wilmington, Weglarz said.

“It sounds ridiculous . . . but he was on video surveillance seen completing documents regarding the sale of a baby,” Weglarz said. “It was clearly visible.”

This kind of illicit and unregulated sale of children is, of course, exactly what Posner said results from the current adoption regime.

(H/T: Law student A.D.)

What is a treaty? Is that the right question?

Matthew Lister — Thu, 08 Sep 2011 10:02:34 +0000

(Thanks to Danielle and the Co-Op crowed for letting me stick around a bit longer.)

I am interested in how we should think about treaties. More specifically, I am interested in different ways we might think about treaties, and why different ways might be appropriate in different circumstances. At one extreme we might think of treaties as establishing sacred duties, as being based on oaths with deep religious implications. (Jeremy Waldon has a very interesting discussion of the history of this idea in his recent Charles E. Test lectures, “A Religious View of the Foundations of International Law”.) I think that there’s a case to be made that supposed principle of international law (or of natural law, depending on one’s account), pacta sunt servanda, depends on this understanding, though I won’t try to make that case here. (If so, this would be interesting in light of fact that Hans Kelsen at one point held, I believe, pacta sunt servanda to be the “basic norm” of international law, though he later abandoned this.)

At the other extreme we might think of treaties as being similar to contracts as understood by proponents of an economic analysis of law. This doesn’t seem plausible for some treaties, such as human rights treaties, but is not implausible in all cases, I’d argue. Something like this seems especially plausible in the cases of treaties relating to economic activity of the sort where something like expectation damages could be applied. Here’s an example of the sort of thing I have in mind, though others might work even better. In the “Beef Hormone Controversy”, the WTO Dispute Settlement Body found, and the appellate body upheld, that the EU was in violation of its WTO obligations in banning the sale of U.S. and Canadian beef that had been treated with certain hormones. The DSB authorized retaliatory tariffs against the EU, and these have been in place for some time. We might think of these tariffs as a punishment, meant to force the EU to live up to its moral obligations under the WTO treaties, but I think it might be more fruitful to think of them as damages that the EU has decided to pay rather than fulfill its contractual obligations. If the damages fully compensate the U.S. and Canada, then it is at least arguable that the E.U. has discharged its obligations under the treaty. (I should note that when I suggested this line of thought to David Unterhalter, then-chairman of the WTO appellate body, at a Salzburg Seminar session, he did not like it at all, though some of the junior WTO lawyers, as well as the director of economic research for the WTO, liked it more. Unterhalter’s objections, which I won’t go in to here, had some force, but didn’t seem to me to be decisive.)

Which view of treaties is right? I’d argue that that is the wrong question, and that we should ask instead when and why a particular approach is right. In particular, it seems to me that the traditional view has the most force when there is no independent body that can adjudicate disputes and try to enforce remedies, and that approaches that are closer to contract law become more appropriate when we have independent bodies that can determine damages and administer the enforcement of claims. There are more and more such bodies in international law, so we should expect to see the way we think of treaties change, at least for some treaties. There is a general moral we might draw from this line of thought, namely, that it will often be a mistake to ask about “the nature” of treaties (or of contracts, or of law in general) in the abstract, and that we should instead look carefully at how these ideas function in particular instances and locations. (This line of thought has some similarity, I think, with the approach Fred Schauer describes in his paper, “The Nature of the Nature of Law”, and in a more distant way, is relevant to Schauer’s re-assessment of certain aspects of John Austin’s approach to law.)

Murdoch’s Illegal Contracts

Lawrence Cunningham — Wed, 20 Jul 2011 11:59:15 +0000

Can you sell your silence, under English (or American) law? Rupert and James Murdoch’s News Corp. tried to buy the silence of victims of their phone hacking ring. To insulate their tabloid newspapers from reputational harm, the company signed what James calls “out of court settlements.”

Hush contracts were made with the English acttress, Sienna Miller, for £100,000 ($161,000) , and with the soccer union leader Gordon Taylor for £725,000 ($1.1 million). There are likely many such others , in which the paper paid cash in exchange for a victim promising to stay quiet. But are these contracts legal?

English (and American) law give a broad space for freedom of contract, and both give wide latitude for people to buy and sell silence. Confidentiality clauses are common in settlement agreements as well as a wide range of settings, from employment contracts and prenups to severance and separation agreements. Bill Gates even put one in his home builder’s contract! There is nothing about silence as such that makes them invalid.

But the law classifies some bargains as illegal and therefore invalid. In the case of contracts for silence, it draws the line at promises to hush up problems that threaten the public interest. In the United States, the law is quite clear that contracts to conceal criminal behavior are illegal and invalid.

Indeed, in the U.S., criminal law holds that a bargain to conceal criminal behavior, including by victims in making a contract of silence, is itself a crime.* In turn, contract law makes any such bargain invalid and unenforceable.**

As a result, under American law, at least, the Murdoch silence contracts are probably invalid and illegal. If English law works the same way, the next questions are whether the victims should be prosecuted criminally and whether the paper may recover the payments made in restitution. The paper should decline any restitution, of course, and the money should go to scholastic programs to promote public ethics.

Other victims should learn from this tawdry affair and come forward with evidence of crimes such as phone hacking and not accept money for silence. They would follow the example of Buckingham Palace, whose reporting of News Corp. violations in November 2004 is the ultimate cause of the Murdoch downfall. (The paper’s jailed writer, Clive Goodman, and a private investigator, Glenn Mulcaire, who also did jail time, reported hacked information about Prince William’s injured knee!)

Whilst the press, police, politicians and public in Britain are ashamed at what they have done to themselves, the Royal Family has thus set an admirable example. They say the Royals are an anachronism; I say Long Live the Queen.

__________

* Model Penal Code : “A person commits a misdemeanor if he accepts or agrees to accept any pecuniary benefit in consideration of refraining from reporting to law enforcement authorities the commission or suspected commission of any offense or information relating to an offense.” [PS: See Orin Kerr's response #1, below, and my response #2 , about the standing of this provision.]

** Restatement (First) of Contracts: “A bargain in which either a promised performance or the consideration for a promise is concealing or compounding a crime or alleged crime is illegal.” [The Restatement (Second) of Contracts dropped this explicit statement, referencing instead the Model Penal Code provisions.]

Losing the Wall St. Journal

Lawrence Cunningham — Fri, 15 Jul 2011 14:34:59 +0000

My friend Rob Cox of Breaking News offers an interesting perspective in today’s New York Times on the Rupert/James Murdoch scandal. It addresses The Wall Street Journal and an integrity clause in an agreement governing it.

The once-venerable Journal, long privately owned by the Bancroft family’s Dow Jones & Co., was revered for excellent reporting and astute coverage of business and world affairs. In 2007, the Bancrofts sold Dow Jones and the paper to the Murdoch tabloid empire, News Corporation, for $5 billion.

The sale was controversial among readers, journalists and editors of the Wall Street Journal. Murdoch’s raunchy and pugnacious style did not mix well with the high standards at the Journal of integrity in reporting and general refinement in opinion making.

To ease the concern, the merger agreement between Dow Jones and News Corporation required execution of an Editorial Agreement. It created a watchdog committee to uphold the Journal’s traditional “principles of integrity” and maintain its longstanding Code of Conduct.

Cox wonders whether that committee has contractual powers to address any violations at the paper and other Dow entities committed by the Murdochs, News Corporation, current managers of Dow, or editors or writers at the Journal. Cox says the phone-hacking crimes the News Corporation papers committed in the U.K. “arguably violate” those principles. If so, the committee ought to get cracking.

But I’m not sure that criminal violations of the phone-hacking sort are what the provisions of the Editorial Agreement were intended to address. Rather, they seem to address journalistic valor of the sort the Journal has gradually and steadily been sacrificing since 2007.

The committee has had clear authority to assert itself in those matters but has not corrected the slide. It is not obvious why it would rise now when its authority to act is far less certain. Put another way, it may be too late to save the Wall Street Journal from the effects of Murdoch ownership.

Excerpt from the Editorial Agreement

Section 2.1(e) provides:

The Company has adopted and shall maintain a set of principles aimed at ensuring the preservation of the integrity, editorial independence and freedom from bias of its publications and newsgathering services . . . These principles will ensure that in all publications and news gathering services of the Company and the Dow Jones Publications:

(i) facts are accurate and fairly presented;

(ii) analyses represent the publications’ best independent judgments rather than their preferences, or those of their owner, sources, advertisers or information providers;

(iii) opinions represent only the applicable publication’s own editorial philosophies centered around the core principle of “free people and free markets”;

(iv) there are no hidden agendas in any journalistic undertakings; and

(v) accuracy and fairness extends to coverage of any real or perceived business interests of the Company or its Affiliates.

Section 2.1(f) adds:

(f) The Company’s principles set forth in Section 2.1(e) shall apply, and the Dow Jones Code of Conduct relating to appropriate professional conduct, as amended January 21, 2004 (the “Code of Conduct”), shall continue to apply. . . . [The Code of Conduct is here and does prohibit unbecoming conduct that would undoubtedly include violations of law but that is merely restating the obvious and is not the thrust of the Code.]

HAT TIP: Stephanie Cuba

Kevin Costner’s Bison

Lawrence Cunningham — Sun, 10 Jul 2011 13:46:04 +0000

The movie star, Kevin Costner, who is also a hospitality entrepreneur, won a round last week in a lawsuit disputing what’s to be done with an elaborate ensemble of sculptures he commissioned years ago for a luxury resort he has fantasized about but never built. The court made the issue sound simpler than the parties thought it was and the opposing lawyer promises an appeal.

Costner’s fantasy, inspired by his heroic 1990 film “Dances With Wolves,” in which he starred as Lt. John J. Dunbar, imagined a 5-star hotel in the Black Mountains near Deadwood, South Dakota. For the centerpiece of the resort, to be called The Dunbar, Costner commissioned 17 massive bronze sculptures, assembled as the “Lakota Bison Jump,” from the noted local artist Peggy Detmers.

They depict 14 bison and three Native Americans hunting them on horseback, at 125% of life-scale. Costner initially commissioned the sculptures in 1994 under an oral agreement, paying Detmers $250,000. The two agreed to share royalties from sales of reproductions of the sculptures, which they expected would generate millions more.

By 2000, however, the Dunbar resort was not yet underway, and Detmers became anxious about whether her sculptures would be displayed and royalties on sales begin to flow. Costner reassured her in a two-page letter of May 2000, which included the following language whose meaning the parties have been disputing:

Although I do not anticipate this will ever arise, if the Dunbar is not built [by 2010] or the sculptures are not agreeably displayed elsewhere, I will give you 50% of the profits from the sale of the sculptures.

In 2002, Costner put the sculptures on the land where the resort was to be built, where they remain today, as a stand-alone visitors’ center, called Tatanka. The luxury resort remains a fantasy in Costner’s mind.

Detmers said that Costner is therefore now obliged to sell the sculptures, which she supposes could fetch some $4 to $6 million, and split the proceeds with her. Costner responded that he never promised to sell the sculptures, only to split the proceeds if he decided, in his sole discretion, to sell them.

The court found a shorter way through that disagreement: the sculptures are “agreeably displayed elsewhere,” at the visitors’ center, so the meaning of the phrase about selling them need not be determined.

Detmers complains that the sculptures are not “displayed elsewhere” because they are displayed on the Dunbar plot, not “elsewhere.” The judge reasoned differently, saying because the Dunbar was never built, the sculptures are “displayed elsewhere.”

The judge also bought Costner’s view of events in 2002 to conclude that Detmers had agreed on the display at the visitors’ center. No wonder the appeal.

Detmers stresses that her deal was to make the sculptures for a discounted up-front price, capturing the bulk of value from sales a 5-star resort could produce.

Compared to the wealthy patrons of the grand resort Costner envisioned, visitors to the small-scale visitors’ center are unlikely to order lucrative reproductions of Detmers’ sculptures. She understood that placing the sculptures at Tatanka was temporary, pending completion of the Dunbar.

I wonder what others think: is the judge right about the meaning of the word “elsewhere” in Costner’s letter? If not, is Detmers or Costner right about how to interpret Costner’s language about selling the sculptures.

Hat Tips:

Andrea Cook & Andy Damgaar

Divorce Law Beats Fraud, Maybe Contract

Lawrence Cunningham — Thu, 23 Jun 2011 22:12:10 +0000

We’ve debated whether mutual mistake is a ground to rescind divorce settlements dividing marital property based on an account held with Madoff. The New York Court of Appeals will soon decide in the case of Simkin v. Blank.

As a matter of contract law, in my opinion, they should be rescindable, when people cannot reasonably be supposed to have allocated the risk that an account was fraudulent.

As I noted in Peter Lattman’s N.Y. Times story on the pending Simkin case, the real policy debate pits principles of contract law, about protecting party risk allocation, against principles of domestic relations law, where the finality of divorce settlements might warrant upholding even such mutually mistaken contracts.

The New York Court of Appeals today issued an opinion, CFTC v. Walsh, with clues about this balance. Today’s divorce settlement case involves an innocent spouse who received millions of dollars from an ex who allegedly committed a spectacular securities fraud (amounting to some $550 million).

Federal agencies want to recover the property from the innocent spouse. The defense: the millions counted as marital property and the settlement agreement makes it hers, even if fraudulently obtained and once belonging to innocent victims.

The Court thus weighed whether to privilege the public policy intended to restore stolen property to rightful owners or the one favoring finality of divorce settlement agreements.

The federal agencies thought you could split the baby: stress the finality of divorce settlements, but make a narrow exception for proceeds of certain kinds of fraudulent activity.

The Court noted how appealing the argument was, but rejected it, putting the finality of divorce agreements first. Here is a flavor of the reasoning:

Ex-spouses have a reasonable expectation that, once their marriage has been dissolved and their property divided, they will be free to move on with their lives. To hold that the proceeds of fraud acquired by one spouse unbeknownst to the other cannot be subject to equitable distribution or conveyed through a settlement agreement as marital property would undermine one of the fundamental policies underlying the equitable distribution process, namely finality. The exception proposed by the [federal authorities] would effectively undo court orders and settlement agreements.

If divorce law warrants such priority over fraud law, it seems even easier to say that divorce law should get priority over contract law. If so, in Simkin v. Blank, even if contract law’s doctrine of mutual mistake were compelling to rescind a divorce settlement, it would yield to the pro-finality policy of the domestic relations law.

The only caveats stated in today’s opinion: the receiving spouse must indeed be innocent, having received the property in good faith on the basis of fair consideration. This is the “good faith purchaser for value” defense of commercial law, and the subject of the second half of today’s opinion.

The agencies denied the possibility of giving “fair consideration” for property obtained illegally, calling any such consideration supporting the divorce settlement “illusory.” Giving up claims to additional slices of fraudulent assets won’t do, the court agreed, noting that would be illusory and the proceeds recoverable despite the divorce settlement.

But, the court added, many other forms of consideration would count as “fair consideration” in divorce settlements, such as ceding claims to other assets, releasing claims or relinquishing child custody. That’s true even if the bulk of the consideration is giving up claims to additional fraud-tainted assets.

In short, claims of fraud victims warrant protection but so do those of innocent spouses making divorce agreements without knowledge of a spouse’s fraud. The court stressed that it will not enforce collusive divorce settlements, of course. But it didn’t probe exactly what sort of ignorance makes for an innocent spouse. Does burying one’s eyes and ears work?

A dissenting judge would have held that an innocent spouse does not give “fair consideration” when settling a divorce in which the bulk of the consideration is giving up claims to additional amounts of fraud-tainted assets, even if you can point to other dribs and drabs of rights ceded or claims released.

The case now heads back to the federal courts, as this opinion addressed two certified questions raised in the federal fraud proceeding, brought by the CFTC and SEC. CFTC v. Walsh, 618 F3d 218 (2d Cir.2010).

Hat Tip: Peter Lattman (N.Y. Times)

Treasury’s AIG Gag Order

Lawrence Cunningham — Tue, 21 Jun 2011 18:37:44 +0000

Top business executives in the United States regularly contact Members of Congress to lobby on legislation and other matters of public policy. But since the September 2008 government takeover of AIG, executives of that company have been forbidden to do so, unless they first get the Treasury Department’s permission, and the Treasury Department refuses to grant it.

Since AIG executives are afraid to speak out, disclosure of this un-American provision was left to Maurice (“Hank”) Greenberg, former chair and until 2008 the largest shareholder of AIG. He disclosed it yesterday on CNBC.

This is yet another example of the dubious tactics used in Sept. 2008 by Hank Paulson and Tim Geithner when they wrested control of AIG for the U.S. government. Besides having scant legal authority for their takeover actions, the successive Treasury Secretaries tried to keep from the public how the government funds injected into AIG did not support it or its shareholders or employees but were funneled as a backdoor bailout of Goldman Sachs and other Wall Street firms.

It is thus par for the course—but equally outrageous—that we now learn that when Paulson and Geithner imposed this straightjacket on AIG, they also made the company (a) adopt a policy suspending all lobbying and then (b) sign a loan agreement prohibiting it from changing that policy without Treasury’s consent—which apparently may be withheld for any reason or no reason.

Mr. Greenberg, who had run AIG for 40 years and lost his personal fortune of $2 billion to the government takeover by Paulson and Geithner, said of this gag order on MNBC yesterday: “It’s incredible. It’s hard for me to believe it happens in America, where you first impose terms on the company by making them a bridge loan, at usurious rates, and then say to the company you can’t lobby any member of Congress to bring about any kind of change whatsoever.” (MNBC Interview, at about 3:50 / 8:26.)

The audacity of Treasury’s original inclusion of these provisions may only be outmatched by its current strict interpretation and stubborn stance. I understand that the Treasury has told AIG’s management that the lobbying policy (excerpted below) prohibits AIG from talking to Members of Congress regarding the terms of the government’s AIG bailout. Apparently the Treasury contends that any such discussions would be lobbying for legislation!

Heated discussions between AIG management and Treasury are ongoing. If this upsets you, call your Member of Congress!

__________

AIG Lobbying Policy: ”All federal lobbying activities by AIG or its representatives related to advocacy on legislation, as well as political contributions on behalf of AIG, and including the operation of AIG’s political action committee, are suspended.”

Section 6.04(e) of the Treasury-AIG Recapitalization Agreement: ”Restrictions on Lobbying. AIG shall continue to maintain and implement its comprehensive written policy on lobbying, governmental ethics and political activity and distribute such policy to all AIG employees and lobbying firms involved in any such activity. Any material amendments to such policy shall require the prior written consent of the UST and any material deviations from such policy, whether in contravention thereof or pursuant to waivers provided for thereunder, shall promptly be reported to the UST. . . .”

Transactional Lawyering at the Movies

Dave Hoffman — Thu, 02 Jun 2011 18:12:59 +0000

I’m looking for some good examples of movie clips from recent films in which the presence (or absence) of transactional lawyering is key to the action. The best example I’ve got so far is from the Social Network. Recognizing that showing clips of business lawyering isn’t for everyone, I’d still appreciate your tips. Negotiation scenes, drafting discussions, closings — anything that would motivate student excitement about transactional practice.

Analysis of Simkin v. Blank

Lawrence Cunningham — Tue, 31 May 2011 22:17:54 +0000

The front page of the New York Times (May 31, 2011) contains a great story by Peter Lattman, quoting me, on the pending case of Simkin v. Blank. The question is whether a divorce agreement based on the assumed existence of an invstment account with Bernie Madoff’s firm can be rescinded due to mutual mistake.

A few of the many comments on Mr. Lattman’s article disagree with my quote in the article that the case is strong for mutual mistake. Absent space in the New York Times to explain, following is an elaboration of this position. It is one of the 45 stories about recent contracts disputes in my forthcoming book, Contracts in the Real World: Stories of Popular Contracts and Why They Matter (Cambridge University Press 2012).

Among investors stung by Madoff’s scam were Steven Simkin, a prominent New York real estate attorney with the firm of Paul, Weiss, Rifkind, Wharton & Garrison, and Laura Blank, a distinguished lawyer working for the City University of New York and heiress to the fortune of the neckwear manufacturing company, J.S. Blank. After 30 years of marriage and raising two children, Steven and Laura separated in 2004, not long after Laura’s mother had died. To finalize their divorce, on June 27, 2006, Steven, who lived in Scarsdale, and Laura, who lived in Manhattan, signed an agreement dividing their property.

In their negotiations, the couple listed their marital assets, including four cars, the Scarsdale and Manhattan homes, and millions in bank, securities and retirement funds, including their investments with Madoff. The homes and cars aside, it appeared that the couple’s total assets amounted to $13.2 million. The agreement provided that Steven would keep most assets in exchange for paying Laura $6.6 million in cash. Thirty months later, when Madoff’s Ponzi scheme was exposed, they discovered that the value of the investments was overstated by $5.4 million because of it.

After Madoff confessed, Steven wanted to rescind the settlement agreement with Laura and redo that part of their deal. He also wanted payback from Laura of $2.7 million, half the amount of their earlier valuation of the Madoff account. Laura refused. Steven said the $5.4 million was a fiction, though they did not know it in 2006. So, Steven argued, Laura got a windfall. For her part, Laura argued that they were not mistaken at all in 2006, because the account did exist then. From Laura’s perspective, the losses arose only in late 2008 after Madoff confessed. By 2008, of course, Steven was the account’s sole owner. Though a superficially close case, Steven had the better of the argument.

People entering bargains are generally held to them, but an exception applies if both parties were mistaken when they made their deal about a basic assumption that materially affects the exchange. In such situations, under the doctrine of “mutual mistake,” either side can void it, so long as the risk of the basic assumption was not taken by one party, but agreed to by both.

A good example involved a coin deal. Beachcomber Coins paid $500 to another coin dealer, Boskett, for a rare dime supposedly minted in 1916 at Denver, signified by a “D” etched on the coin’s reverse (“tails”) side. Boskett had acquired the dime, along with two modest coins, for $450. He told a Beachcomber representative he would not sell it for less than $500. The representative studied the coin before buying it.

Afterwards, another buyer offered Beachcomber $700 for it, subject to getting a genuineness certificate from the American Numismatic Society. The Society declared that the “D” on the coin’s reverse side was counterfeit. Beachcomber wanted to rescind its deal with Boskett, citing mutual mistake. Boskett refused, claiming that customary coin dealing practice called for dealers buying coins to do their own investigation and take all risks: caveat emptor, Latin for “let the buyer beware.” The New Jersey Supreme Court held that the case fit the mutual mistake excuse to a tee, and, accordingly, rescinded the sale.

Both sides assumed the coin was a genuine Denver-minted dime. This assumption was central to the pricing and both were mistaken about it. True, contracts can allocate risks of mistake to one side or the other. That happens when parties throw up their hands about whether some assumption is true or false. When people say things like “we’re not sure,” “we’re uncertain,” or “it’s a matter of judgment,” they are consciously allocating a known risk.

In the coin case, however, both sides committed to a specific deal about mintage, neither indicating uncertainty about its authenticity and both assuming the coin was the real thing. Two factors reveal that both parties thought the coin was real: one, Boskett bought the coin for just less than $450, and two, Beachcomber’s rep examined it for some time and then forked over the hefty price. . . .

The Madoff account is much like the dime. The parties in each case thought something was real—an account with securities in it, a dime minted in Denver. Both were mutually mistaken because of someone else’s fraud and traded something different from what they thought they were swapping. Enforcing either contract would let happenstance of fraud, rather than intention, determine what bargains are made and how gains are distributed.

Neither case involves questions about what the dime or the account are really worth, how value fluctuates in markets, or how different people may assign different values. A mere change in the market value of exchanged property does not justify excuse for mutual mistake. Beachcomber couldn’t rescind its coin deal by saying the rare coin market had plummeted and Steven couldn’t rescind his agreement with Laura based solely on a decline in the stock market.

Laura said there was no mistake when she and Steven signed their contract in 2006. They thought there was an account and there was, she said. Steven withdrew funds from it in 2006 and added funds before 2008. An account can exist although money deposited into it is not the same money that is paid when funds are withdrawn. Even after December 2008, the account “existed” in many senses. The account was the basis for Madoff customers to claim under a securities investor protection fund and it determined which customers had to return redemptions to the fund. . . .

Steven countered that the case was a “textbook example of a mutual mistake.” If a real account existed, there would be no mutual mistake, Steven allowed, and value declines his risk to take. But no real account ever existed. It was irrelevant whether the fictional account had some value for some time. Though withdrawals could be made, the money would have been stolen from others. . . .

By textbook example, Steven had in mind the landmark case that put mutual mistake firmly on the books. It involved the sale of a blooded, polled Angus cow named “Rose 2d of Aberlone.” Both parties, the seller Hiram Walker, who ran the liquor business that distributes Canadian Club Whiskey, and T.C. Sherwood, a prominent banker who became Michigan’s first banking commissioner, assumed the cow was barren and useless as breeding stock. The contract price was $80. Right before the cow was to be delivered, however, she produced a calf.

Now valued as a breeder, Rose 2d of Aberlone was worth $750. The court held that the seller could rescind, as the mistaken belief that the calf was barren was the basic assumption of the deal, indicated by the pricing of the cow, showing that the two had a specific set of bovine attributes in mind that turned out to be incorrect. Mutual mistake applied because mistaken beliefs about a bargain would result in the incorrect distribution of benefits.

The same was true in the case of Steven and Laura. Their bargain was to split economic value both parties thought to be $5.6 million. They were both innocently mistaken about that. In reality, there was nothing to split. There were no investments, securities, or returns or losses, and without those attributes the idea of an account is a nullity. Fraudulent institutional account statements are not a risk parties reasonably perceive or should prudently guard against in forming contracts. To hold parties to those terms after discovering the error is to hold them to a bargain they did not intend to make. . . .

[The piece goes on to discuss a renowned case about violins, which Mr. Lattman referenced in his New York Times piece, where both parties vouched that they were buying and selling a Stradivarius that turned out to be a fake, illustrating mutual mistake as a basis to rescind a contract.].

Like the violin case or the cattle deal, Steven and Laura’s divorce settlement agreement was a model case of mutual mistake, resulting in rescission. Though ancient cases put caveat emptor in a rarified place, modern doctrines mediate it. Bargains today that amount to happenstance, rather than actual intentions of both parties, can be rescinded. When parties make a deal based on a shared central assumption that proves to be wrong—whether the parties are coin dealers, cattle traders, violin collectors, or divorcees—they are entitled to rescind it. The doctrine of mutual mistake protects the benefit of bargains people intended to make while freeing them from those they did not.

Cases:

Beachcomber Coins, Inc. v. Boskett, 400 A.2d 78 (N.J. 1979).

Sherwood v. Walker, 33 N.W. 919 (Michigan 1887).

Smith v. Zimbalist, 38 P.2d 170 (Cal. App. 1934).

Pareto in Practice

Andrew Sutter — Wed, 18 May 2011 16:48:08 +0000

It’s not everyday that textbook law and economics concepts have a practical application. But a nice little object lesson came up recently in my practice. It’s a classic case of Pareto inefficiency, or suboptimality – arising entirely from the way lawyers chose to draft a contract. The true life case study is after the fold.

Green Co., a Delaware corporation, had been spun out as a dividend from an older privately-held company based in New York City. So it began life with a couple of dozen shareholders on three continents. I represented one based in Japan, who held 200 shares, well under 0.5% of the outstanding; some people held even less. The new entity set up its offices in Toronto, Canada, and a law firm there acted as main counsel. (The vast majority of the shareholders were not Canadian.) Recently Green had a round of venture financing. In addition to buying newly-issued shares, the investors offered to purchase up to US$10 million of shares from existing stockholders, who were invited to tender either at least 250 shares or, if they held fewer than that number, 100% of their holdings. If the offer was oversubscribed, all sellers would be reduced pro rata. In this case, the total tendered came out to roughly $15 million at the deal’s price per share, so each seller was cut back to roughly 2/3 of the number of shares tendered.

The timetable worked this way:

Friday, ___ 1st, 17:00 EST: Deadline to deliver notice of tender by email or fax, stating number of shares tendered;
Monday, ___ 4th, 17:00 EST: Email distribution of Stock Purchase Agreement (SPA) to selling stockholders, indicating the number of shares being sold by each Seller, reflecting oversubscription reduction;
Friday, ___ 8th, 17:00 EST: Deadline to submit signature page and “duly endorsed” share certificate (or affidavit of loss) by emailed scan/.pdf or by fax;
Friday, ____ 15th, 17:00 EST: Deadline for originals of sig page and endorsed certificate to be received by Escrow Agent (Green Co.’s outside law firm).

The SPA included this provision about the closing:

“2.6 At the Closing:
“(i) the funds received by the Escrow Agent from the Purchasers will thereupon be held in trust for the Sellers, each of whom instruct the Escrow Agent, subject to subsection 2.6 (iii), to remit such Seller’s portion of the purchase price solely upon receipt by the Escrow Agent of the original of the stock certificate duly endorsed by such Seller representing the Securities sold by such Seller or an affidavit of loss in respect thereof;
(“ii) subject to the terms and conditions hereof, the Escrow Agent shall hold in trust for each of the Purchasers duly executed stock certificates representing the Securities purchased by such Purchaser, registered in the name of such Purchaser, and, subject to subsection 2.6 (iii), shall expedite same by no later than [Monday, Week 4]; and
“(iii) In the event that, for any reason whatsoever, the Escrow Agent has not received, before 5:00 p.m. EST on [Friday, ___ 15th], any original stock certificates duly endorsed by Sellers in whose name such certificate is registered or original affidavit of loss in respect thereof, the purchase and sale of the Securities represented by such certificates shall thereupon be deemed to be null and void, and (a) the number of Securities purchased by the Purchasers as set forth on Schedule B hereto shall be reduced accordingly and proportionally between all Purchasers, and (b) the Sellers having failed to so deliver such originals irrevocably instruct the Escrow Agent to return to the Purchasers such Sellers’ portion of the purchase price held in trust.” (Emphasis added.)

So far, so good. The first hiccup came when tried to figure out what “duly endorsed” meant. We realized on the 7th Japan time (Thurs.) that the SPA was silent on that point. Clearly, it wouldn’t do for the stockholder to just sign and fill in the number of shares, and then send it in: not only does that mean that the next person who handles it could cause shares to be transferred to himself or herself, but most common carriers, including Fed Ex, won’t carry such “endorsed stock certificates” – and this puppy had to get to Canada. I emailed the lawyers, and got an apologetic reply and instructions on how to fill in the blanks for the recipients’ name and the name of an attorney-in-fact for transfer. We met the Friday deadline for electronic delivery. But it was too late to send the original certificate and sig page out by carrier until after the weekend (Japan being 14 hours ahead of EST).

A bigger hiccup came when my client went to Japan Post on Monday. Delivery of “documents” to Toronto took only three days, so there was an extra day’s margin. But he had to fill out a customs declaration – which agitated first him and then the JP staff he was talking to. I had to go there myself and explain in my broken Japanese why the certificate was less negotiable than a money order. But we could only pray that the way we described the contents on the airbill (“Stock certificate – NON-NEGOTIABLE”) would reassure Canadian customs officials. Needless to say, the Canadian lawyers hadn’t provided any guidance on how to finesse this description. And lots of selling stockholders would be in the same boat.

What would happen if the package were in Canada, but stuck in customs when the 5:00 PM Friday deadline passed? A look at the SPA wasn’t reassuring. Section 2.6(iii) said that if there was a delay “for any reason whatsoever,” the sale would be rescinded. There wasn’t any force majeure clause (while customs delay might not count as force majeure, we were lucky that there wasn’t another huge earthquake). And as for waiver, the SPA said this, in relevant part:

“6.4 Amendment and Waiver. Any provision of this Agreement may be amended and the observance thereof may be waived (either generally or in a particular instance and either retroactively or prospectively), only by the written consent of the Sellers, the Purchasers and the Company.”

In other words, just to cut my client, or some other unlucky stockholder, a break, all the sellers and all the purchasers, plus the Company, would have to sign something in writing. Fat chance. If a seller’s certificate was stuck in customs, then by the terms of the SPA the deal would almost certainly unravel as to his or her shares.

How did my client find himself in this predicament? My client steamed that it was all the lawyers’ fault. If they had included an adequate definition of “duly endorsed,” we wouldn’t have lost a day or more. And if they had given non-Canadian sellers a head’s-up about clearing Canadian customs, we wouldn’t be biting our nails. Maybe some readers will look at things differently: after all, it was incumbent on the stockholder to read the SPA immediately and identify any problems — then he could have gotten endorsal instructions a couple of days sooner. And he could have chosen a more expensive, but faster, method of shipment. (Though each of these measures might only have improved his odds as to timely customs clearance – for all anyone knew, that might take a week or more).

To see where Pareto comes in, let’s review some economic terminology. Given a couple of situations, X and Y, you can call X “Pareto superior” if at least one person is better off in X than in Y, and if no one is better off in Y than in X. If there isn’t any other available situation that’s Pareto superior to X, we can say X is “Pareto optimal” or “efficient.” And of course Y would be “suboptimal,” or “inefficient.”

Now consider this case: Each Seller wants to sell his or her shares — and the Purchasers want to buy them. Rescission of the sale means not only that the individual Seller doesn’t get to sell, but the remaining Sellers don’t pick up the slack – the amount each of them sells remains fixed at the amount specified in the SPA (and indicated in the endorsement on their respective stock certificates). So the rescission means the Purchasers can’t buy as many shares as they were hoping to do. That is, it’s a lose-lose. No one is better off, and some people on both sides of the deal are worse off. On the other hand, allowing some grace period so that the sale can go forward doesn’t make anybody worse off, and makes people on both sides of the deal better off. (I’m not saying the same would be necessarily true if the deadline for the closing were extended forever — I’m just talking about some wiggle room.) So giving the sale a chance to go forward is “Pareto superior” to the way things play out under the SPA, which is “inefficient” by comparison.

And the source of this inefficiency? The gratuitously hardball language in the contract — courtesy of the lawyers on the deal.

Gratuitous, because the drafters could have chosen language to make rescission less automatic, or easier to waive. For example, there could have been a provision that if a Seller sent in the certificate by traceable means and the package were determined to be in customs at the deadline, there would be a grace period of __ days. Or that the deadline provision in 2.6(iii) could be waived in a writing signed by the Purchasers only (much less difficult, since they weren’t so numerous).

Were the lawyers in this case incompetent? I don’t think so – more like very typical, in my experience. In the name of a different sort of “efficiency,” they simply redacted some earlier agreement, probably from an entirely domestic U.S. deal. The problems we encountered were subtle ones, and unlikely to have been very obvious to the lead sellers and purchasers who did negotiate the deal (assuming this SPA was even negotiated at all).

A real pitfall is that phrases like “for any reason whatsoever” have a certain grandiloquence that lawyers tolerate without hesitation. Most lawyers are proud that they have the patience to read, and the muscular fingers to write, pompous stuff that makes lesser mortals’ eyes glaze over. And such language shows that the contract “means business” (with the connotations of ‘tough’ and ‘serious’) or, to use a more contemporary idiom, that it “creates incentives for compliance.” The irony is that such provisions can be entirely contrary to the business of the parties. The usefulness – albeit very narrow, I suggest – of doing a Paretian reality check from time to time while drafting a contract is that it can help you to distinguish language that merely strikes you as pleasingly orotund or appropriately incentivizing from language that actually helps the parties to do the deal they want to do.

Help Wanted: Editing Contracts Monograph

Lawrence Cunningham — Mon, 16 May 2011 22:10:36 +0000

I’m seeking editorial assistance from a few good Contracts scholars to provide a substantive review of the manuscript for my newest book, provisionally entitled Contracts in the Real World: Stories of Popular Contracts and Why They Matter (noted here).

The manuscript, now nearly complete to become a 240-page book, has been professionally edited for content and style, is trimmed to scale, and earlier chapter drafts have been read by a half dozen colleagues and several anonymous peer-reviewers. At this near-final stage, I’m looking for overall substantive evaluation, including not only correcting errors and minimizing unnecessary quibbling, but promoting the work’s utility to teachers of contracts and their students.

I would be delighted by anyone volunteering to read a few chapters to provide feedback, but am also prepared to pay a stipend (from my advance) for a more rigorous read of the full manuscript giving specific corrections, observations and suggestions. Any Contracts professor interested in either role, please email me: lacunningham@law.gwu.edu, letting me know.