Having advanced that research, I find that a handful of identical contracts that pass corporate law’s waste test would fail contract law’s unconscionability doctrine in most states—though not Delaware’s, where contractual unconscionability law is practically as anemic as its corporate law of waste.

So I’ve focused on whether there is a route to scrutinize some classes of Delaware corporate board decisions under the contract law of another state rather than the corporate (or contract law) of Delaware. An important class concerns executive compensation, particularly stock option pay.

Delaware judges [...]]]> In a post last summer that attracted helpful comments, I reported on research investigating whether corporate board decisions costing enormous resources for negligible gain, that invariably pass the anemic corporate law waste test, could be challenged under contract law’s unconscionability doctrine.

Having advanced that research, I find that a handful of identical contracts that pass corporate law’s waste test would fail contract law’s unconscionability doctrine in most states—though not Delaware’s, where contractual unconscionability law is practically as anemic as its corporate law of waste.

So I’ve focused on whether there is a route to scrutinize some classes of Delaware corporate board decisions under the contract law of another state rather than the corporate (or contract law) of Delaware. An important class concerns executive compensation, particularly stock option pay.

Delaware judges applying its corporate law do nothing to police these.  There is a way that courts of other states could provide scrutiny by applying their doctrine of contract unconsionability to obnoxious stock option pay contracts.

Challenges to corporate pay decisions are invariably seen to involve the internal affairs of a corporation. The story usually is that the arrangements involve boards seeking to align executive incentives with shareholder interests.

That implicates a conflicts-of-law principle making applicable the law of the corporation’s state of incorporation. Under Delaware corporate law’s anemic waste doctrine, that means the case is a loser.

The pay cases also invariably assert claims against the corporate board that authorized the compensation and seek damages for fiduciary breach. That means the case is classified as a derivative shareholder suit.

Under Delaware law, that classification puts most power in the board rather than shareholders. The board can take charge of the lawsuit, investigate it, and recommend its dismissal, which Delaware courts are inclined to grant under Delaware corporate law.

These obstacles to judicial scrutiny of stock option pay contracts can be overcome. First, everyone now knows that stock option pay contracts do not align manager and shareholder interests. By riveting managerial attention pathologically on stock price, manager incentives actually diverge from shareholder interests.

Today, the better rationale for stock option pay is to attract and retain managerial talent. That removes the contract from the realm of internal corporate affairs and makes it like all other external corporate contracts. Governing law is not determined by the internal affairs doctrine, but according to factors like the place of contract formation and performance.

Second, shareholders challenging stock option pay contracts as unconscionable would not sue the board seeking damages for breach of duty that make the claim derivative. They sue the executive, seeking a declaration of contractual unconscionability and the remedy of rescission (plus, if amounts have been paid, restitution). The case is a direct shareholder claim, not derivative , and may proceed without board interference inherent in derivative litigation.

Ultimately, the case is decided not under Delaware corporate law’s anemic waste standard subject to procedural usurpation by the corporate board, but under another state’s contract law that enables scrutiny for unconscionability, free of director interference. Will this work?

Rarely, but that is enough.  The serious legal difficulties with both the conflict of law and litigation classification raise the broader challenge of comity. Non-Delaware courts, even those clearly having jurisdiction based on factors like place of contract formation and performance, could find each of those issues too close to call so  defer to Delaware.

But that may be a desirable feature of prescribing this route around Delaware corporate law’s jealous and provincial grasp on stock option pay contracts. Only a few courts, and only in cases challenging the most odious contracts, would deign to entertain the claim. And that may be all it takes.

One big case, or a few small ones, holding a stock option pay contract unconscionable would deter boards from granting extravagant payouts to executives for negligible corporate gain.

Consider the notorious Delaware corporate law case of Disney for comparison. Delaware judges faced ten years of shareholder derivative litigation challenging a stock option pay contract against directors for breach of duty. They finally rejected all claims, including that of waste, filtered entirely through Delaware’s lenient corporate law lens.

Talk in the cases indicated that the judges thought the contract obnoxious, as it paid an executive $140 million for about a year’s work of negligble value.  Other state courts readily would have taken that thought to declare the contract unconscionable under contract law and ordered rescission and restitution.

No one can say that such judicial rebuke to board extravagance would have diminished other manifest corporate excesses we see mounting up daily.  But it could have helped a bit.

Beginning exactly one year ago, amid all the public wrangling over the terms of these contracts, the company persistently asserted they were iron-clad agreements obligating it to make full payment. Supporters invoked nebulous assertions about the sanctity of contracts.

On the other side, amid a political firestorm, President Obama told his Treasury Department to “pursue every single [...]]]> The notorious AIG bonus contracts are back in the news. The company now reportedly says the express contract terms limit the company’s obligation to pay bonuses. The reported clause authorizes the company to reduce payments to employees earning outside income by the amount of that income. For bonus payments the company is making today, this clause authorizes it to reduce aggregate amounts by $21 million, from $67 million to $46 million.

Beginning exactly one year ago, amid all the public wrangling over the terms of these contracts, the company persistently asserted they were iron-clad agreements obligating it to make full payment. Supporters invoked nebulous assertions about the sanctity of contracts.

On the other side, amid a political firestorm, President Obama told his Treasury Department to “pursue every single legal avenue” to abrogate or limit the company’s payment obligations. Members of Congress joined that chorus, some making hysterical threats to confiscate the payments by punishing excise taxes.

At that time, in a post on this blog that became a New York Times op-ed piece, I identified numerous grounds to question the company’s assertion and mediate the presidential and congressional hysteria, emphasizing that no one could determine the company’s rights or employees duties “without reading the contracts.” I imagined examples of possible clauses that could limit the company’s payment duties, specifically any right to terminate an employee for cause.

Finally, the company appears to have read the contracts and identified a clause that does limit the company’s payment duties. It could have been helpful to make that disclosure a year ago.  It could even have been helpful as recently as last month, when the company made additional bonus payments without mentioning this clause.   (See my blog post here.)

Perhaps the facts have changed, with employees now generating outside income subject to the clause, while none had earned outside income before.  Or, perhaps, the company has decided it really does need to look at the contracts to see what its legal obligations really are.  If so, the saga may not be over.  It would need to review payments made to employees previously to determine whether any outside income they generated should have been deducted.

One of the most important and unresolved quandaries of First Amendment jurisprudence involves when civil liability for speech will trigger First Amendment protections. When speech results in civil liability, two starkly opposing rules are potentially applicable. Since New York Times v. Sullivan, the First Amendment requires heightened protection against tort liability for speech, such as defamation and invasion of privacy. But in other contexts involving civil liability for speech, the First Amendment provides virtually no protection. According to Cohen v. Cowles, there is no First Amendment scrutiny for [...]]]> I’ve been meaning to announce, but keep forgetting to get around to it, that my article with Neil Richards was recently published — Rethinking Free Speech and Civil Liability, 109 Columbia Law Review 1650 (2009).  Here’s the abstract:

One of the most important and unresolved quandaries of First Amendment jurisprudence involves when civil liability for speech will trigger First Amendment protections. When speech results in civil liability, two starkly opposing rules are potentially applicable. Since New York Times v. Sullivan, the First Amendment requires heightened protection against tort liability for speech, such as defamation and invasion of privacy. But in other contexts involving civil liability for speech, the First Amendment provides virtually no protection. According to Cohen v. Cowles, there is no First Amendment scrutiny for speech restricted by promissory estoppel and contract. The First Amendment rarely requires scrutiny when property rules limit speech.

Both of these rules are widely-accepted. However, there is a major problem – in a large range of situations, the rules collide. Tort, contract, and property law overlap significantly, so formalistic distinctions between areas of law will not adequately resolve when the First Amendment should apply to civil liability. Surprisingly, few scholars and jurists have recognized or grappled with this problem.

The conflict between the two rules is vividly illustrated by the law of confidentiality. People routinely assume express or implied duties not to disclose another’s personal information. Does the First Amendment apply to these duties of confidentiality? Should it? More generally, in cases where speech results in civil liability, which rule should apply, and when? The law currently fails to provide a coherent test and rationale for when the Sullivan or Cohen rule should govern. In this article, Professors Daniel J. Solove and Neil M. Richards contend that the existing doctrine and theories are inadequate to resolve this conflict. They propose a new theory, one that focuses on the nature of the government power involved.

In Columbia Law Review’s Sidebar, Professor Timothy Zick has a very thoughtful response piece entitled “Duty-Defining Power” and the First Amendment’s Civil Domain.

CDSs on government bonds provide insurance against sovereign default. Accordingly, their prices are a barometer the market’s assessment of a country’s fiscal risk. They are particularly important indicators when countries structure their debts such that other [...]]]> The European Commission has decided that it is going to investigate the market in credit default swaps (CDSs) on sovereign debt. There is some concern that speculation in these markets is creating problems for Greece and other fiscally rickety European countries such as Spain, Portugal, and Ireland. The move in Brussels isn’t as crass as the accusations in the Greek press that their sovereign debt crisis is being driven a sinister cabal of “Anglo-Saxon speculators,” but it seems to partake of some of the same spirit.

CDSs on government bonds provide insurance against sovereign default. Accordingly, their prices are a barometer the market’s assessment of a country’s fiscal risk. They are particularly important indicators when countries structure their debts such that other indicators of market confidence, like the spread between short term and long term interest rates on government bonds are not available. Accordingly, they are a favorite target of politicians, who rightly point out that the holder of such contracts make money when a country’s finances deteriorate. Evil speculators! Of course, the CDS market also tells politicians when they are doing their jobs badly. In effect, the effort to regulate such markets amounts to politicians telling some of their most important — and informed — critics to shut up.

We saw the same thing in 2008, when the SEC banned short selling of the stocks of financial companies. Dick Fuld insisted that Lehman Brother’s stock was being pummeled by malicious, short-selling hedge funds. Look, he insisted, our stock price cannot reflect real value because our books show that we have all these really valuable assets. The shorts are just trying to manipulate the price as part of a nefarious plot! The shorts, however, didn’t believe Fuld’s accounting. They thought the stock price would fall in the future because they thought that Lehman was in effect lying to the market about its real value. They were right.

In the current political climate in the United States and Europe it is easy to demonize derivatives, and heaven knows that they were used to cause enough havoc. But it is important to remember that they perform a very important function by allowing the market to tell important men in expensive suits when they are full of crap, whether the important men are heads of state or CEOs. It’s hardly surprising that both the pols and the executives would rather that derivatives just went away.

In the ancient Near East, contracts were often solemnized by hacking up a goat. The ritual was in effect an enacted penalty clause: “If I breach this contract, let it be done to me as we are doing to the goat.” This Article argues that we are not so far removed from our goat-hacking forbearers. Legal scholars have argued that contractual liability is best explained by the morality of promising or the need to create optimal incentives in contractual performance. In contrast, [...]]]> My latest offering is now up on SSRN for your enjoyment. This particular paper began with a simple question: “Why did people in the ancient world formalize their contracts by hacking up a goat?” Here’s the abstract for the paper that resulted:

In the ancient Near East, contracts were often solemnized by hacking up a goat. The ritual was in effect an enacted penalty clause: “If I breach this contract, let it be done to me as we are doing to the goat.” This Article argues that we are not so far removed from our goat-hacking forbearers. Legal scholars have argued that contractual liability is best explained by the morality of promising or the need to create optimal incentives in contractual performance. In contrast, this Article argues for the simpler, rawer claim that contractual liability consists of consent to retaliation in the event of breach. In the ancient ritual with the goat, the retaliation consented to consisted of self-help violence against life and limb. The private law in effect domesticates and civilizes retaliation by replacing private warfare with civil recourse through the courts. It thus facilitates the social cooperation made possible by the ancient threats of retaliation while avoiding the danger of escalation and violence that such private violence presented. This civil recourse theory of contractual liability provides an explanation for a number remedial doctrines that have proven difficult for rival interpretations of contract law to explain, including the penalty clause doctrine, limitations on expectation damages, and the basic private law structure of contractual liability. Finally, this Article responds to some of the most powerful objections that might be made against a civil recourse theory of contractual liability.

The article, “Consent to Retaliation: A Civil Recourse Theory of Contractual Liability,” is, to my knowledge, the first full-length article on civil a recourse theory and contract. Civil recourse, of course, has been a much discussed topic in the philosophy of tort law, where it has been championed by John Goldberg and Benjamin Zipursky. My take on the normative foundations of civil recourse, however, is a bit different than theirs. Hence, in addition to illuminating the mystery of the hacked up goats, my hope is that the article will contribute to debates in the philosophy of contract law and the philosophy of private law more generally. Enjoy!

The argument is fairly easily to follow. She argues that tort liability, because it is prospective and systemic, motivates providers to invest in precautions that are general and non-rivalrous: a collective good.  Thus, medical safety investments will be underproduced if left to the incentives of individual contracting parties, since each patient will want to free-ride off others’ choices to purchase “liability” from their doctors.  Moving liability to managed care organizations [...]]]> Jennifer Arlen came to Temple on Monday to workshop her paper, Contracting Over Malpractice Liability, forthcoming in the Penn Law Review.  I was her commentator.  Prof. Arlen uses fairly traditional economic analysis, assuming that patients are rational, to argue that it not welfare maximizing to permit patients to contract out of the background medical malpractice regime.

The argument is fairly easily to follow. She argues that tort liability, because it is prospective and systemic, motivates providers to invest in precautions that are general and non-rivalrous: a collective good.  Thus, medical safety investments will be underproduced if left to the incentives of individual contracting parties, since each patient will want to free-ride off others’ choices to purchase “liability” from their doctors.  Moving liability to managed care organizations doesn’t help matters, it turns out, because it would simply permit the company to segregate between consumers who need liability protection (ones who are, or are likely to become, sick) and those who don’t (the young and healthy).  Under such a system, MCOs will package “good” health insurance together with liability, meaning that healthy individuals with a taste for liability coverage will need to pay a premium to access it.  This again leads to insufficient amount of liability protection over all patients.

It’s an important paper, not least because the form of argument may generalize to other kinds of contracting over private law.  Isn’t it true for most forms of negligence protection that the benefits are non-rivalrous and hard to exclude?  If so, permitting any contracting out of tort law likely results in a net loss of socially optimal deterrence.  Similarly, contracting out of civil procedure may lead to loss in societal benefits (like, for example, the litigation-generated-spillovers resulting from more information about the content and operation of legal rules.)  That said, as I commented to Prof. Arlen, it’s not clear whether she really maintains that patients are rational maximizers, since some of the argument relies on facts about the world (e.g., bad monitoring by insurance companies, insufficient lawsuits) that are difficult to square with rational choice theory. Also, what does medical error mean anyway?

I thought it would be worthwhile to bring this paper to your attention, since we’re living in a world where contract law’s dominance over torts is becoming ever more evident.  As this law firm circular points out, doctors are requiring patients to sign enforceable arbitration clauses.  It’s my sense that the bleak view that Arlen’s paper gives of contracting out of liability entirely also extends to such agreements.

*Whether they are a true public good or rather a club good is a little bit obscure in the paper.

The Supreme Court soon will decide, and on what this may depend. Its precedents, construing the Federal Arbitration Act, state the standard of clear and unmistakable intention. A pending case presents a contract clearly and unmistakably committing all disputes, including disputes about the contract’s enforceability, to arbitration. The opinion being reviewed, a 2-1 by [...]]]> Suppose the law is pellucid that a contract providing for resolving all disputes by arbitration requires that they be submitted to arbitration if the parties clearly and unmistakably so intend. Then suppose a boilerplate employment contract saying: “We clearly and unmistakably intend that all disputes arising hereunder, including disputes about the enforceability of this agreement, shall be submitted to arbitration.” A dispute arises. Can that dispute be litigated or is arbitration required?

The Supreme Court soon will decide, and on what this may depend. Its precedents, construing the Federal Arbitration Act, state the standard of clear and unmistakable intention. A pending case presents a contract clearly and unmistakably committing all disputes, including disputes about the contract’s enforceability, to arbitration. The opinion being reviewed, a 2-1 by the Ninth Circuit, prescribes a threshold issue for judicial decision before determining whether the dispute is subject to arbitration: whether the contract is unconscionable.

The logic? “Intentions of the parties” is a meaningful legal notion only when a bargain is the product of free exchange. The doctrine of unconscionability recognizes that some purported bargains do not follow that pattern. Instead, terms are massively one-sided, obnoxiously unfair, and presented as a take-it-or-leave it contract of adhesion. Contracts formed that way do not manifest recognizable intention that can be evaluated, whether as clear and unmistakable or otherwise. The threshold issue of unconscionability must therefore be resolved, by a court, before deciding whether the dispute is subject to binding arbitration. Or so said a majority of the Ninth Circuit panel.

The case, Jackson v. Rent-A-Center, involves a terminated (apparently at-will) employee suing an employer for wrongful discharge (on grounds of retaliation and race discrimination). The employer moved to dismiss under the agreement, which the employee opposed, asserting unconscionability. The district court granted the motion, applying the clear and unmistakable standard, but a divided Ninth Circuit reversed, directing judicial determination of the threshold unconscionability claim.

The unconscionability claim, in turn, asserts both substantive and procedural elements, as any successful unconscionability claim must. The substantive unconscionability assertion cites lop-sided provisions governing sharing of the arbitration’s costs, its discovery procedures and the claims covered. The procedural unconscionability assertion points to the contract’s take-it-or-leave it quality (an assertion that it is a contract of adhesion). The District Court did not evaluate all these assertions, only finding the cost-sharing term passed muster, and the Ninth Circuit affirmed that, but directed judicial examination of the others too.

The dissent notices that the court faced an arbitration agreement more favorable to the employer than most are but an unconscionability claim thinner than most are. It worries that the majority invites litigation of run-of-the-mill arbitration clauses on mere assertions of unconscionability, even when the writing “clearly and unmistakably” makes arbitration the dispute resolution device. It reads the Supreme Court precedents more capaciously, as directing threshold determinations about intention to arbitrators too, so long as the language makes that clear and unmistakable.

The majority makes good points as matters of contract law and logic and the dissent’s objection is fair—if the standard complaint registered against judicial supervision of contract arrangements. But neither opinion sees another way to resolve case. They do not distinguish between various clauses within the agreement.

These include the issue of who decides enforceability, how a particular arbitration would proceed, and the commitment to arbitrate underlying substantive disputes. The majority suggests that, if any part of the agreement is unconscionable (an adhesion contract containing lop-sided discovery and claims coverage clauses, say), then the entire agreement is unenforceable, including other rules of arbitration procedure and the arbitration clause itself.

That may be fine. But another approach would identify the unconscionable provisions, as a judicial matter, and declare those unenforceable. Here, if the discovery and claims coverage clauses are substantively unconscionable, and the form was an adhesion contract, then those clauses would be stricken. But that should not necessarily render the other terms unenforceable.

This alternative resembles a severability approach or the “blue-pencil” route some courts use to rewrite overly-broad covenants not to compete to render the revision enforceable. It strikes the obnoxious clauses and lets the others stand. Is that unconscionable?

At the outset, I’ll stipulate that I am no expert in health care but that my biases are strongly against the expansion of government entitlements in this or other areas. Discount my meanderings as you see fit. My understanding, however, is that a large part of the problem in health care costs comes in the way in which we price the system. We pay for services rather than outcomes. [...]]]> One of the joys of being a contracts prof is that you get to teach Hawkins v. McGee, the hairy-hand case of Paper Chase fame. Reading this week’s Economist briefing on health care has got me thinking about the meaning of the holding in that case for the current health care debates.

At the outset, I’ll stipulate that I am no expert in health care but that my biases are strongly against the expansion of government entitlements in this or other areas. Discount my meanderings as you see fit. My understanding, however, is that a large part of the problem in health care costs comes in the way in which we price the system. We pay for services rather than outcomes. This creates an incentive for providers to create a system structured around providing expensive procedures rather than providing positive health outcomes. I wonder, however, if Hawkins v. McGee doesn’t provide a way forward.

The case is normally presented as being about the proper measure of damages. Hawkins had a badly burned hand, and McGee promised that if he could perform an experimental skin graft Hawkin’s hand would be a “one hundred percent good hand.” The operation was a horrible failure, leaving Hawkins with a maimed and hairy hand. The court awarded expectation damages, namely the difference between what was promised — a good hand — and what was delivered — a maimed and hairy hand. (It turns out that a hand wasn’t worth much in New Hampshire in 1929; Hawkins got a couple of hundred bucks.) The case is odd because it presents what would ordinarily be a malpractice claim as a contract claim precisely because McGee did more than simply promise to perform services for a fee. He promised an outcome.

Suppose that we replaced the ordinary healthcare contract with the Hawkins v. McGee contract, namely that hospitals promised to deliver healthcare outcomes rather than healthcare services. First, it would align the incentives of health care providers much more closely with patients. Second, it would inject a lot of uncertainty into health care providers liabilities. After all, in many cases they will not be able to deliver particular outcomes, causing a breach of their contracts. This second issue could be controlled in two ways. First, health care providers could specify the amount they would pay in the event of unsuccessful treatment in a liquidated damages clause. Provided the courts enforced these clauses, they would diminish the unpredictability of payouts. Second, and perhaps more importantly, a fee-for-outcome contract would create a powerful incentive for healthcare providers to actuarialize the effectiveness of treatments, carefully compiling data on how likely successful outcomes actually are.

Were this contract adopted, going to the doctor would involve the purchase of a very different bundle of rights. Rather than buying services on the advice of a conflicted expert advisor, one would in effect purchase a form of insurance. In return for a fee, you would be promised a favorable outcome or the payment of some sum of money. The hospitals would then, in effect, be in the position of making bets on the effectiveness of their own treatments, bets that would become more profitable the better the outcomes were.

First, given that Domino’s only has a couple of seconds to get across its message, do most viewers really appreciate the reference to puffery?  To be sure, Domino’s loves it so much that they have dedicated a whole site to the “Stop the Puffery” idea and “calling out Papa John’s”.  Moreover, it seems to be garnering a lot of buzz on legal blogs, such as these thoughts on ContractsProf Blog and Above the  Law.  But as those posts reveal, the initial puffery reference stems from an old case between Papa John’s and Pizza Hut where Papa John’s essentially [...]]]> Like Nate, the Domino’s puffery commercial caught my eye.  In addition to his concerns, the commercial prompted me to think about at least two other issues related to the commercial’s effectiveness.

First, given that Domino’s only has a couple of seconds to get across its message, do most viewers really appreciate the reference to puffery?  To be sure, Domino’s loves it so much that they have dedicated a whole site to the “Stop the Puffery” idea and “calling out Papa John’s”.  Moreover, it seems to be garnering a lot of buzz on legal blogs, such as these thoughts on ContractsProf Blog and Above the  Law.  But as those posts reveal, the initial puffery reference stems from an old case between Papa John’s and Pizza Hut where Papa John’s essentially admits that its “Better Ingredients. Better Pizza” slogan is puffery in order to avoid Pizza Hut’s claim that ads using the slogan were false and misleading.   Interestingly, the Fifth Circuit case notes that “Pizza Hut does not appear to contest the truthfulness” of Papa John’s factual assertions that Pizza Hut used frozen dough, made its dough using “whatever comes out of the tap,” and made its sauce from remanufactured tomato paste.  Instead, Pizza Hut suggest that the ingredients make no difference in terms of taste.   In any event, the Fifth Circuit concludes that Papa John’s slogan is non-actionable puffery and thus did not really impact people’s buying decision.  From Domino’s perspective, calling Papa John’s slogan puffery is supposed to get across the idea that the slogan is “NOT FACT”–or in Papa’s John’s words, involves claims about “common sense choice.”  But it is not clear how much, if any, of that gets across in the ad. 

Second, wasn’t it just last month that Domino’s launched an ad strategy based on a mea culpa where company executives not only quoting comments likening Domino’s crust to cardboard and the sauce to ketchup, but also comments like “worst excuse for pizza I ever had,” and “totally devoid of flavor”?  The apology strategy seemed both bold and risky.  Though one could argue that it is only a few steps removed from ads that offer “new and improved” products, except those ads don’t explicitly admit that the old product was relatively worse.  Nevertheless, Domino’s apologetic strategy seems at odds with the attack strategy in these puffery commercials.   Indeed, the apology appears to be aimed at fostering good will and a positive outlook.  Moreover, the apology seems to be at the very least an implicit acknowledgement that Domino’s pizzas (and ingredients) were worse than their competitors.  So the puffery attack seems a bit hard to swallow. 

But in the interest of being honest, I will admit that I have not yet tasted the new and improved Domino’s pizza, and hence can’t really say anything about the pizza. . .just the pizza ad.

(And don’t forget to read “The Best Puffery Article Ever”)

You may not use or otherwise export or re-export the Licensed Application except as authorized by United States law and the laws of the jurisdiction in which the Licensed Application was obtained. In particular, but without limitation, the Licensed Application may not be exported or re-exported (a) into any U.S. embargoed countries or (b) to anyone on the U.S. Treasury Department’s list of Specially Designated Nationals or [...]]]> Today in my contracts call we were looking at boilerplate and the problems of contracts of adhesion.  After class one of my students pointed out to me that buried in the fine print of its iTunes Store Terms and Conditions is a clause where Apple is doing its bit to foster non-proliferation.  Clause 34(g) declares in part

You may not use or otherwise export or re-export the Licensed Application except as authorized by United States law and the laws of the jurisdiction in which the Licensed Application was obtained. In particular, but without limitation, the Licensed Application may not be exported or re-exported (a) into any U.S. embargoed countries or (b) to anyone on the U.S. Treasury Department’s list of Specially Designated Nationals or the U.S. Department of Commerce Denied Person’s List or Entity List. By using the Licensed Application, you represent and warrant that you are not located in any such country or on any such list. You also agree that you will not use these products for any purposes prohibited by United States law, including, without limitation, the development, design, manufacture or production of nuclear, missiles, or chemical or biological weapons.

Notice, as I read this clause not only are terrorists — or at least those on terrorist watch lists — prohibited from using iTunes to manufacture WMD, they are also prohibited from even downloading and using iTunes.  So all the Al-Qaeda operatives holed up in the Northwest Frontier Provinces of Pakistan, dodging drone attacks while listening to Britney Spears songs downloaded with iTunes  are in violation of the terms and conditions, even if they paid for the music!

That’ll show ‘em…

(Unless, of course, they can argue that the clause violates the reasonable expectations doctrine.  I mean, don’t we assume that when we download iTunes that we’ll be able to use it construct a nuclear missile?)

Dear Sir,

In your most recent Lexington column you reiterated the Economist’s long standing preference for a carbon tax rather than a cap-and-trade system for dealing with global warming.  Your preference has always puzzled me.  The Economist is quite right to insist that providing market incentives is a better way of controlling carbon emissions than command-and-control style regulations.  However, I have yet to see you make the case for carbon taxes.

A cap-and-trade system assumes that the government can set the optimal level of emissions and then lets the market determine the price of carbon.  A carbon tax assumes that the government can determine the costs that emissions impose [...]]]> I recently sent the following letter to the editor of the Economist magazine:

Dear Sir,

In your most recent Lexington column you reiterated the Economist’s long standing preference for a carbon tax rather than a cap-and-trade system for dealing with global warming.  Your preference has always puzzled me.  The Economist is quite right to insist that providing market incentives is a better way of controlling carbon emissions than command-and-control style regulations.  However, I have yet to see you make the case for carbon taxes.

A cap-and-trade system assumes that the government can set the optimal level of emissions and then lets the market determine the price of carbon.  A carbon tax assumes that the government can determine the costs that emissions impose on society, price those through a tax and then lets the market determine the overall level of emissions.  Another way of putting this, is that a cap-and-trade system assumes that scientists can determine the optimal level of carbon given the mosterously complex phenomena of the global climate.  A carbon tax, in contrast, assumes that economists can determine the costs that carbon imposes on society given the monsterously complex phenomena of the climate’s effect on the economy.

Other than your publication’s name, I am at a loss as to why you believe that the scientists are at a disadvantage to the economists.  Indeed, given the heroic intellectual feats that either policy demands, I’m at a loss as to which group of scholars has the edge.  Sadly, I suspect that we actually don’t know.

Nathan Oman

One year on, while that fury has died out, the country is no closer to a valid substantive answer to the fundamental question of whether the law of contracts requires paying the bonuses or recognizes an excuse from doing so. Instead, tomorrow and next month the same company reportedly will pay the same employees large bonuses, with a [...]]]> Nearly this time last year, I wrote in The New York Times, that the inflammatory exchange of “nebulous assertions and hysterical threats” would not get the country any closer to resolving the fury over paying millions in bonuses to employees of American International General, a firm whose wild financial products contributed decisively to the prevailing financial calamity still throttling us, and now propped up by US government financial support.

One year on, while that fury has died out, the country is no closer to a valid substantive answer to the fundamental question of whether the law of contracts requires paying the bonuses or recognizes an excuse from doing so. Instead, tomorrow and next month the same company reportedly will pay the same employees large bonuses, with a slight discount, in the name of honoring what the company continues to call, and the US government now agrees without explanation are, “legally binding” contracts.

During the past year, Ken Feinberg, the Obama administration’s special master on compensation for bailed out companies, urged AIG to reduce the bonuses. The company reports it has done so, though only by about half what Fienberg recommended. It proposes to pay, tomorrow and next month, to the same employee group who enjoyed them last year, a total of about $200 million in bonuses. Employees receiving these amounts this month reportedly agreed to hair cuts of 10-20% off what they say their contracts require (in exchange for getting them one month early); those getting them next month reportedly refused the hair cut and insist on getting 100% of the contractually committed amount.

This post is not to contend that the AIG employees are not contractually entitled to the payments, nor that they have breached any contractual or other duties during this past year. Nor is it to say that Mr. Feinberg, whom I have met and admire, has shirked his duties. But it is not obvious that the new arrangements meet the requirements Mr. Feinberg set and there has not been any publicized analysis, by AIG, Mr. Feinberg or the US government, concerning the enforceability of these contracts.

All we have are assertions that retaining these employees is somehow indispensable to unwinding AIG’s catastrophic business and repeated, nebulous, assertions that the contracts are “legally binding,” along with assertions, by people speaking on AIG’s or its employees’ behalf, including lawyers representing them, that these modest concessions are enough and “should put the matter behind us.”

Amid last year’s public conflagration, I recommended that emotions on this charged issue remain cool. But I assumed that AIG and/or the US government would justify that prescription by providing level-headed analysis of the relevant legal issues. It is difficult to prescribe cool emotions when that analysis has not been provided. Ideally, a responsible authority would provide a definitive legal analysis of why these bonus contracts must be enforced.  Absent that, financial institutions and the Obama administration should expect intensified heat for their ham-handling of large bonuses paid during a deep economic recession to employees of US government-supported financial institutions.

The bulk of Bernstein’s discussion focuses on the history of long distance trade between Europe and the Far East from Roman times through the nineteenth century.  He [...]]]> I just finished reading William Bernstein’s A Splendid Exchange: How Trade Shaped the World.  The goal of the book is to provide a global history of international trade from ancient times to the present.  The book doesn’t quite deliver on this promise.  For example, trade within Africa and the Americas prior to the age of discovery is almost completely ignored.  Likewise, for those who know their international economic history, the book isn’t likely to contain anything new.  Still it’s a good read, and there is something to be said for seeing huge swaths of history in a single view.

The bulk of Bernstein’s discussion focuses on the history of long distance trade between Europe and the Far East from Roman times through the nineteenth century.  He tells how this trade was dominated successively by Greeks, Arabs, Portuguese, Dutch, and finally the English.  One of the striking themes is how little there was in the West that the Chinese or Indians actually wanted.  Another theme is the often symbiotic relationship between trade and violence, most dramatically illustrated by the Opium Wars between Britain and China in the nineteenth century.

After recounting the Opium Wars, Bernstein’s focus shifts to the politics of free trade and protectionism.  Bernstein clearly believes that the free traders have the better of this argument (which, of course, is true) but he is sensitive to the way in which trade can hurt particular groups even if its benefits ultimately outweigh its costs.  He also has a good nose for stories of how protectionism has backfired in the past.  For example, in the first part of the eighteenth century English weavers rioted repeatedly, placing pressure on Parliament to exclude cheaper (and higher quality) cotton textiles from India.  Shielded from low wage Indian labor, English weavers claimed victory.  The tariff, however, also gave manufacturers and incentive to find some other way of avoiding high-wage English weavers.  The result was the mechanization of cloth production in the late eighteenth century, which ultimately displaced more high-wage weavers than the India trade ever did.

Perhaps my favorite story from the book has to do with the rise of containerization.  Over the course of the nineteenth century the cost of shipping fell dramatically.  Indeed, it fell so dramatically that prices for internationally traded goods continued to fall even after the onset of protectionist politics in the 1880s.  Technological innovation simply swamped the effects of legal policy.  By the early twentieth century, shipping costs were so low that the vast majority of the cost of moving goods around the world was incurred in the short trip from ship to wharf.    The solution to this problem is containerization, an idea that had been around since the first half of the nineteenth century.  It didn’t catch on, however.  The Interstate Commerce Commission early on took jurisdiction over the matter and at the behest of longshoremen’s unions squelched containerization, insuring that goods had to be unpacked and then repacked at the water’s edge.  The racket was finally brought to an end in the 1950s when a federal court declared that the regulation of shipping containers was beyond the jurisdiction of the ICC.

UPDATE: William Bernstein has also twice been a guest on Russ Roberts’s excellent EconTalk podcast.  You can check out the interviews here and here.

 A September 8, 2004 broadcast Rather narrated on CBS’s 60 Minutes concerned then-President George W. Bush’s service in the Texas Air National Guard. It turned out to be erroneous and some asserted Rather knew or should have known this. CBS disavowed the broadcast and Rather made a public apology—which he later retracted, saying CBS fraudulently induced [...]]]> Brains rightly concentrated last week on the lively Conan O’Brien-NBC contract dispute (some of my thoughts are here and here) though not to be overlooked is the final resolution of the Dan Rather-CBS contract dispute. The New York Court of Appeals ended that litigation last week by declining to hear Rather’s appeal from an intermediate court denying claims for breach of contract, breach of fiduciary duty and fraud against CBS.

 A September 8, 2004 broadcast Rather narrated on CBS’s 60 Minutes concerned then-President George W. Bush’s service in the Texas Air National Guard. It turned out to be erroneous and some asserted Rather knew or should have known this. CBS disavowed the broadcast and Rather made a public apology—which he later retracted, saying CBS fraudulently induced him to do it.

CBS soon removed Rather as anchor of the CBS Evening News, gave him de minimus assignments on 60 Minutes, and paid him the balance due under the contract. In dispute was exactly what those 60 Minutes assignments were and whether they conformed to the contract, plus whether Rather was entitled to work elsewhere during the period. These issues implicated the Rather-CBS employment contract, dating back 40 years and amended many times.

All seem agreed that the Rather-CBS contract provided that if CBS removed Rather as news anchor it would give him some sort of correspondents’ job on 60 Minutes and in any event pay all amounts otherwise due under the contract. All also seem agreed it paid him those amounts (some $6 million). The dispute centered on whether CBS did reassign him and whether he was entitled to work elsewhere during the period.

No Breach of Contract. Rather said CBS gave him at best de minimus assignments and, yes, paid him, but also prevented him from pursuing other work, causing him damages for lost business opportunities. CBS said it wasn’t required to give any particular assignments and, so long as it paid him, was not responsible for amounts he could have earned elsewhere. The court sided with CBS, construing the contract as a pay-or-play arrangement, obliging CBS to pay no matter what, which it did, not requiring it to use him, as anchor, correspondent or anything else. So CBS was not in breach of contract.

No Breach (or Existence) of Fiduciary Duty. Rather tried to paint his relation with CBS as fiduciary, meaning CBS owed him duties beyond their contractual relationship. The primary basis for this assertion seemed to be the length of the relation, some 40 years. This was simply wrong: New York law is clear that employment relationships do not create fiduciary relationships. Employers do not owe employees any fiduciary duty.

Rather sought to analogize his situation to that of a new rock music band signing with a record producer, which has been held to owe fiduciary duties to the band. But that is entirely different. It is an exclusive dealing arrangement not an employment relationship. Plus, the fledgling band was unsophisticated and necessarily relied upon the producer’s skill and expertise, contra the sophisticated Rather. Nor did the Rather-CBS deal involve the employer in unusual transactions on behalf of the employee, like financial arrangements with third parties, that could justify imposing special duties beyond those expressed or implied by contract.

 No Fraud. Rather’s assertions of CBS fraud concerned various misrepresentations, like false promises to defend Rather’s reputation, investigate the broadcast, use Rather’s talents, release him or extend his contact, and so on. None of these was actionable. Any CBS statements to the general public about Rather’s broadcast or reputation were time-barred under the applicable statute of limitations, those about not using him elsewhere or releasing him were simply erroneous restatements of the breach of contract claims, and promises about contract extension were mere non-actionable statements of future intention.

No Fraud Damages. Even if a claim of fraud were made as a matter of liability, Rather misunderstood the nature of damages such a claim could entitle its victim to recover. Rather argued that his damages from fraud, like those that would arise from breach of contract, were essentially the benefit of the bargain. He wanted those measured as the difference between what he would have earned in the future, absent the fraud, and what he would earn as a result of it.

But damages for fraud under New York law are governed by its so-called out of pocket rule, not a contract measure, but a tort measure. They are measured by the difference in value between the fraud-induced bargain and the “value of the consideration exacted as the price of the bargain.” The issue is what Rather gave up when induced by fraud compared to what he got. He offered no evidence of such damages.

An Easy Case?  This ended up, after a few years of litigation, looking like a very easy case, though the opinion makes the construction of the contract’s pay-or-play clauses look easier than it is.  Still, there is a good chance that, despite the seeming legal uncertainty aroused by reported or probable facts in the Conan-NBC dispute, a judicial opinion a few years from now would make it look like an easy case to resolve too.   That’s an interesting thing about the judicial process.  Cases can tend to get or look easier as they wind their way through the grueling process.  Readers of opinions years later should not forget the angst.

“You agree to pay Google an equipment subsidy recovery fee (the “Equipment Recovery Fee”) equal to the difference between the full price of the Nexus handheld device without service plan and the price you paid for the Nexus handheld device if you cancel your wireless plan prior to 120 days of continuous wireless service. For example, if the full price of the Nexus [...]]]> Tech blogs are astir today at the fine print in Google’s Nexus One’s terms of sale. Turns out, if you buy a subsidized phone through google and cancel your phone contract “early”, not only must you pay a fee to the carrier, but google also wants you to pay it the difference between the list price of the phone and the sale price.

“You agree to pay Google an equipment subsidy recovery fee (the “Equipment Recovery Fee”) equal to the difference between the full price of the Nexus handheld device without service plan and the price you paid for the Nexus handheld device if you cancel your wireless plan prior to 120 days of continuous wireless service. For example, if the full price of the Nexus handheld device without service plan was $529 USD and the price you paid for the Nexus handheld device was $179 USD with a service plan, the Equipment Recovery Fee you pay will be $350 USD in the event you cancel within the first 120 days of carrier service . . . You authorize Google to charge the Equipment Recovery Fee directly to your credit card, or other payment method used to purchase the Nexus handheld device, upon cancellation of your wireless plan . . .

You agree that the Equipment Recovery Fee is not a penalty but is for liquidated damages Google will incur as a result of such cancellation. These damages may include, but are not limited to, loss of compensation and administrative costs associated with such cancellation or changing of wireless service provider(s), market changes, and changes in ownership. Please note that the Equipment Recovery Fee is imposed by Google and not your chosen carrier and is in addition to any early termination fees that may be charged by your chosen carrier in connection with termination of your wireless plan prior to fulfillment of your chosen carrier’s service agreement term.”

Notwithstanding the language of agreement that this is a liquidated damages clause, I’m pretty sure that customers could legitimately challenge this fee in court as a penalty .  As many have noted, customers will end up paying more in termination fees than the cost of the phone (since both google and the carrier can charge in this model).  As we all know, liquidated damages must be either a fair estimate of an uncertain harm, or be relatively close to the actual damages suffered by the promisee.  The harm here isn’t at all uncertain, and I don’t think that charging more than the sales price constitutes a good measure of the seller’s actual damages.  Notably, we can’t simply use the difference between list price and sales price as the lost expectation, since the sales price is inflated by the business model (sort of like health care costs charged by hospitals).

The collection method that google built into contract here is also a problem.  It’s a form of self-help which customers ought to be able to challenge with their credit card companies.  Indeed, the clause is so riddled with obvious legal issues that I started to wonder whether google wrote it seeking to take advantage of behavioral research suggesting that liquidated damages clauses change individuals’ feelings about breach.  What do you think?  Is google’s new slogan “Don’t be evil.  But if you must be evil, be really good at it?”

Time Slot: Parol Evidence Rule. Concerning the contract’s asserted silence as to The Tonight Show’s time slot, I noted how silence could mean either NBC retained time slot discretion or how expression was unnecessary because The Tonight Show always aired at 11:30.

But a fundamental issue is what evidence a court would entertain to choose between such constructions. This raises a branch of the parol evidence rule, a complex doctrine barring the admission of certain kinds of evidence in the face of a [...]]]> My post on the Conan-NBC contract affair generated excellent comments, several gracious private emails, many cross-postings, including in the Washington Post, Conglomerate and Contracts Prof blog and, above all, lively discussion in my Contracts class. In light primarily of the latter, a few supplements follow.

Time Slot: Parol Evidence Rule. Concerning the contract’s asserted silence as to The Tonight Show’s time slot, I noted how silence could mean either NBC retained time slot discretion or how expression was unnecessary because The Tonight Show always aired at 11:30.

But a fundamental issue is what evidence a court would entertain to choose between such constructions. This raises a branch of the parol evidence rule, a complex doctrine barring the admission of certain kinds of evidence in the face of a complete and final written agreement.

This branch concerns whether a writing contains ambiguities that cannot be resolved without resort to evidence to aid its interpretation or construction. In some contexts, courts, appreciating that words have many uses rather than stable meanings, grant wide latitude in admitting explanatory evidence, perhaps especially amid contractual silence. In others, appreciating facing busy workloads and taking a pragmatic approach to contractual expression, it is prudent to adopt the “plain meaning rule,” disallowing evidence offered to explain contract terms, sometimes even as to omitted terms.

In Conan’s favor, because not requiring the admission of evidence but an assertion of logic and canons of contract interpretation, one could observe that if the parties intended for NBC to have time-slot discretion, the contract easily could have been written to say so. Contractual silence therefore warrants construing it to deny NBC that discretion.  (Taking the plain meaning rule literally, if The Tonight Show airs at 12:05 am, it is not a show tonight but one this morning!)

NBC, in contrast, would benefit only by persuading a judge that this case warrants admiting evidence about the meaning of silence.  If successful, it could adduce evidence showing that such time slot commitments appear in other network-host contracts, including with Jay Leno and David Letterman, according to reports widely available on the Internet. If so, silence here would support construing the contract to mean that no time slot commitment was intended and NBC retains discretion over that issue.  On the parol evidence issue, then, advantage: Conan.

Third Parties. In addition to noted risks facing Fox for interfering with the NBC-Conan contract and Conan for interfering with the NBC-Jimmy Fallon contract, Jay Leno is another potentially relevant third party. He and his advisors must take care to avoid action that could expose him to liability for interfering with the Conan-NBC contract. Given Leno’s reported role in this affair, this is another advantage to Conan.

Covenant Not to Compete. The most extensive discussion in comments to my post concerned the issue of any covenant not to compete the NBC-Conan contract may contain (or that any settlement agreement between them might include). Two additional points are worthwhile, each with opposing implications for relative NBC-Conan bargaining power.

In NBC’s favor, even if such a covenant would be unenforceable under California law, that law does not prohibit covenants that restrict a person’s right to poach employees and other assets when departing an employment. If some of Conan’s team on the show, including his sidekick and band leader, are NBC employees, such a clause could impair Conan’s right to bring them with him to any competing program. Point for NBC.

On the other hand, aiding Conan, contract law generally provides that it is a constructive condition to one contract party’s duties that the other is not in breach. Subject to some qualifications generally designed to protect an exchange upon breach, if NBC is in material breach of contract, then Conan’s duties would be excused, including any arising under any otherwise enforceable covenant not to compete.  Net gain for Conan.

Liquidated Damages. Reports around the Internet say the contract contains a clause obliging NBC to pay Conan a stipulated sum, reportedly in the $40 million range, if it breaches. If NBC is in breach, this attempt to liquidate damages for breach may be enforceable if actual damages are difficult to ascertain and the stipulated amount reasonable in relation to forecast or actual damages. To avoid overcompensating aggrieved parites, contract law provides that, if damages are ascertainable or the stipulated amount is designed to be punitive, to punish breach, they are unenforceable.

It is difficult without seeing the contract, particularly its economic terms, to say much about this clause, whether it is intended to be compensatory or punitive. Worth noting, however, is how some devoted fans of Conan, rooting for him to claim the award, repeatedly and emphatically call it a penalty. Though words like that do not determine legal interpretation of a clause, calling this one a penalty would not help but jeopardize Conan’s chances of recovering it. 

Overall. Ongoing discussions between NBC and Conan illustrate the notion of bargaining in the shadow of the law, working out arrangements in light of known or probable legal claims and consequences. Non-legal forces of course are at work.  Conan’s legal position, still incrementally weaker to me despite the foregoing, may play a role in his decision to communicate directly to the public.  But his public relations gambit may also be deftly designed for other reasons.  It paints NBC, and Jay Leno, as the bad guys, and portrays himselt as the guy in the white hat, a subtle bid to disaffect viewers from NBC, and Leno, a sort of blackmail, though not illegal.

Hat Tips: To my wonderful Contracts students at GW Law School.

But substantive law is an intrinsic part of the institutional structure. If the quality of institutions matter, then by definition the quality of laws matter. That is a point made over and over again by Coase, North, Williamson and other economists.

Yes and no. I don’t deny that law plays a role in the quality of the institutions that resolve disputes. I also don’t deny that the overall quality of dispute resolving institutions is effected by the substantive law that the institutions apply. On the other hand, legal institutions are the result of much more than either the legal rules that define [...]]]> There is an interesting exchange in the comments of my last post between Dan Cole,Jeff Lipshaw, and Michael Froomkin about institutions and the limits of substantive law. Dan Cole writes:

But substantive law is an intrinsic part of the institutional structure. If the quality of institutions matter, then by definition the quality of laws matter. That is a point made over and over again by Coase, North, Williamson and other economists.

Yes and no. I don’t deny that law plays a role in the quality of the institutions that resolve disputes. I also don’t deny that the overall quality of dispute resolving institutions is effected by the substantive law that the institutions apply. On the other hand, legal institutions are the result of much more than either the legal rules that define their workings or the legal rules that they apply. They are also the result of things like allocation of resources and informal social practices.

I was once at a panel that brought this point home forcefully. It was on comparativecommercial law and that perennial chestnut, which is better the common law or the civil law.  The partisans of the common law were laboring hard to establish the virtues of its flexibility and respect for freedom of contract.   (I’ve labored over these virtues myself on occasion.)  At this point, a long-time commercial practitioner on the panel interjected remarks to this effect:

At the margins, I suppose that the common law is slightly more friendly to commercial innovation than is the civil law. When I go to a civil law jurisdiction I often learn that there are certain transactions I simply can’t run or are more complicated to structure. On the other hand, when I am assessing the economic prospects in any particular country, my main question isn’t “Is this a civil law or a common law jurisdiction?” Rather, my main question is whether or not the fact that the lawyer on the other said is the judge’s cousin will effect the outcome of the case.

That is what I mean when I say that institutions matter more than substantive law.

Conan, a rising talk show host, and NBC, a major television network, entered into a contract providing that Conan would, starting six years hence, host The Tonight Show, a 60-year old program NBC always launched at 11:30 or 11:35 p.m., right after local television news. 

The two performed under that contract, beginning seven months ago, but now NBC has determined that the show should be aired at 12:05 a.m., with a different [...]]]> Thanks to Conan O’Brien, NBC and Fox, the country is being entertained in contract law, in a case raising some fundamental and fun issues.  To resolve them requires reading the Conan-NBC contract and learning facts about its negotiation, performance and current impasse.  But some main issues can be identified by making some basic suppositions.   

Conan, a rising talk show host, and NBC, a major television network, entered into a contract providing that Conan would, starting six years hence, host The Tonight Show, a 60-year old program NBC always launched at 11:30 or 11:35 p.m., right after local television news. 

The two performed under that contract, beginning seven months ago, but now NBC has determined that the show should be aired at 12:05 a.m., with a different talk show, hosted by The Tonight Show’s previous host, Jay Leno, aired during the previous half hour.  Conan objects.  A competing network, Fox, expresses interest in having Conan host a competing show.  What are the main issues?  Who seems to have the better position?

Time Slot.  NBC has publicly stated that the contract is silent concerning whether The Tonight Show must air at 11:30/35 p.m.  Assuming that is true, it is unsurprising, though for two reasons that pose conflicting implications.  On the one hand, it could be that such operational decisions must be left with the network to enable overall management of programming. That construction of silence as to time slot could give NBC the right to make this decision without breaching. 

On the other hand, it could be that such contractual silence simply reflects what everyone knows: for 60 years, The Tonight Show always aired just after the local news.  So there was no need to say anything in the contract about the starting time. That construction could mean the time slot shift would be a breach of contract.  Even so, or if NBC’s contractual silence assertion is false, and the contract expressly contemplates the 11:35 slot, NBC could seek other contractual grounds to make the switch.

Good Faith.  NBC’s rights to switch times could be governed by more general contract terms, express or implied.  Performance under many contracts involves such intricate matters that it is cost-prohibitive to elaborate all rights and duties in all states of the world.  As a result, many contain general promises of both parties to use reasonable, best or good faith efforts in performance.  Even absent such clauses, it is standard contract law, originating in parallel exclusive dealing contracts, for law to imply such an obligation.  Notably, Conan would be subject to corollary duties.     

Application.  Such good faith or reasonable efforts standards are Protean, deliberately broad, vague and open-textured.  They depend on context and here the standard will invite contending positions.  Conan credibly can argue that NBC has only allowed the show the traditional time slot for seven months and that it takes more time than that for a new host of such a venerable show to promote and sustain it.  

Conan may seek to prove that NBC’s decision was motivated more by its interests in the ratings of other shows, including Leno’s rescheduled show, than Conan’s.  Conan credibly can contend that the timing shift threatens serious damage to The Tonight Show as a franchise and Conan’s concomitant contractual position. 

These allegations may be difficult to rebut, though NBC could credibly counter in a few ways.  Foremost, it is equally in NBC’s as in Conan’s interest to maintain the franchise value of The Tonight Show, so assertions about time shift damage may not be persuasive.   Moreover, Conan’s own good faith obligation may require some flexibility on his part, including performing the show at hours NBC elects, so long as these are reasonable. 

More pernicious NBC decisions, like airing at 2 am or only on alternate nights, could appear to comply with technical contract terms but abrogate the contract’s spirit, a bad-faith practice called pervishing in the book publishing industry.  That would be a breach but it could be difficult to sustain such a characterization in this context.    

Mitigation.   Supposing NBC is in breach of contract, either based on a time clause or good faith obligation, it may yet credibly assert that it is taking steps to reduce resulting damages, by offering Conan the alternative arrangement of a later time slot.  If so, this implicates contract law’s mitigation principle and influences the relative stakes and power between NBC and Conan. 

In general, aggrieved contract parties cannot recover damages that they could avoid with reasonable diligence.  That sometimes means their damages are reduced by amounts that they could obtain through substitute performance.  But in employment cases like this, the doctrine is applied with some scrutiny. 

In a famous potentially analogous case, from 1970, the actress Shirley McClain was entitled to full contract damages, not mitigated, when a movie studio breached her contract and offered a much worse alternative.  The original contract promised her the lead in a musical, Bloomer Girl, to be shot in LA, and gave her director and screenplay approvals.  The studio breached that contract and offered her instead the lead in a dramatic western, Big Country, to be shot in Australia and lacking actress approval rights.

The Supreme Court of California, recognizing the mitigation or avoidable loss doctrine, nevertheless limited it to alternative offers the breaching party affirmatively proves are “comparable or substantially similar,” which it took to mean neither “different nor inferior.”  It held, over a vigorous dissent, that the Big Country alternative was both different and inferior to the Bloomer Girl deal.  So McClain won full contract damages, unreduced by that alternative.  

In our case, Conan would emphasize how the Tonight Show is a unique franchise, one with a 60-year history at 11:35, right after the local news.  Even a slightly later airing is both different and inferior so NBC, if in breach, owes him full contract damages.  NBC would contend the difference is not so consequential and is the only thing that distinguishes the two deals. 

A fact-intensive and judgment-laden disputation arises.  The burden of proof would be on NBC.  But the fact of the offer, and the single factual difference, gives incrementally greater power in the current high stakes discussions to NBC, not Conan.  

Third Parties.  Two third parties may be directly affected by the unfolding facts.  Their legal interests warrant consideration too.  In each case, the broad issue concerns laws that limit the rights of strangers to contracts to interfere with them.

First, and of high significance, the competing network, Fox, expresses interest in taking Conan on board if his contractual obligations with NBC can be lawfully eliminated.  If Fox, aware of the Conan-NBC contract, intentionally acts in ways calculated to induce Conan to breach that contract, it would expose itself to liability for tortious interference with contract. This is potentially dangerous territory.  In another famous case, from 1987, Pennzoil won a multi-billion dollar judgment against Texaco for the latter’s interfering with the former’s contract to buy part of Getty Oil.  This too is a factor weighing in favor of NBC, not Conan, and certainly not Fox.

Second, and of lesser consequence, NBC’s proposal to move The Tonight Show to 12:05 also means that the show currently occupying that slot, Late Night (hosted by Jimmy Fallon, Conan’s successor), is moved back another half hour as well.  Conan could credibly be concerned that his participation in facilitating that shift could interfere with contractual relations between NBC and Fallon.  This may be somewhat far-fetched, but is non-trivial, and adds incremental power to Conan’s negotiating position, at least.

Covenant Not to Compete?  A final issue concerning any Conan interest in alternative employment other than with NBC concerns whether their contract contains any limitation on his rights to compete with The Tonight Show or NBC after their contract ends.  Such covenants not to compete are fairly common in high-stakes personal services contracts like this and, so long as reasonably bounded in terms of time, geographic scope and activity, would be enforced.   Again, an incremental power point goes to NBC and against Conan.

Overall.  Subject to seeing the contract and learning more facts, the net balance of contract law power appears, at least incrementally if not decisively, to favor NBC over Conan.  This may explain why Conan is going to great lengths to influence the public in his favor on this dispute and why NBC is being remarkably quiet in public.

Hat Tip: Mollie Bren Hailey, my current Contracts student at GW Law School. 

Disclosure: Conan’s brother was a student at Cardozo Law School when I taught there years ago.

UPDATE: For further analysis of the issues, see my supplemental post here.