prior probability

In our previous post, we revisited the case of Mattei v. Hopper. Today, let’s talk about dispute between Peter Cooper’s Glue Factory (manufacturer/seller) and the Oscar Schlegel Manufacturing Company (distributor/buyer), a leading case involving the validity of so-called requirements contracts. (In a requirements contract, the seller agrees to meet the buyer’s requirements.) According to the distributor/buyer, the manufacturer/seller promised to sell “Special BB” glue to the buyer at 9 cents per pound. The main piece of evidence in this case consists of the following letter that the manufacturer/seller sent to the distributor/buyer:

GENTLEMEN.— We are instructed by our Mr. Von Schuckmann to enter your contract for your requirements of ‘Special BB’ glue for the year 1916, price to be 9c per lb., terms 2% 20th to 30th of month following purchase. Deliveries, to be made to you as per your orders during the year and quality same as heretofore. Glue to be packed in 500 lb. or 350 lb. barrels and 100 lb. kegs, and your special Label to be carefully pasted on top, bottom and side of each barrel or keg. . . .

signed/ PETER COOPER’S GLUE FACTORY, W. D. DONALDSON, Sales Manager.

The president of the distributor firm received this letter, wrote the words “Accepted, Oscar Schlegel Manufacturing Company” on the bottom, and then returned it back to the seller. Later, towards the end of 1916, there was an unexpected and dramatic change in the price of glue on the market. The price shot up to 24 cents per pound, so the buyer ordered large quantities of the “Special BB” glue from the seller, hoping to make a huge profit by buying glue at the contract price (9 cents/lb.) and reselling it the higher price of (24 cents/lb.).

Soon enough, the seller decided to repudiate the contract and not take any more orders from the buyer, so the buyer sued the seller to enforce their agreement. It’s unclear from the record in this case what motivated the seller’s repudiation–whether it lacked the industrial capacity to fill the buyer’s large orders or whether the seller simply wanted to sell the glue directly to the distributor’s customers. That is, we don’t know the real reason why A wanted to get out of the contract–was it impossibility, or was it greed? (In any case (pun intended), should A’s reason for getting out of the contract matter?) This case went all the way up to New York’s highest court, and that court ruled that the “alleged contract” (in the words of the court) was invalid for lack of mutuality! As a result, not only was the seller not required to fill any new orders from the buyer; the seller did not owe the buyer any monetary damages for repudiating the contract (since the underlying agreement was legally invalid)!

Now, let’s discuss Victor Goldberg’s expert analysis of this case in Chapter 3 of his book “Framing Contract Law.” According to Professor Goldberg, the court got it wrong! The contract was either a valid bilateral agreement or a valid unilateral contract (p. 90). Either way, both parties would still have the freedom to repudiate their agreement at any time in the event of a dramatic change in the market price for glue. But what about damages for breach? Not to worry, argues Goldberg, because the non-breaching party would have the legal duty to mitigate its damages.

Again, we find ourselves in complete agreement with Professor Goldberg. Just imagine what would have happened if the price of glue in this case had fallen below 9 cents per pound and if it were the buyer, not the seller, who had repudiated the agreement to minimize his losses. One of the main purposes of commercial contracts is to hedge risks, and one risk in commercial contracts is “commodity price risk.” If the validity of a contract were to depend on the stability of the price of the goods being sold under the contract, commercial contracts would be worthless! Next, we will revisit Wood v. Lucy and thus conclude our review of Part I of “Framing Contract Law.”

Last week, we posted a list of our mid-April readings. Now it’s time for us to review the first few chapters of “Framing Contract Law” by Victor Goldberg. Part I of Goldberg’s excellent book (pictured below) consists of three chapters of varying lengths and presents three classic cases on the problem of contract formation:

1. Wood v. Lucy (Chapter 2);
2. Oscar Schlegel Manufacturing Co. v. Peter Cooper’s Glue Factory (Ch. 3); and
3. Mattei v. Hopper (Ch. 4).

What is the common thread here? These leading cases ask in one form or another the same fundamental question: what does it take to make a legally-binding and enforceable contract? Let’s discuss the last case first:

Mattei v. Hopper

Let’s begin with Mattei, a California case that was decided in 1958. In this case, Peter Mattei, a real estate developer, wanted to purchase a plot of land from Amelia Hopper to build a shopping center. After negotiating a purchase price of $57,500 for the land, Mr Mattei and Ms Hopper signed an agreement called a “deposit receipt.” Here is how the court described the terms of their deal:

The parties’ written agreement was evidenced on a form supplied by the real estate agent, commonly known as a deposit receipt. Under its terms, [Mr Mattei] was required to deposit $1,000 of the total purchase price of $57,500 with the real estate agent, and was given 120 days to “examine the title and consummate the purchase.” At the expiration of that period, the balance of the price was “due and payable upon tender of a good and sufficient deed of the property sold.” The concluding paragraph of the deposit receipt provided: “Subject to Coldwell Banker & Company obtaining leases satisfactory to the purchaser.”

Mr Mattei paid the deposit, but Ms Hopper got cold feet during the 120-day option period and backed out of the deal, so Mr Mattei sued her to enforce the contract. Ms Hopper’s lawyers, however, came up with a clever legal loophole to try to get out of the deal: lack of “consideration.” In contract law, not all promises are legally binding, only those promises that are backed up by “consideration.” In short, both parties must give up something of value (e.g. time, money, know-how, etc.) to meet the consideration requirement.

In the words of the court: “When the parties attempt, as here, to make a contract where promises are exchanged as the consideration, the promises must be mutual in obligation. In other words, for the contract to bind either party, both must have assumed some legal obligations. Without this mutuality of obligation, the agreement lacks consideration and no enforceable contract has been created.” Another way a contract could be declared defective for lack of consideration is when the parties make “fake promises” under the doctrine of illusory promises. Again, in the words of the court: “… if one of the promises leaves a party free to perform or to withdraw from the agreement at his own unrestricted pleasure, the promise is deemed illusory and it provides no consideration.”

But why did the Hopper-Mattei deal lack consideration? After all, the parties agreed to a definite price, and the buyer paid a deposit. According to Ms Hopper’s lawyers (George R. Gordon, John L. Garaventa, and Dean Ormsby), it was because the contract had a “satisfaction clause”: Mr Mattei was not obligated to pay the full amount for Ms Hopper’s land if he was not satisfied with the commercial leases to be obtained by Coldwell Banker for the future shopping center he was planning to build.

Although Ms Hopper prevailed in the lower courts, Mr Mattei (represented by Jay R. Martin and William F. Sharon) took his case up to the California Supreme Court and won! According to the high court, a satisfaction clause does not destroy mutuality or create an illusory promise because the parties to a contract must act in good faith. As a result, an implicit duty to always act in good faith applied to Mr Mattei’s decision regarding the suitability of the commercial leases under the satisfaction clause.

For his part, Professor Goldberg agrees with the result but not with the court’s reasoning (p. 98): “by making the buyer’s good faith a necessary element of the contract …, the [court’s decision] needlessly raises good faith from a default rule to a nearly mandatory rule; and … good faith does not provide a coherent constraint on the buyer’s discretion.” Instead, the contract should be reframed as an option contract: when Mr Mattei paid the $1000 deposit, he paid for the exclusive right to decide whether he wanted to go through with the deal or not.

For our part, we agree 100% with Professor Goldberg’s reframing of the substance of the Mattei-Hopper deal as an option, and we would add one further critique of the court’s decision in this case. The court upholds the deal because it says Mr Mattei was required to act in good faith at all times, even under the satisfaction clause, but alas, this reasoning is circular! It begs the fundamental question whether the parties had a binding contract in the first place. By reframing the Mattei-Hopper contract as an option, good faith becomes irrelevant, since there is no question that the parties in this case made mutual obligations to each other.

(We will discuss Oscar Schlegel Manufacturing Co. v. Peter Cooper’s Glue Factory and Wood v. Lucy in our next two blog posts.)

Remember Blockbuster Video? At its height, Blockbuster operated more than 9000 video rental stores across the world, but that very success drew new competitors into the video rental market. Brent Lang (@BrentALang) explains Blockbuster’s demise thus in this excellent essay: “In the 1990s and early aughts, the video rental chain loomed over the home entertainment market. Its rows of new releases and thousands of locations made it unrivaled, and its profit margins grew fat thanks to the exorbitant late fees it charged. But Blockbuster became complacent. Redbox and Netflix upended the business by offering cheaper, more convenient alternatives, allowing people to rent films at kiosks or have them delivered to their homes via mail or, eventually, streaming. In the process, consumers grew accustomed to paying only 99 cents a night for a movie (Redbox) or shelling out a flat monthly fee (Netflix). In a few short years, Blockbuster was a bankrupt anachronism.” So, how long will it take before Facebook becomes the next Blockbuster?

The editors of GQ recently published this list of 20 overrated books (as well as a corresponding list of 20 underrated books). We went through their list and are by and large in complete agreement with their selections. Here’s just one example: