George Mason School of Law Contracts I P. Distributorships F.H. Buckley fbuckley@gmu.edu

Exclusive Dealing Wood v. Duff-Gordon p. 341 Lady Duff Gordon

Exclusive Dealing Wood v. Duff-Gordon Wood to have the exclusive right to market her clothes or endorsements In return to receive one-half of all “profits and revenues” One year term, renewable unless cancelled on 90 days notice

Exclusive Dealing Wood v. Duff-Gordon Is this a binding contract?

Exclusive Dealing Wood v. Duff-Gordon Is this a binding contract? Is it too uncertain? What’s missing?

Exclusive Dealing Wood v. Duff-Gordon Is this a binding contract? Is it too uncertain? Does it lack consideration?

Exclusive Dealing Wood v. Duff-Gordon Is this a binding contract? Cardozo: decries a “primitive age of formalism” What is the canonical take-away line?

Exclusive Dealing Wood v. Duff-Gordon Is this a binding contract? Finds “an instinct with an obligation” imperfectly expressed to use reasonable efforts The Moorcock: Bowen L.J.: imply a term to give business efficacy to an agreement

Exclusive Dealing Wood v. Duff-Gordon What is the economic rationale for finding a binding contract here?

Exclusive Dealing Wood v. Duff-Gordon What is the economic rationale for implying duties by the distributor? Consider Wood’s incentive to make contract-specific investments absent a binding contract

Exclusive Dealing Wood v. Duff-Gordon How would you formulate the duties of the parties, as a matter of legal drafting?

Exclusive Dealing Wood v. Duff-Gordon How would you formulate the duties of the parties, as a matter of legal drafting? Good faith by Duff-Gordon Best efforts by both

Exclusive Dealing Wood v. Duff-Gordon UCC § 2-205. Every contract imposes upon each party a duty of good faith and fair dealing in its performance and enforcement."

Exclusive Dealing Wood v. Duff-Gordon UCC § 2-306(2) A lawful agreement by either the seller or the buyer for exclusive dealing in the kind of goods concerned imposes unless otherwise agreed an obligation by the seller to use best efforts to supply the goods and by the buyer to use best efforts to promote their sale.

What are Good Faith Standards Van Valkenburgh p. 354

What are Good Faith Standards Van Valkenburgh p. 354 Just where did the publisher cross the line?

What are Good Faith Standards Van Valkenburgh p. 354 What is the answer to the query at the bottom of 354?

What is best efforts? Bloor v. Falstaff 343

Bloor v. Falstaff

Bloor v. Falstaff

Bloor v. Falstaff What was the deal?

Bloor v. Falstaff Falstaff buys all Ballantine assets except the brewery for $4M plus a royalty of 50 cents on each barrel of Ballantine sold over a 6 yr. period Buyer to use best efforts to promote and maintain a high volume of sales Buyer to pay up to $1.1M if it substantially discontinues selling Ballantine

Bloor v. Falstaff Why structure it that way? What are the alternatives?

Bloor v. Falstaff Falstaff’s history with the Ballantine brand

Bloor v. Falstaff Falstaff’s history with the Ballantine brand Brieant: nonfeasances and misfeasances Falstaff stressed profit at the expense of volume “Falstaff simply didn’t care about Ballantine’s volume” Falstaff put more effort into the Falstaff brand

Bloor v. Falstaff Falstaff to use “best efforts to promote and maintain a high volume” Was this a drafting problem? Or did they get it just right?

Bloor v. Falstaff Falstaff’s history with the Ballantine brand Remedy?

Bloor v. Falstaff Can you articulate a standard by which best efforts can be judged? What would be excessive?

Bloor v. Falstaff Can you articulate a standard by which best efforts can be judged? What would be excessive? Friendly: “Even without the best efforts clause, Falstaff would have been bound to make a good faith effort to see that substantial sales of Ballantine products were made”

Bloor v. Falstaff Can you articulate a standard by which best efforts can be judged? What would be excessive? Friendly: Profit uber alles was the problem

Bloor v. Falstaff How to establish what is the right amount of effort to require of Falstaff in pushing Ballantine beer?

Bloor v. Falstaff How to establish what is the right amount of effort to require of Falstaff in pushing Ballantine beer? The case is made easier by the finding that Falstaff maximized Falstaff profits and not the joint venture’s profits

Bloor v. Falstaff Supposing that Falstaff had purchased Ballantine outright. Would profit uber alles have been a problem?

Bloor v. Falstaff Supposing that Falstaff had purchased Ballantine outright. Would profit uber alles have been a problem? Let’s say that in such a case Falstaff had cut the Ballentine marketing efforts in just the same way

Bloor v. Falstaff Would you expect that the parties would want to bargain for sales efforts that would exceed what Falstaff would expend had it a 100 % equity stake in the Ballantine brand?

Bloor v. Falstaff Would you expect that the parties would bargain for sales efforts that would exceed what Falstaff would expend had it a 100 % equity stake in the Ballantine brand? Would Ballantine be able to pay Falstaff to do so? Would you pay $10 to make $9?

Bloor v. Falstaff An agency cost problem

Agency: Common Law Legal relationship whereby a principal, expressly or impliedly, authorizes an agent to create a legal relationship between the principal and a third party

Agency: An economic concept Any relationship in which a principal, expressly or impliedly, authorizes an agent to confer benefits or impose costs on the principal

The two definitions may overlap Real estate agents

The two definitions may overlap Real estate agents Distributorships (Duff Gordon)

The two definitions may overlap Real estate agents Distributorships (Duff Gordon) Partnerships One partners is an agent for his fellow partners

But the economic definition is broader Beneficiaries and trustees

But the economic definition is broader Beneficiaries and trustees Shareholders and company directors

But the economic definition is broader Beneficiaries and trustees Shareholders and company directors Creditors and corporate debtors

But the economic definition is broader Profit-sharing ventures: Falstaff

Agency Costs Because the incentives of agents are not perfectly aligned with those of his principal, the agent may impose costs on him.

The Agency Cost Problem Agent misbehavior Underperformance by agent retained by principal (shirking, or breach of duties of care)

Of COURSE I can sell your beautiful house!!! Shirking

The Agency Cost Problem Agent misbehavior Underperformance by agent retained by principal (shirking, or breach of duties of care)

The Agency Cost Problem Agent misbehavior Underperformance by agent retained by principal (shirking, or breach of duties of care) Expropriation of an opportunity (breach of duties of loyalty)

The Agency Cost Problem How would a principal respond? Monitoring of agent

The Agency Cost Problem How would a principal respond? Monitoring of agent Underinvestment in agency relationships

The Agency Cost Problem Agency Costs as the sum of Underperformance by agents Underinvestment by principals Monitoring costs

Back to Falstaff The agent (Falstaff) has to decide how much money to spend on marketing the principal’s (Ballantine) beer

Agency Costs How much Ballantine beer to sell? $ Horizontal axis measures the quantity of beer sold Quantity of beer

Agency Costs $ Assume a constant amount of revenue for each case of Ballantine beer sold Marginal Revenue

Agency Costs $ Marginal Cost of Marketing Marginal Revenue Falstaff has to spend an increasing amount on marketing for additional units of beer sold

Agency Costs $ Marginal Cost of Marketing Marginal Revenue X Optimal marketing and sales at Quantity X

At X* Falstaff can profitably spend more on marketing $ Marginal Cost of Marketing Marginal Revenue X* X

At X* Falstaff can profitably spend more on marketing $ Marginal Cost of Marketing Marginal Revenue X* X

At X~ Falstaff can profitably reduce marketing expenditures $ Marginal Cost of Marketing Marginal Revenue X X~

At X~ Falstaff can profitably reduce marketing expenditures $ Marginal Cost of Marketing Marginal Revenue X X~

Now what happens when revenues are shared with an agent? $ Marginal Cost of Marketing Marginal Revenue X

The principal’s marginal revenue curve is lowered $ Marginal Cost of Marketing MRFalstaff+Ballantine The 50 percent tax MRFalstaff X

So that Falstaff has an incentive to reduce marketing expenditures $ Marginal Cost of Marketing MRFalstaff+Ballantine MRFalstaff X X* Jensen and Meckling, 3 J Fin Econ 305 (1976)

Falstaff What are Ballentine’s incentives? It gets 50 percent of the revenues and bears none of the marketing costs. So how much would it want spent on marketing?

Falstaff Neither Falstaff nor Ballantine had perfect incentives Ballantine has an incentive to spend too much and Falstaff too little.

Falstaff If the goal is optimal joint production, how would you formulate the legal standard?

Agency Costs $ Marginal Cost of Marketing Marginal Revenue X Optimal marketing and sales at Quantity X

Falstaff If the goal is optimal joint production, how would you formulate the legal standard? How would you draft Falstaff’s duties?

Falstaff If the goal is optimal joint production, how would you formulate the legal standard? How would you draft Falstaff’s duties? “best efforts” and “good faith” “reasonable best efforts” Non-discrimination

Responses to Agency Costs? Legal standards (e.g., best efforts)

Responses to Agency Costs? Legal standards (e.g., best efforts) Incentivize the parties Cost-sharing Sliding scale of profits

Responses to Agency Costs? Legal standards (e.g., best efforts) Incentivize the parties Relational contracts

Responses to Agency Costs? Legal standards (e.g., best efforts) Incentivize the parties Relational Contracts Vertical Integration

Post-contractual opportunism But see R.H. Coase, The Acquisition of Fisher Body by General Motors, 43 J.L.E. 15 (2000) 77 77

Responses to Agency Costs? Legal standards (e.g., best efforts) Incentivize the parties Relations and Iterated PD Games Vertical Integration Monitoring plus termination rights