George Mason School of Law

George Mason School of Law Contracts I O. Output Contracts and Distributors F.H. Buckley fbuckley@gmu.edu

Output and Requirements contracts • UCC § 2-306(1) A term which measures the quantity by the output of the seller or the requirements of the buyer means such actual output or requirements as may occur in good faith, except that no quantity unreasonably disproportionate to any stated estimate or in the absence of a stated estimate to any normal or otherwise comparable prior output or requirements may be tendered or demanded.

Requirements Contracts Requirements contract: producer agrees to sell as much of his product as buyer requires 3

Requirements Contracts • Requirements contract: producer agrees to sell as much of his product as buyer requires • Strategic behavior: misincentives as to quantity 4

Requirements Contracts and Incentives as to Quantity

Requirements Contracts and Incentives

Output Contracts • Output contract: buyer agrees to purchase seller’s entire output

Output Contracts • Buyer agrees to buy all of producer’s output • Risks to buyer:

Output Contracts • Buyer agrees to buy all of producer’s output • Risks to buyer: • What if market price < contract price

Output Contracts • Buyer agrees to buy all of producer’s output • Risks to buyer: • What if market price < contract price • What if buyer can’t use the output • Weak demand for buyer’s product • Higher costs for buyer

Output Contracts • Buyer agrees to buy all of producer’s output • Risks to seller:

Output Contracts • Buyer agrees to buy all of producer’s output • Risks to seller: • What if market price > contract price

Output Contracts • Buyer agrees to buy all of producer’s output • Risks to seller: • What if market price > contract price • What if seller’s cost > contract price

Price Changes: Output Contracts Assuming that Contract Price > Market Price

Price Changes: Output Contracts Assuming that Market Price > Contract Price

Price Changes: Output Contracts Assuming that Market Price < Contract Price

What if Seller’s Costs Increase?

Output ContractsCost to Seller

Output Contracts: Feld v. Levy p. 332 Bakery Levy Distributor Feld Bread crumbs

Output Contracts: Feld v. Levy • A renewable one-year contract in which Levy agrees to sell all its bread crumbs to Feld for $1/lb. • Feld thinks he can resell at $1.50/lb.

Output Contracts: Feld v. Levy • A renewable one-year contract in which Levy agrees to sell all its bread crumbs to Feld • Levy discovers that the marginal cost ($1.06) exceeds the contract price ($1.00) and cancels

Output Contracts: Feld v. Levy • Held: It would be bad faith for Levy to stop crumb production just because their profits aren't as high as they expected, but it would be good faith for Levy to stop crumb production if they incurred losses from such production that were "more than trivial".

Output Contracts: Feld v. Levy • See excerpt on 345

Output Contracts: Feld v. Levy • Does it make sense to require the baker to lose money?

Output Contracts: Feld v. Levy • Does it make sense to require the baker to lose money? • Is there something troubling about the numbers?

Output Contracts: Feld v. Levy

Output Contracts: Feld v. Levy • What if the baker could sell elsewhere for $1.20 • Do you think this might do something to his reported costs, if this affords him an out?

Output Contracts: Feld v. Levy • What if the cost of production is now $1.50?

Output Contracts: Feld v. Levy

Output Contracts: Feld v. Levy • How is this case like Empire Gas?

Output Contracts: Feld v. Levy • Can a buyer in a requirements contract purchase zero quantities? • Empire Gas

Output Contracts: Feld v. Levy • Can a buyer in a requirements contract purchase zero quantities? • Empire Gas • Can a seller in an output contract sell zero quantities? • Feld v. Levy

Output contracts • Good faith standards imposed in both cases

Exclusive DealingWood v. Duff-Gordon p. 341 Lady Duff Gordon

Exclusive DealingWood 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 DealingWood v. Duff-Gordon • Is this a binding contract?

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

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

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

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

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

Exclusive DealingWood 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 DealingWood 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."

George Mason School of Law