CONTRACT LAW

Renegotiating Contracts (from final exam, Fall 2007)

I run a retail store that hires extra cashiers for the holiday rush. Each year, we sign six-week contracts with short-term employees, under which we train them for two weeks before Thanksgiving and then employ them as cashiers for all of December at a pre-agreed wage.

Consider the following two scenarios:

- You agree to the contract. The day after Thanksgiving, I've already invested time and money in training you, and don't have time to train a replacement; you suddenly realize you're in a strong bargaining position, and threaten to quit unless I raise your salary. Feeling I have no choice, I rewrite the contract to pay you more.

- You agree to the contract. Watching you interact with customers and other employees during training, I realize you're better suited to be a store manager than a cashier. The work is harder - you wouldn't agree to do it for the same wage - but your additional value to me as a manager is much greater than the additional cost (effort) to you. We rewrite the contract to make you a manager and pay you more.

(a) Give an economic argument why the renegotiated contract should be enforced in the second scenario, while the original contract should be enforced in the first.

(b) Would either renegotiated contract be enforced under the Bargain Theory of contracts?

Reliance and Breach (from midterm exam, Fall 2009)

Explain why...

(a) expectation damages lead to efficient breach.

(b) the efficient level of reliance is decreasing in the probability of breach - that is, the more likely a promisor is to breach, the lower is the efficient level of reliance.

(c) including the anticipated benefit from reliance investments in the calculation of expectation damages leads to overreliance.

Fortunate Contingency (from midterm exam, Fall 2008)

(From Thomas Miceli, The Economic Approach to Law, 2009, Stanford University Press)

A buyer hires a manufacturer to build a specialized machine for delivery on a certain date. The value of the machine to the buyer is $2,000, and the price, payable on delivery, is $1,500. Suppose that after the machine is completed but before delivery, a second buyer arrives and offers the manufacturer $2,500 for it.

a. From a social (efficiency) perspective, who should get the machine?

b. Calculate the value of expectation damages for the first buyer and show that it gives the seller the correct incentives regarding breach of the original contract.

c. Suppose the first buyer went to court, and was granted a specific performance remedy. How will this affect the ultimate ownership of the machine compared to expectations damages? (Assume that the first buyer is aware of the second buyer's offer and that the two buyers can bargain.)

d. The arrival of the second buyer created a "surplus" of $500 (the excess of his offer over the valuation of the first buyer). Describe how this surplus is divided between the seller and first buyer under the two breach remedies.

"Zero-Sided Contracts" (from midterm exam, Fall 2007)

David Friedman's book, "Law's Order," discusses the following situation:

"A physician comes upon an auto accident, stops, and treats an unconscious and badly bleeding victim. A week later the victim receives a bill for services rendered. Must he pay it?

Under current U.S. law the answer is yes."

Consider the following alternatives:

(i) The victim need not pay anything

(ii) The victim must pay only the value of whatever materials were used up in treating him (bandages, etc.)

(iii) The victim must pay the going market rate for comparable medical services

(iv) The victim must pay whatever the doctor demands

Which of these do you expect to lead to the most efficient outcomes? Why?