George Mason School of Law
P.
Contracts I
Distributorships
F.H. Buckley
[email protected]
1
Exclusive Dealing
Wood v. Duff-Gordon p. 341
Lady Duff Gordon
2
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
3
Exclusive Dealing
Wood v. Duff-Gordon
 Is this a binding contract?
4
Exclusive Dealing
Wood v. Duff-Gordon
 Is this a binding contract?
 Is it too uncertain?
 What’s missing?
5
Exclusive Dealing
Wood v. Duff-Gordon
 Is this a binding contract?
 Is it too uncertain?
 Does it lack consideration?
6
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?
7
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
8
Exclusive Dealing
Wood v. Duff-Gordon
 What is the economic rationale for
finding a binding contract here?
9
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
10
Exclusive Dealing
Wood v. Duff-Gordon
 How would you formulate the duties
of the parties, as a matter of legal
drafting?
11
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
12
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."
13
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.
14
What are Good Faith Standards
 Van Valkenburgh p. 354
15
What are Good Faith Standards
 Van Valkenburgh p. 354
 Just where did the publisher cross the
line?
16
What are Good Faith Standards
 Van Valkenburgh p. 354
 What is the answer to the query at
the bottom of 354?
17
What is best efforts?
 Bloor v. Falstaff 343
18
Bloor v. Falstaff
19
Bloor v. Falstaff
20
Bloor v. Falstaff
 What was the deal?
21
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
22
Bloor v. Falstaff
 Why structure it that way?
 What are the alternatives?
23
Bloor v. Falstaff
 Falstaff’s history with the Ballantine
brand
24
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
25
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?
26
Bloor v. Falstaff
 Falstaff’s history with the Ballantine
brand
 Remedy?
27
Bloor v. Falstaff
 Can you articulate a standard by
which best efforts can be judged?
 What would be excessive?
28
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”
29
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
30
Bloor v. Falstaff
 How to establish what is the right
amount of effort to require of Falstaff
in pushing Ballantine beer?
31
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
32
Bloor v. Falstaff
 Supposing that Falstaff had
purchased Ballantine outright. Would
profit uber alles have been a
problem?
33
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
34
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?
35
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?
36
Bloor v. Falstaff
 An agency cost problem
37
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
38
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
39
The two definitions may overlap
 Real estate agents
40
The two definitions may overlap
 Real estate agents
 Distributorships (Duff Gordon)
41
The two definitions may overlap
 Real estate agents
 Distributorships (Duff Gordon)
 Partnerships
 One partners is an agent for his fellow
partners
42
But the economic definition is
broader
 Beneficiaries and trustees
43
But the economic definition is
broader
 Beneficiaries and trustees
 Shareholders and company directors
44
But the economic definition is
broader
 Beneficiaries and trustees
 Shareholders and company directors
 Creditors and corporate debtors
45
But the economic definition is
broader
 Profit-sharing ventures: Falstaff
46
Agency Costs
 Because the incentives of agents are
not perfectly aligned with those of his
principal, the agent may impose costs
on him.
47
The Agency Cost Problem
 Agent misbehavior
1. Underperformance by agent retained by
principal (shirking, or breach of duties of
care)
48
Shirking
49
Of COURSE I
can sell your
beautiful
house!!!
The Agency Cost Problem
 Agent misbehavior
1. Underperformance by agent retained by
principal (shirking, or breach of duties of
care)
50
The Agency Cost Problem
 Agent misbehavior
1. Underperformance by agent retained by
principal (shirking, or breach of duties of
care)
2. Expropriation of an opportunity (breach
of duties of loyalty)
51
The Agency Cost Problem
 How would a principal respond?
 Monitoring of agent
52
The Agency Cost Problem
 How would a principal respond?
 Monitoring of agent
 Underinvestment in agency relationships
53
The Agency Cost Problem
 Agency Costs as the sum of
 Underperformance by agents
 Underinvestment by principals
 Monitoring costs
54
Back to Falstaff
 The agent (Falstaff) has to decide
how much money to spend on
marketing the principal’s (Ballantine)
beer
55
Agency Costs
How much Ballantine beer to sell?
$
Horizontal axis measures
the quantity of beer sold
Quantity of beer
56
Agency Costs
$
Assume a constant amount of revenue
for each case of Ballantine beer sold
Marginal Revenue
57
Agency Costs
$
Marginal Cost of Marketing
Marginal Revenue
58
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
59
At X* Falstaff can profitably spend
more on marketing
$
Marginal Cost of Marketing
Marginal Revenue
X*
60
X
At X* Falstaff can profitably spend
more on marketing
$
Marginal Cost of Marketing
Marginal Revenue
X*
61
X
At X~ Falstaff can profitably reduce
marketing expenditures
$
Marginal Cost of Marketing
Marginal Revenue
X
62
X~
At X~ Falstaff can profitably reduce
marketing expenditures
$
Marginal Cost of Marketing
Marginal Revenue
X
63
X~
Now what happens when revenues
are shared with an agent?
$
Marginal Cost of Marketing
Marginal Revenue
X
64
The principal’s marginal revenue
curve is lowered
$
Marginal Cost of Marketing
MRFalstaff+Ballantine
The 50 percent tax
MRFalstaff
X
65
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)
66
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?
67
Falstaff
 Neither Falstaff nor Ballantine had
perfect incentives
 Ballantine has an incentive to spend too
much and Falstaff too little.
68
Falstaff
 If the goal is optimal joint production,
how would you formulate the legal
standard?
69
Agency Costs
$
Marginal Cost of Marketing
Marginal Revenue
X
Optimal marketing and sales at Quantity X
70
Falstaff
 If the goal is optimal joint production,
how would you formulate the legal
standard?
 How would you draft Falstaff’s duties?
71
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
72
Responses to Agency Costs?
 Legal standards (e.g., best efforts)
73
Responses to Agency Costs?
 Legal standards (e.g., best efforts)
 Incentivize the parties
 Cost-sharing
 Sliding scale of profits
74
Responses to Agency Costs?
 Legal standards (e.g., best efforts)
 Incentivize the parties
 Relational contracts
75
Responses to Agency Costs?




76
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
Responses to Agency Costs?





78
Legal standards (e.g., best efforts)
Incentivize the parties
Relations and Iterated PD Games
Vertical Integration
Monitoring plus termination rights