**George Mason School of Law

Contracts I

Unconscionability

F.H. Buckleyfbuckley@gmu.edu

Next day

Offers and Invitations to TreatAcceptanceCounter-offers

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*Forms of Unconsionability

UCC 2-302. Unconscionable Contract or Clause(1) If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.

*Forms of Unconsionability

Substantive UnconscionabilityThe just price doctrine

Procedural Unconscionabilitybargaining naughtiness

*Substantive Unconscionability

Thornborrow v. Whitacre, 92 Eng.Rep. 270 (1705): W. borrows 5 and in return promises to pay two grains of rye-corn in the first week, four in the second, eight in the third, and so on for a year. The court refused to enforce the contract when it appeared that there was not enough grain in the whole world to satisfy this.

*Substantive Unconscionability in Walker-Thomas Furniture?*Consumer lending and usury

*Substantive Unconscionability

Why did the church prohibit usury?

*Substantive Unconscionability

Why did the church prohibit usury?The Biblical prohibition against taking interest on a loanDeut. 23:20Unto a stranger thou mayest lend upon usury; but unto thy brother thou shalt not lend upon usury: that the LORD thy God may bless thee . Canon 27, Council of Nicea

*Substantive Unconscionability

Why did the church prohibit usury?The Biblical prohibition?Rent-seeking?Tolleson et al., 5 J.L.E.O. 307 (1989)

*Substantive Unconscionability

Why did the church prohibit usury?The Biblical prohibition?Rent-seekingMoral Hazard?: Eric Posner

*Moral Hazard A range of outcomes associated with an investment opportunity

*Moral Hazard How is ones economic calculus affected if costs are curtailed at 0 on the left side of the curve?

*Moral Hazard In that case, its all upside

*Moral Hazard I wouldnt do this without insurance!

*Moral Hazard Do traffic signals cause accidents?

*How to reduce speed levels

*Substantive UnconscionabilityWhy would a consumer agree to high interest rates?

*Substantive UnconscionabilityWhy would a consumer agree to high interest rates?Ignorance as to the terms?

*Substantive UnconscionabilityWhy would a consumer agree to high interest rates?Ignorance as to the terms?Signalling? Two borrowers approach a lender. One is high risk, the other low risk. The borrowers know their quality but the lender cannot tell them apart. How can he distinguish them?

*Substantive UnconscionabilitySignalling? Two borrowers approach a lender. One is high risk, the other low risk. The borrowers know their quality but the lender cannot tell them apart. How can he distinguish them? Assume that the low risk borrower can hold his hand in a fire for a longer period of time

*Substantive UnconscionabilitySignalling? Two borrowers approach a lender. One is high risk, the other low risk. The borrowers know their quality but the lender cannot tell them apart. How can he distinguish them? The willingness to do so might provide a separating equilibrium

*Substantive UnconscionabilitySignalling: Separating and pooling equilibria:

*Secured Lending as a separating equilibriumSignalling? Two borrowers approach a lender. One is high risk, the other low risk. The borrowers know their quality but the lender cannot tell them apart. How can he distinguish them? Assume that default is costly for both borrowers. However, the low risk borrower has a lower probability of default and a lower cost of default

*Substantive UnconscionabilitySeparating and pooling equilibria:

Separating equilibrium: Benefit > CostHigh Quality Borrower Benefit < CostLow Quality Borrower

*Substantive UnconscionabilitySeparating and pooling equilibria:

Separating equilibrium: Benefit > CostHigh Quality Borrower Benefit < CostLow Quality Borrower

Pooling equilibrium: Benefit > CostHigh Quality Borrower Benefit > CostLow Quality Borrower

*Cheap Talk as a Pooling EquilibriumHobbes: He which performeth first doth but betray himself to his enemy.

*Substantive UnconscionabilitySignalling? Two borrowers approach a lender. One is high risk, the other low risk. The borrowers know their quality but the lender cannot tell them apart. How can he distinguish them? A separating equilibrium if the low risk borrower is ready to accept a penalty on default?

*Now Procedural Unconscionability

*Now Procedural Unconscionability Is unconscionability something different from the fraudlets we have seen?Is it simply all or many of them, in the ensemble?Or a weaker threshold for the ?Or something else entirely?

*Now Procedural Unconscionability

Just what was wrong in Walker-Thomas?

*Now Procedural Unconscionability

Just what was wrong in Walker-Thomas?CapacityPovertyNature of goodsWelfare grantsKids

*Seabrook: 502Apartment to be ready three months later

*Unfinished Apartment Building

*Seabrook

Lets say your counsel for Commuter Housing. How would you draft clauses 33 and 19 differently?*

*Seabrook

Can you articulate the legal principle behind the case?*

*Heres one*

*Seabrook

Did the lessee have no choice but to sign an unconscionable lease agreementdoes not have the option of shopping around *

*Seabrook

Did the lessee have no choice but to sign an unconscionable lease agreement Were there other rental properties in NYC?*

*Seabrook

Did the lessee have no choice but to sign an unconscionable lease agreement Were there other rental properties in NYC?If they were hard to get, might rent control have had something to do with this?*

*Seabrook

Just what was unconscionable?Did the lessee know that the building was not completed when he signed the lease?*

*Seabrook

Just what was unconscionable?Do you think the lessee might have considered that there was a possibility that the building would not be completed three months later?*

*Seabrook

Just what was unconscionable?Do you think the lessee might have considered that there was a possibility that the building would not be completed three months later?What do you think he would have expected to happen in that case?*

*Seabrook

Just what was unconscionable?Do you think the lessee might have considered that there was a possibility that the building would not be completed three months later?What do you think he would have expected to happen in that case?What do you think was the s argument?*

*Seabrook

If youve rented an apartment, did you sign a lease agreement?Can you articulate the principle that such agreements are unenforceable in our enlightened society?What do you think the consequences might be if lease contracts are presumptively unenforceable?*

*Seabrook

If youre advising a lessor, do you take any drafting tips from this case?*

*Seabrook

If youre advising a lessor, do you take any drafting tips from this case?If you thought that the lessor should have known just what problem would arise, is that the hindsight bias at work?*

*Henningsen1960 Plymouth*

*Henningsen1960 Plymouth in two-tone!*

*HenningsenWith a push-button tranmission!*

*And today?2011 Chevrolet Spark

*Henningsen1960 Plymouth*

*HenningsenAnd what did they do with their car!!*

*Henningsen

What did the warranty cover? Can you think of any business reason why it was drafted that way?

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*Henningsen

Was the exemption clause per se illegal (substantive unconscionability)? Inimical to the public good

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*Henningsen

Was the exemption clause per se illegal? Inimical to the public good

But also grossly disproportionate bargaining power*

*Henningsen*FriedrichKessler

*Henningsen

Were the Big Three immune from competition?*

*Henningsen

Were the Big Three immune from competition?

Is a similarity in prices or terms across a market evidence of cartelization? *

*Henningsen

Were the Big Three immune from competition?Is a similarity in prices or terms across a market evidence of cartelization?Would you expect to see more competition as to prices than as to terms? *

*HenningsenWere the Big Three immune from competition?Is a similarity in prices or terms across a market evidence of cartelization?Does competition as to terms assume that all consumers screen?Free riding?*

*HenningsenWere the Big Three immune from competition?Is a similarity in prices or terms across a market evidence of cartelization?Does competition as to terms assume that all consumers screen?Suppose you heard that one firm had an extortionate contract?*

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*Substantive Unconscionability againThe two-person bargaining game

The Edgeworth Box Function provided a bargaining model based on ordinal utility (indifference curves)

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*The two-person bargaining game

The Edgeworth Box Function teaches us that bargaining is a non-zero sum game

But at the heart of the bargaining game is a zero-sum game

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* *MaryBessABCDEFGRecall the Contract Curve Indifference curve in commodity space

* *ABCFGA is the endowment pointBlowing up the bargaining lens

* *MaryBessABCDEFGRecall the Contract Curve Indifference curve in commodity space

* *ABCFGAt C Mary is much better off than at A, and Bess is neither better nor worse offA is the endowment pointBlowing up the bargaining lens

* *ABCFGAt B Bess is much better off than at A, and Mary is neither better nor worse off

A is the endowment pointBlowing up the bargaining lens

* *ABCFGA is the endowment pointAt G both parties are better off than at A

Blowing up the bargaining lens

* *ABCFGDoes unconscionability have anything to do with how bargaining gains are divided?Is your intuition that G is in some sense fairer than B or C?

* *ABCFGDoes unconscionability have anything to do with how bargaining gains are divided?But as we are talking about ordinal utility, it is not meaningful to speak of how much better off someone isat G relative to B or C

* *ABCFGDoes unconscionability have anything to do with how bargaining gains are divided?To do so, we would need to move from ordinal to cardinal utility

*Ordinal and Cardinal Utility

Ordinal numbers: First, second, third

Cardinal numbers: 1, 2, 3 *

*Ordinal and Cardinal Utility

The Edgeworth Box Function provided a bargaining model based on ordinal utility (indifference curves)

However, prior to the ordinalist revolution of the 1930s, economists thought of utility in a cardinal way*

*Cardinal utility

*Act always to increase the greatest happiness of the greatest numberThe auto-icon

*The Ordinalist Revolution One could dispense with cardinal utility and interpersonal comparisons while preserving much of standard economics by concentrating on choices made at the margin

*Vilfredo Pareto

*The Revival of Cardinal UtilityGame Theory

*John von Neuman, Theory of Games and Economic Behavior (1944)

*Are you a cardinalist?

Not if you think interpersonal utility comparisons arent meaningful

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*Are you a cardinalist?

You are charged with designing a countrys welfare policy. Should wealth transfers be from rich to poor or the other way around?

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*Are you a cardinalist?

You are charged with designing a countrys welfare policy. Should wealth transfers be from rich to poor or the other way around?

*Blimey, this social justice business is trickier than I thought!

* *AGCWe move from commodity to utility spaceCardinalists assume we can measure utility levels

* *AGCThe units of measurement are now in utils, not commoditiesCardinalists assume we can measure utility levels

* *AGCCardinal, not ordinal utilityUtility spaceLets suppose we can measure Marys utility levels

* *AGCG'BMarys utilityBesss utilityUtility SpaceAnd suppose we can do the same for Bess

* *01.01.0MaryBessTo simplify we normalize the utility functions of both from 0 to 1.0

* *ACBBC is concave (bends outward) because we assume that joint utility is maximized when gains are sharedMaryBessWe can then represent the contract curve in utility space

* *ACBMaryBessThe PresolutionBC represents the presolution to the game: it is feasible and efficient

* *MaryBessABCDEFGRecall where were getting this from

* *01.01.0MaryBessThe solution to the two-person bargaining game picks one point on the contract curve The Solution

* *01.01.0MaryBessNash solution of (.75* .8 =) .6Howard Raiffa, The Art and Science of Negotiation (1982)Nash maximizes the product of the utility gainsThe Nash Solution

* *01.01.0MaryBessMary insists on a payoff of .95.95.95The hard bargainer doesnt seek the Nash Solution

* *We have $1,000 to divide between us. I first decide how the money is to divided.The ultimatum game

* *We have $1,000 to divide between us. I first decide how the money is to divided.In the second stage you decide whether or not to accept the split I propose.The ultimatum game

* *We have $1,000 to divide between us. I first decide how the money is to divided.In the second stage you decide whether or not to accept the split I propose.If you accept the split we both take our respective shares.If you reject the split neither of us get anything.The ultimatum game

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In the first round I choose $950, leaving you $50

Take it or leave it?The ultimatum game

* The ultimatum gamePlayer 1FairUnfairAcceptAcceptRejectReject500, 5000, 00, 0950, 50Player 2Player 2Is the unfair solution Paretian?

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You see that Safeway refuses to charge a premium for a shovel during a snow stormIs it being irrational?

Do we have built-in fairness constraints?

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Do men play differently than women?

Do we have built-in fairness constraints?

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Do people play differently when the payoffs are higher?

Do we have built-in fairness constraints?

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Do people play differently when they are told that player 1 has earned the money?

Do we have built-in fairness constraints?

* *01.01.0MaryBessQu. How many such bargains will be lost through bargaining breakdown?.95The hard bargainer

* *01.01.0MaryBessAssume that an arbitrator can measureutilities and refuses to enforce bargains that allocate .95 of the gains to one party.95Getting to Yes:Suppose we resist enforcing hard bargains?

* *01.01.0MaryBessSome contracts will not be enforced. But might more be entered into because hard bargainers have been chilled? .95Getting to Yes:Suppose we resist enforcing hard bargains?

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Suppose we refused to enforce bargains that appear wholly one-sided? This would result in an efficiency loss. But would chilling the hard bargainers result in a greater number or bargains, and a net efficiency gain?Now back to the ultimatum game

Last fairness question: Distributional Justice*

* *MaryBessABCDEFGDistributional Justice:Who says it was fair to start at point A?

* *MaryBessABCDEFGDistributional Justice:What if we started at point E?

**George Mason School of Law

Contracts II

F.H. Buckleyfbuckley@gmu.edu

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