1 George Mason School of Law Contracts I N.Requirements Contracts F.H. Buckley [email protected].
Dec 23, 2015
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Output and Requirements Contracts: A special case of uncertainty
Vas ist das? 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.
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Output and Requirements Contracts
Vas ist das? Output contract: buyer agrees to
purchase seller’s entire output
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Output and Requirements Contracts
Vas ist das? Output contract: buyer agrees to
purchase seller’s entire output Requirements contract: producer agrees
to sell as much of his product as buyer requires
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Output and Requirements Contracts
Why enter into such agreements?
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Output and Requirements Contracts
Why enter into such agreements? Output contract: producer locks in to
sale, can safely bulk up on inventory
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Output and Requirements Contracts
Why enter into such agreements? Output contract: producer locks in to
sale, can safely bulk up on inventory Requirements contract: buyer assures
himself of supply
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Requirements Contracts
Risks to producer?
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Requirements Contracts
Risks to producer What if market price > contract price
Market @ 120, contract @100
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Requirements Contracts
Risks to producer: What if market price > contract price What if cost of production > contract price
Cost @120, contract @100
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Eastern at 317
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Eastern
Requirements contract where Gulf was to supply jet fuel to Eastern
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Eastern
Requirements contract where Gulf was to supply jet fuel to Eastern Price adjustment clause : Gulf to pass on
50% of the increase in West Texas Sour
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So what happened to oil prices in 1974?
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So what happened to oil prices in 1974?
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Eastern Air Lines
August 15, 1971: Nixon announces price controls to combat inflation
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With predictable results…
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Gas lines at the pump, 1974
Eastern Air Lines
August 15, 1971: Nixon announces price controls to combat inflation
June 27, 1972: Contract signed
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Eastern Air Lines
August 15, 1971: Nixon announces price controls to combat inflation
June 27, 1972: Contract signed Oct. 6, 1973: Yom Kippur War Oct. 17, 1973: Arab members of OPEC
announce an oil embargo on the US Nov 27, 1973: Emergency Petroleum Allocation
Act with two-tier pricing
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Eastern Air Lines
August 15, 1971: Nixon announces price controls to combat inflation
June 27, 1972: Contract signed Oct. 6, 1973: Yom Kippur War Oct. 17, 1973: Arab members of OPEC
announce an oil embargo on the US Nov 27, 1973: Emergency Petroleum Allocation
Act with two-tier pricing With the result that prices went up
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Supplier
Buyer
Requirements ContractsPrice fluctuations and Incentives
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Contract Price > Market Price
SupplierSupplier wants to sell as much as he can
Buyer
Requirements ContractsPrice fluctuations and the Incentives of the Parties
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Contract Price > Market Price
SupplierSupplier wants to sell as much as he can
BuyerBuyer wants to buy as little as he can
Requirements ContractsPrice fluctuations and the Incentives of the Parties
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Contract Price > Market Price
Market Price > Contract Price
Supplier
Buyer
Requirements ContractsPrice fluctuations and the Incentives of the Parties
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Contract Price > Market Price
Market Price > Contract Price
SupplierSupplier wants to sell as little as he can
Buyer
Requirements ContractsPrice fluctuations and the Incentives of the Parties
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Contract Price > Market Price
Market Price > Contract Price
SupplierSupplier wants to sell as little as he can
BuyerBuyer wants to buy as much as he can
Requirements ContractsPrice fluctuations and the Incentives of the Parties
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Contract Price > Market Price
Market Price > Contract Price
Supplier Gulf wants out
BuyerEastern wants to enforce contract
Requirements ContractsPrice fluctuations and the Incentives of the Parties
Eastern Air Lines
So why didn’t the price adjustment clause cover the increase?
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Eastern Air Lines
So why didn’t the price adjustment clause cover the increase? Based on West Texas Sour (domestic) The Nixon administration imposed price
controls, fixing the price of old oil and permitting higher prices only to the extent that new oil was produced.
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Eastern
Wouldn’t it have been simpler to base the price on Gulf’s costs?
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Eastern Air Lines
What is the uncertainty problem? And how did courts handle it before UCC
2-306?
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Eastern Air Lines
What is the uncertainty problem? And how do courts handle it under UCC
2-306? “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”
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Eastern Air Lines
What is the uncertainty problem? And how do courts handle it under UCC
2-306? “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”
Why is this a criterion of good faith?
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Eastern Air Lines
How would you approach this as an economic question?
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Eastern Air Lines
How would you approach this as an economic question? Who was in the best position to solve the
informational problem?
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Eastern Air Lines
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Who might have predicted the Yom Kippur War?
Eastern Air Lines
Suppose you could purchase gas at $1 per gallon. How much would you want to buy?
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Eastern Air Lines
Who was behaving opportunistically? Overinvestment: was Eastern using too
much fuel?
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Eastern Air Lines
Who was behaving opportunistically? Overinvestment: was Eastern using too
much fuel? What is fuel freighting?
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Eastern Air Lines
Who was behaving opportunistically? Overinvestment: was Eastern using too
much fuel? What is fuel freighting? Gas is $4 a gallon. Your tank is half full.
You spot a serve station sell gas at $3 a gallon an you tank up. Problems?
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Eastern Air Lines
Who was behaving opportunistically? Undersupply: Was Gulf looking for an
excuse to get out of the contract?
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Eastern Air Lines
Who was behaving opportunistically? Cf. Orange and Rockland at p. 333
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Eastern Air Lines
Who was behaving opportunistically? Cf. Orange and Rockland at p. 333
Buyer increases consumption when gas prices go up, propelling itself to be a large seller of power to other utilities
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Contract Price > Market Price
Market Price > Contract Price
SupplierSupplier wants to sell as little as he can
BuyerBuyer wants to buy as much as he can
Requirements ContractsPrice fluctuations and the Incentives of the Parties
Empire Gas 324
What was the contract? And why did American Bakeries enter into it?
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What happened to oil prices in 1979?
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Empire Gas
Which explains American Bakeries’ projected switch from gas to propane To buy propane solely from Empire For approximately 3,000 conversion
units, more or less depending upon requirements of buyer
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What happened to oil prices in 1981?
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Contract Price > Market Price
Market Price > Contract Price
Supplier Gulf wants out
BuyerEastern wants to enforce contract
Requirements ContractsPrice fluctuations and the Incentives of the Parties
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Contract Price > Market Price
Market Price > Contract Price
Supplier Empire Gas
BuyerAmerican Bakeries
But what if it’s the other way around?
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Contract Price > Market Price
Market Price > Contract Price
Supplier Empire Gas
Wants to enforce
BuyerAmerican Bakeries
Wants out
But what if it’s the other way around?
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Contract Price > Market Price
Market Price > Contract Price
Supplier Empire Gas
Over-supply
BuyerAmerican Bakeries
Under-consumption
Empire GasThe demand for propane declined as gas prices fell
Empire Gas
What was the contract? Does the buyer owe good faith duties not
to underconsume?
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Empire Gas
Posner: If there aren’t any good faith restrictions, that would make this an option contract, and requirements contracts are not option contracts
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Empire Gas
Posner’s good faith duties: Buyer can cancel if a change in his
business makes the contract too costly Southwest Natural Gas at 329
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Empire Gas
But here: No reason given by buyer No change in fleet of trucks No business emergency
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Contract Price > Market Price
Market Price > Contract Price
Supplier
Wants to enforce: Empire Gas
BuyerBuyer wants out: Empire Gas
Requirements Contracts
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Contract Price > Market Price
Market Price > Contract Price
SupplierSupplier wants out: Eastern Airlines
BuyerWants to enforce: Eastern Airlines
Requirements Contracts
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Contract Price > Market Price
Market Price > Contract Price
Supplier
Wants to enforce: Empire Gas
Supplier wants out: Eastern Airlines
BuyerBuyer wants out: Empire Gas
Wants to enforce: Eastern Airlines
Requirements Contracts
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