Contracts Limerick of the Week: Market Street Associates v. Frey

There has been a lot of interest on the blog latelyin the topic of contracts law and morality, e.g. here and here.  Our comments section has beenunusually active, which is terrific.  A recent comment got me to thinking about MarketStreet Associates v. Frey.  

That case involved a lease agreement between GE PensionTrust (GE) and Market Street Associates (MSA) as the assignee of JC Penny.   The lease had a provision thatallowed MSA to seek a loan from GE for the purpose of improving theproperty.  If GE refused, MSA hadan option to buy the property for the original purchase price plus 6% annualinterest. 

MSA offered to repurchase the property from GE, butGE demanded $3 million, which MSA thought was too much.  MSA then requested financing, and whenGE refused on the ground that it was not offering loans in amounts less than $7million, MSA demanded the sale of the property pursuant to the lease provision.  Under the terms of the lease, MSA wouldhave been entitled to buy the property for about $1 million.  GE claimed that because MSA had failedto remind it of the option in the lease, MSA had acted in bad faith. 

The district court granted summary judgment to GE,finding that under the doctrine of good faith or simply as a matter of contractinterpretation, MSA had a duty to remind GE of the option provision.  This led Judge Posner to a lengthyrumination on the nature of terms such as “good faith” in contract law.  Not surprisingly, Judge Posner does notfind these terms very useful. However, he was able to explain the value of the doctrine of good faithin economic terms, and that permitted him to find that in fact MSA’s conductmight well have violated the duty to act in good faith.

For Posner, what we call the duty of good faith isreally just about reducing transactions costs by creating a disincentive tosharp practices in the course of performance.  Sharp practices, says Judge Posner, are perfectly fine whennegotiating a deal, but once the parties enter into an agreement, they are nowin a “cooperative relationship” in which each lowers her guard.  The doctrine of good faith thusprotects against opportunistic behavior that can arise in the context of the sortof bilateral monopoly that can develop after the parties have committedthemselves to a contractual relationship.

As many commentators on the blog have pointed out,there are many reasons to doubt that the moralizing tone underlying terms such as“good faith” could or should be eliminated from contracts law.   But even assuming we were toattempt to understand contracts law entirely in terms of transactions costs,Posner’s position remains highly dubious. 

First, at least since the Restatement (2d) and theUCC, contracts law has been sensitive to the difficulty of attempting topinpoint the moment at which a threshold from a pre-contractual to a post-contractual relationship has been crossed.  Parties continue to negotiate and change deals as theygo.  There is thus little reason tosuspect that parties immediately let down their guards once they have enteredinto a cooperative relationship.

Second, if sharp practices increase transactionscosts, then they do so regardless of when they occur.  A party that engages in sharp practices will get areputation for doing so.  Otherparties dealing with that party will be cautious and will engage in extradiligence that will complicate negotiations and may ultimately prevent manydeals from occurring because a fundamental mistrust cannot be overcomesatisfactorily.  

Finally, if one is really interested in reducingtransactions costs, then hold sophisticated, well-resourced parties to theterms of the agreements they sign. If GE wants a provision requiring notice before its contractual partnertriggers its option to purchase, it can very easily write that duty to notifyinto the contract.  A party like GEshould have no recourse to a doctrine like good faith when it had the means andthe ability to protect its own interests in both the pre- and thepost-contractual moments.

Still, Posner opinions are always stimulating andthus Limerickworthy:

Market Street Associates v. Frey

“Don’t get moralistic with me,”
 Said Judge Posner to trustee, GE.
 “Though when I hear ‘good faith,’
 I reach for my . . . Wraith.
 Opportunists ain’t my cup o’ tea.”

[Jeremy Telman]