1. 11 George Mason School of Law Contracts II Unconscionability F.H. Buckley fbuckley@gmu.edu

2. 2 Williams v. Walker-Thomas 2

3. 3 Walker-Thomas Furniture Store 1074 Seventh St. NW (at L) 3

4. 4 Why didn’t she shop at Woodward & Lothrop? 10 blocks from Walker-Thomas

5. 5 Or Garfinckel’s? 11 Blocks from Walker-Thomas

6. 6 What happened to Walker-Thomas? 1074 Seventh St. NW (at L) 6

7. 7 Seventh Street NW, April 5, 1968 What happened the day before?

8. 8 Do you recognize Kann’s Department Store? Virginia Square, Arlington VA

9. 9 Would the Shaw community have been better off had Walker-Thomas never been there? 9

10. 10 George Mason School of Law Contracts II Unconscionability F.H. Buckley fbuckley@gmu.edu

11. 11 Would the Shaw community have been better off had Walker-Thomas never been there? 11

12. 12 Seventh Street NW, April 5, 1968

13. 13 What might be wrong here?  Substantive Unconscionability The “just price” doctrine  Procedural Unconscionability “bargaining naughtiness”

14. 14 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.

15. 15 Substantive Unconscionability  Is lending (with interest) per se wrong?

16. 16 Substantive Unconscionability  Is lending (with interest) per se wrong? The usury prohibition against taking interest on a loan  Deut. 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

17. 17 Substantive Unconscionability  Why did the church prohibit usury? The Biblical prohibition?

18. 18 Substantive Unconscionability  Why did the church prohibit usury? The Biblical prohibition? Rent-seeking?  Tolleson et al., 5 J.L.E.O. 307 (1989)

19. 19 Substantive Unconscionability  Why did the church prohibit usury? The Biblical prohibition? Rent-seeking Moral Hazard?: Eric Posner

20. 20 Moral Hazard A range of outcomes associated with an investment opportunity

21. 21 Moral Hazard How is one’s economic calculus affected if costs are curtailed at 0 on the left side of the curve?

22. 22 Moral Hazard In that case, it’s all upside

23. 23 Moral Hazard Thank God I have insurance!

24. 24 Moral Hazard Do traffic signals cause accidents?

25. 25 How to reduce speed levels…

26. 26 Substantive Unconscionability  Is lending per se wrong?

27. 27 Substantive Unconscionability  Is lending per se wrong?  Secured lending, then?

28. 28 Substantive Unconscionability  Is lending per se wrong?  Secured lending, then? UCC 9-201. General Validity of Security Agreement. Except as otherwise provided by this Act, a security agreement* is effective according to its terms between the parties, against purchasers of the collateral and against creditors. *A security agreement creates a security interest in collateral

29. 29 Substantive Unconscionability  Is lending per se wrong?  Secured lending, then?  What about a security interest in after-acquired property?

30. 30 Substantive Unconscionability  Is lending per se wrong?  Secured lending, then?  What about a security interest in after-acquired property? 9-204 (1). After-Acquired Property. Except as provided in subsection (2), a security agreement may provide that any or all obligations covered by the security agreement are to be secured by after- acquired collateral.

31. 31 Substantive Unconscionability  Is lending per se wrong?  Secured lending, then?  What about a security interest in after-acquired property? Otherwise how could a lender take an interest in inventory or accounts receivable?

32. 32 Substantive Unconscionability  Is lending per se wrong?  Secured lending, then?  What about a security interest in after-acquired property of a consumer?

33. 33 Substantive Unconscionability  Is lending per se wrong?  Secured lending, then?  What about a security interest in after-acquired property of a consumer? 9-204 (2). After-Acquired Property. No security interest attaches under an after-acquired property clause to consumer goods* … when given as additional security unless the debtor acquires rights in them within ten days after the secured party gives value. *Goods “used or bought for use primarily for personal, family or household purposes”

34. 34 Substantive Unconscionability  Is lending per se wrong?  Secured lending, then?  What about a security interest in after-acquired property of a consumer? What’s the point of this?  “Exempt Property” in Chapter 7

35. 35 Substantive Unconscionability  The specter of household repossessions

36. 36 Substantive Unconscionability  Why would a consumer ever agree to a security interest in after-acquired property? Ignorance as to the terms?

37. 37 Substantive Unconscionability  Why would a consumer ever agree to this? 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?

38. 38 Substantive Unconscionability  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?  Assume that the low risk borrower can hold his hand in a fire for a longer period of time…

39. 39 Substantive Unconscionability  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?  The willingness to do so might provide a separating equilibrium

40. 40 Substantive Unconscionability  Signalling  S eparating and pooling equilibria:  Pooling equilibrium: Benefit > Cost High Quality Borrower Benefit > Cost Low Quality Borrower  Separating equilibrium: Benefit > Cost High Quality Borrower Benefit < Cost Low Quality Borrower

41. 41 Cheap Talk as a Pooling Equilibrium Hobbes: He which performeth first doth but betray himself to his enemy.

42. 42 Secured Lending as a separating equilibrium  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?  Assume that default is costly for both borrowers. However, the low risk borrower has a lower probability of default…

43. 43 Secured Lending as a separating equilibrium  Signalling?  Assume that default is costly for both borrowers. However, the low risk borrower has a lower probability of default…  The cost C for each borrower is: p D * L, where  p High quality borrower < p Low quality borrower  So that C High quality borrower < C Low quality borrower

44. 44 Substantive Unconscionability  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?  A separating equilibrium if the low risk borrower is ready to accept a penalty on default?

45. 45 Now Procedural Unconscionability

46. 46 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 Π? Or something else entirely?

47. 47 Now Procedural Unconscionability  A rule of capacity in Walker-Thomas? Do such people as the Π have the capacity to enter into the Walker- Thomas sales contract?

48. 48 A Rule of Capacity?  Do such people as the Π have the capacity to enter into the Walker- Thomas sales contract? And just how would you codify this?  Define “such people” 48

49. 49 A Rule of Capacity?  If we don’t legislate this ex ante, how about letting all “such people” set aside their contracts ex post under UCC § 2-302? 49

50. 50 A Rule of Capacity?  If we don’t legislate this ex ante, how about letting all such people set aside their contracts ex post under UCC 2- 302? Same diff from an ex ante perspective? 50

51. 51 A Rule of Capacity?  Did the Π understand the cross- collateral clause? 51

52. 52 Is her poverty relevant?  What were her financial resources?

53. 53 Is her poverty relevant?  What were her financial resources? Are we quite sure about that?

54. 54 Is her poverty relevant?  What were her financial resources? You mean we let poor people enter into contracts?

55. 55 Did it matter what was purchased? Perfectionism, not paternalism? 55 Suppose it had been a 10-year subscription to The New Republic?

56. 56 Did it matter what was purchased? 56 “Man does not live by bread alone… He also needs strawberry jam.” Lionel Trilling

57. 57 “Gross inequality of bargaining power” 57 Friedrich Kessler

58. 58 “Gross inequality of bargaining power”  The specter of monopoly capitalism “The weaker party is frequently not in a position to shop around for better terms, either because the author of the standard contract has a monopoly (natural or artificial) or because all competitors use the same clause.” 58 Friedrich Kessler, Contracts of Adhesion, 43 Colum. L.Rev. 629

59. 59 The specter of monopoly capitalism Is that what happened? 59 Joseph Schumpeter on the “creative destruction” of capitalism, in Capitalism, Socialism, Democracy

60. 60 “Gross inequality of bargaining power”  Is the inequality greater when you purchase at Macy’s?

61. 61 “Gross inequality of bargaining power” 61 $12.99!!! I think we can do better than that, don’t you? “An absence of meaningful choice” unless we can dicker?

62. 62 “Gross inequality of bargaining power”  Are all purchases in the inner city automatically suspect? Let them shop at Garfinckels…

63. 63 Standard Form Contracts  Would Skelly Wright enforce any consumer contract based on a standard form? No “objective manifestation of consent” 63

64. 64 Why Employ Standard Form Contracts?  Trick consumers?  Economize on negotiations  Police consumer fraud  Economize on litigation  Police agency costs of merchant 64

65. 65 George Mason School of Law Contracts II Unconscionability F.H. Buckley fbuckley@gmu.edu

66. 66 Seabrook: What might be wrong here?  Substantive Unconscionability The “just price” doctrine  Procedural Unconscionability “bargaining naughtiness”

67. 67 Seabrook 67 Unfinished Apartment Building

68. 68 Seabrook  Let’s say your counsel for Commuter Housing. How would you draft clauses 33 and 19 differently? 68

69. 69 Seabrook  Can you articulate the legal principle behind the case? 69 Unfinished Apartment Building

70. 70 Here’s one… 70

71. 71 Seabrook  Did the lessee have “no choice but to sign an unconscionable lease agreement” 71

72. 72 Seabrook  Did the lessee have “no choice but to sign an unconscionable lease agreement” Were there other rental properties in NYC? 72

73. 73 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? 73

74. 74 Seabrook  Just what was unconscionable? Did the lessee know that the building was not completed when he signed the lease? 74

75. 75 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? 75

76. 76 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? 76

77. 77 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 then are the terms of the bargain? 77

78. 78 Seabrook  If you’ve 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? 78

79. 79 Seabrook  If you’re advising a lessor, do you take any drafting tips from this case? 79

80. 80 Seabrook  If you’re 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? 80

81. 81 Henningsen 1960 Plymouth 81

82. 82 Henningsen 1960 Plymouth … in two-tone! 82

83. 83 Henningsen With a push-button tranmission! 83

84. 84 And today? 2010 Chevrolet Spark

85. 85 Henningsen 1960 Plymouth 85

86. 86 Henningsen And what did they do with their car!! 86

87. 87 Henningsen  What did the warranty cover? Can you think of any business reason why it was drafted that way? 87

88. 88 Henningsen  Was the exemption clause per se illegal? “Inimical to the public good” 88

89. 89 Henningsen  Was the exemption clause per se illegal? “Inimical to the public good”  But also “grossly disproportionate bargaining power” 89

90. 90 Henningsen  Were the Big Three immune from competition? 90

91. 91 Henningsen  Were the Big Three immune from competition?  Is a similarity in prices or terms across a market evidence of cartelization? 91

92. 92 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? 92

93. 93 Henningsen  Were 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? 93

94. 94 Henningsen  Were 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? 94

95. 95 Substantive Unconscionability again The two-person bargaining game  The Edgeworth Box Function provided a bargaining model based on ordinal utility (indifference curves) 95

96. 96 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 96

97. 97 Mary Bess A   B C D E  F  G    Recall the Contract Curve Indifference curve in commodity space

98. 98 A B C F G A is the endowment point Blowing up the bargaining lens

99. 99 Mary Bess A   B C D E  F  G    Recall the Contract Curve Indifference curve in commodity space

100. 100 A B C F G At C Mary is much better off than at A, and Bess is neither better nor worse off A is the endowment point Blowing up the bargaining lens

101. 101 A B C F G At B Bess is much better off than at A, and Mary is neither better nor worse off A is the endowment point Blowing up the bargaining lens

102. 102 A B C F G A is the endowment point At G both parties are better off than at A Blowing up the bargaining lens

103. 103 A B C F G Does 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?

104. 104 A B C F G Does 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 is at G relative to B or C

105. 105 A B C F G Does unconscionability have anything to do with how bargaining gains are divided? To do so, we would need to move from ordinal to cardinal utility

106. 106 Ordinal and Cardinal Utility  Ordinal numbers: First, second, third…  Cardinal numbers: 1, 2, 3 … 106

107. 107 Ordinal and Cardinal Utility  The Edgeworth Box Function provided 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 107

108. 108 Cardinal utility 108 Act always to increase the greatest happiness of the greatest number

109. 109 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 109 Vilfredo Pareto

110. 110 The Revival of Cardinal Utility Game Theory 110 John von Neuman, Theory of Games and Economic Behavior (1944)

111. 111 AG C The units of measurement are now in “utils,” not commodities Cardinalists assume we can measure utility levels

112. 112 AG C We move from commodity to utility space Cardinalists assume we can measure utility levels

113. 113 AG C Cardinal, not ordinal utility Utility space Let’s suppose we can measure Mary’s utility levels

114. 114 AG C G'G' B Mary’s utility Bess’s utility Utility Space And suppose we can do the same for Bess

115. 115 0 1.0 Mary Bess To simplify we normalize the utility functions of both from 0 to 1.0

116. 116 AC B BC is concave (bends outward) because we assume that joint utility is maximized when gains are shared Mary Bess We can then represent the contract curve in utility space

117. 117 AC B Mary Bess The Presolution BC represents the “presolution” to the game: it is feasible and efficient

118. 118 Mary Bess A   B C D E  F  G    Recall where we’re getting this from

119. 119 0 1.0 Mary Bess The “solution” to the two-person bargaining game picks one point on the contract curve The Solution

120. 120 0 1.0 Mary Bess Nash solution of (.75*.8 =).6 Howard Raiffa, The Art and Science of Negotiation (1982) Nash maximizes the product of the utility gains The Nash Solution

121. 121 0 1.0 Mary Bess Mary insists on a payoff of.95.95.95.95 The hard bargainer doesn’t seek the Nash Solution

122. 122 Paul Newman in The Hustler The hard bargainer: Wanna shoot with Fast Eddie? Yeah. The Church of the Good Hustle It’s like a church

123. 123  We have $1,000 to divide between us.  I first decide how the money is to divided. The ultimatum game

124. 124  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

125. 125  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

126. 126  In the first round I choose $950, leaving you $50  Take it or leave it? The ultimatum game

127. 127 The ultimatum game Player 1 FairUnfair Accept Reject 5, 5 0, 0 9.5, 0 Player 2

128. 128  You see that Safeway refuses to charge a premium for a shovel during a snow storm Is it being irrational? Do we have built-in fairness constraints?

129. 129  Do men play differently than women? Do we have built-in fairness constraints?

130. 130  Do men play differently than women?  Do men play differently when they play against women? Do we have built-in fairness constraints?

131. 131  Do men play differently than women?  Do women play differently when they play against men? Do we have built-in fairness constraints?

132. 132  Do people play differently when the payoffs are higher? Do we have built-in fairness constraints?

133. 133  Do people play differently when they are told that player 1 has “earned” the money? Do we have built-in fairness constraints?

134. 134  Do we distinguish between strangers and brothers? Greater interdependence and stronger fairness norms in market societies Weaker fairness norms in diverse societies? Do we have built-in fairness constraints?

135. 135 0 1.0 Mary Bess Qu. How many such bargains will be lost through bargaining breakdown?.95 The hard bargainer

136. 136 0 1.0 Mary Bess Assume that an arbitrator can measure utilities and refuses to enforce bargains that allocate.95 of the gains to one party.95 Getting to Yes: Suppose we resist enforcing hard bargains?

137. 137 0 1.0 Mary Bess Some contracts will not be enforced. But might more be entered into because hard bargainers have been chilled?.95 Getting to Yes: Suppose we resist enforcing hard bargains?

138. 138  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

139. 139 George Mason School of Law Contracts II Statute of Frauds F.H. Buckley fbuckley@gmu.edu