1. George Mason School of Law
Contracts I
O. Requirements Contracts
F.H. Buckley

2. Indefinite Agreements
Why leave a term open
Didn’t occur to one
The informational problem and the impossibility of a Complete Contingent Contract
Uncertain outcomes

3. Output and Requirements Contracts: A special case of uncertainty
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.

4. Output and Requirements Contracts
Vas ist das?
Output contract: buyer agrees to purchase seller’s entire output

5. Output and Requirements Contracts
Vas ist das?
Output contract: buyer agrees to purchase seller’s entire output
Requirements contract: seller agrees to sell as much of his product as buyer requires 5

6. Output and Requirements Contracts
Supplier sells output
Supplier
Customer
Customer buys
requirements

7. Output and Requirements Contracts
Why enter into such agreements?

8. Output and Requirements Contracts
Why enter into such agreements?
Output contract: supplier locks in to sale, can safely bulk up on inventory and fire the sales department

9. Output and Requirements Contracts
Why enter into such agreements?
Output contract: supplier locks in to sale, can safely bulk up on inventory
Requirements contract: buyer assures himself of supply, fires the marketing department 9

10. Requirements Contracts
Risks to supplier?

11. Requirements Contracts
Risks to supplier
What if market price > contract price
120,
Supplier would like to sell at 120 but is bound to sell at 100

12. Requirements Contracts
Risks to supplier:
What if market price > contract price
What if cost of production > contract price

13. Eastern at 317

14. Eastern
Requirements contract where Gulf was to supply jet fuel to Eastern

15. 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

16. So what happened to oil prices in 1974?

17. So what happened to oil prices in 1974?

18. Eastern Air Lines
1970: OPEC formed
“the handwriting was on the wall”

19. Eastern Air Lines
August 15, 1971: Nixon announces price controls to combat inflation

20. Eastern Air Lines
August 15, 1971: Nixon announces price controls to combat inflation
June 27, 1972: Contract signed

21. Eastern Air Lines
August 15, 1971: Nixon announces price controls to combat inflation
June 27, 1972: Contract signed
Oct. 6, 1973: Yom Kippur War
Defcom III: Air Force ready to strike in 15 minutes

22. 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—which raises prices for new oil

23. 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 for oil went up

24. Requirements Contracts Price fluctuations and Incentives
Supplier
Buyer

25. Requirements Contracts Price fluctuations and the Incentives of the Parties
Contract Price > Market Price
Supplier
Buyer

26. Requirements Contracts Price fluctuations and the Incentives of the Parties
Contract Price > Market Price
Supplier
Supplier wants to sell as much as he can
Buyer

27. Requirements Contracts Price fluctuations and the Incentives of the Parties
Contract Price > Market Price
Supplier
Supplier wants to sell as much as he can
Buyer
Buyer wants to buy as little as he can

28. Requirements Contracts Price fluctuations and the Incentives of the Parties
Contract Price > Market Price
Market Price > Contract Price
Supplier
Buyer

29. Requirements Contracts Price fluctuations and the Incentives of the Parties
Contract Price > Market Price
Market Price > Contract Price
Supplier
Supplier wants to sell as little as he can
Buyer

30. Requirements Contracts Price fluctuations and the Incentives of the Parties
Contract Price > Market Price
Market Price > Contract Price
Supplier
Supplier wants to sell as little as he can
Buyer
Buyer wants to buy as much as he can

31. Requirements Contracts Price fluctuations and the Incentives of the Parties
Contract Price > Market Price
Market Price > Contract Price
Supplier
Gulf wants out
Buyer
Eastern wants to enforce contract

32. Eastern Air Lines
So why didn’t the price adjustment clause cover the increase?

33. 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.

34. Eastern
Wouldn’t it have been simpler to base the price on Gulf’s costs? 34

35. Eastern Air Lines What is the uncertainty problem?
And how did courts handle it before UCC 2-306?

36. 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”

37. 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?

38. Eastern Air Lines
How would you approach this as an economic question?

39. Eastern Air Lines How would you approach this as an economic question?
Who was in the best position to solve the informational problem?

40. Eastern Air Lines
Who might have predicted the Yom Kippur War?

41. Eastern Air Lines
Who was behaving opportunistically?

42. Eastern Air Lines Who was behaving opportunistically?
Overinvestment: was Eastern using too much fuel?

43. Eastern Air Lines Who was behaving opportunistically?
Overinvestment: was Eastern using too much fuel?
What is fuel freighting?

44. Eastern Air Lines Who was behaving opportunistically?
Overinvestment: was Eastern using too much fuel?
What is fuel freighting?
Gas is $3 a gallon. Your tank is half full. You spot a serve station sell gas at $1 a gallon an you tank up. Problems?

45. Eastern Air Lines Who was behaving opportunistically?
Undersupply: Was Gulf looking for an excuse to get out of the contract?

46. Eastern Air Lines Who was behaving opportunistically?
Cf. Orange and Rockland at p. 333

47. 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 47

48. Eastern Air Lines Who was behaving opportunistically?
Cf. Southwest Natural Gas at p. 329
Need for gas falls when new boiler installed 48

49. Empire Gas 324
What was the contract? And why did American Bakeries enter into it?

50. What happened to oil prices in 1979-80?

51. Empire Gas
Which might explain American Bakeries’ projected switch from gas to propane (and then back again)
To buy propane solely from Empire
For approximately 3,000 conversion units, more or less depending upon requirements of buyer

52. Incentives Contract Price > Market Price
Market Price > Contract Price
Supplier
Empire Gas
Over-supply
Buyer
American Bakeries
Under-consumption

53. Incentives as to conversion units
Contract Price > Market Price
Market Price > Contract Price
Supplier
Empire Gas wants to enforce
Buyer
American Bakeries
wants out

54. Empire Gas What was the contract?
Does the buyer owe good faith duties not to underconsume?

55. 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

56. 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

57. Empire Gas But here: No reason given by buyer
No change in fleet of trucks
No business emergency

58. Requirements Contracts
Contract Price > Market Price
Market Price > Contract Price
Supplier
Wants to enforce: Empire Gas
Supplier wants out: Eastern Airlines
Buyer
Buyer wants out: Empire Gas
Wants to enforce: Eastern Airlines