1. 11 George Mason School of Law Contracts II Unconscionability Not to be shared © F.H. Buckley fbuckley@gmu.edu

2. 2 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.

3. 3 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.

4. 4 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.

5. 5 Forms of Unconsionability  Substantive Unconscionability The “just price” doctrine  Procedural Unconscionability “bargaining naughtiness”

6. 6 Was secured lending in Walker-Thomas a problem of substantive unconscionability? 6

7. 7 Substantive Unconscionability  Usury legislation  Barriers to personal property security interests in consumer goods in Article 9

8. 8 Procedural Unconscionability  Was Mrs. William’s consent tainted in some way, short of actual duress or fraud?

9. 9 Why might a consumer agree to “excessive” interest rates?  Lack of capacity?  Something like Duress?  Something like Fraud: An informational problem?

10. 10 Lloyds Bank v. Bundy

11. 11 Lloyds Bank v. Bundy  What did the bank manager (Head) do that was wrong?  Did he owe any duties to the borrower (Michael)?  Did he owe any duties to Herbert?

12. 12 Denning’s Categories  “Duress of goods”: Inequality of bargaining power Hochman at 407 Austin v. Loral

13. 13 Denning’s Categories  The expectant heir: One-and-twenty Wealth, my lad, was made to wander, Let it wander as it will; Call the jockey, call the pander, Bid them come and take their fill. 20 When the bonny blade carouses, Pockets full, and spirits high— What are acres? What are houses? Only dirt, or wet or dry. Should the guardian friend or mother 25 Tell the woes of wilful waste, Scorn their counsel, scorn their pother;— You can hang or drown at last! Samuel Johnson

14. 14 Denning’s Categories  Undue influence  Fiduciary relationship  Employer exploiting employee  D&C Builders v. Rees D&C accepts £300 as full payment of a debt of £482 when it desperately needed money to fend off bankruptcy, and Rees knew this

15. 15 Denning’s Categories  Salvage Agreements  Post v. Jones

16. 16 A General Principle of Inequality of Bargaining Power?  “English law gives relief to one who, without independent advice, enters into a contract or transfers property for a consideration which is grossly inadequate, when his bargaining power is grievously impaired by reason of his own needs or desires, or by his own ignorance or infirmity, coupled with undue influences or pressures brought to bear on him by or for the benefit of the other.”

17. 17 Why look at an English case?  Maryland is a foreign jurisdiction to Virginians…

18. 18 Why look at an English case?  The importance of style: Broadchalke is one of the most pleasing villages in England. Old Herbert Bundy was a farmer there. His home was at Yew Tree Farm. It went back for 300 years. His family had been there for generations. It was his only asset. But he did a very foolish thing. He mortgaged it to the bank. Up to the very hilt.

19. 19 Why look at an English case?  The Analogic Imagination: Gathering all together, I would suggest that through all these instances there runs a single thread. They rest on "inequality of bargaining power".

20. 20 Why might a consumer agree to “excessive” interest rates?  An informational problem 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. Was Lloyd’s Bank such as case? Or Williams v. Walker-Thomas

21. 21 Why might a consumer agree to “excessive” interest rates?  A moral hazard problem  What does bankruptcy law and the welfare safety net do to our investment decisions?

22. 22 Moral Hazard A range of outcomes associated with an investment opportunity

23. 23 Moral Hazard How is one’s economic calculus affected if costs are curtailed at 0 on the left side of the curve?

24. 24 Moral Hazard In that case, it’s all upside: Heads I win, tails you lose

25. 25 Moral Hazard: We make risker choices when we don’t pay for downsides Thank God I have insurance!

26. 26 Moral Hazard Do traffic signals cause accidents?

27. 27 How to reduce speed levels…

28. 28 Moral Hazard  So a consumer might be more willing to court default with a high risk loan because of the welfare safety net.

29. 29 Moral Hazard  So what’s “excessive”? Is there such a thing as “excessive risk aversion”

30. 30 Why might a consumer agree to “excessive” interest rates?  Signalling

31. 31 Signalling  T wo 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?

32. 32 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 and a lower cost of default

33. 33 Signalling  A signalling equilibria if a “non- mimicry” constraint  By their willingness to accept the cost of a high interest loan one can tell them apart and they don’t have an incentive to switch

34. 34 Signalling  Separating equilibrium: Benefit > Cost* High Quality Borrower Benefit < Cost* Low Quality Borrower *Cost is a function of the probability of default

35. 35 Signalling  Signalling doesn’t work if a pooling equilibrium  Low quality can mimic high quality

36. 36 Signalling  Pooling equilibrium Benefit > Cost High Quality Borrower Benefit > Cost Low Quality Borrower

37. 37 Cheap Talk as a Pooling Equilibrium Hobbes: He which performeth first doth but betray himself to his enemy.

38. 38 Signalling  A separating equilibrium if the low risk borrower is unwilling to accept a penalty on default?

39. 39 Seabrook: 502 Apartment to be ready three months later 39 Unfinished Apartment Building

40. 40 Seabrook  How long was the delay? 40

41. 41 Seabrook  Do you think counsel for Commuter Housing was trying to pull a fast one in clauses 33 and 19? 41

42. 42 Seabrook  Do you think counsel for Commuter Housing was trying to pull a fast one in clauses 33 and 19?  What did the court say was missing? 42

43. 43 Seabrook  Do you think counsel for Commuter Housing was trying to pull a fast one in clauses 33 and 19?  What did the court say was missing?  Why not strike the clause and imply a reasonable time (and might that be four months? 43

44. 44 Seabrook  Can you articulate the legal principle behind the case? 44

45. 45 Seabrook  Can you articulate the legal principle behind the case? “absence of meaningful choice” “Once the consumer enters to merchant’s trap … he is caught in a web” Land a “scarce commodity” “The concept of laissez-faire... Has no place in our enlightened society” 45

46. 46 Here’s one legal principle … 46

47. 47 Seabrook  Did the lessee have “no choice but to sign an unconscionable lease agreement” “does not have the option of shopping around” 47

48. 48 Seabrook  Did the lessee have “no choice but to sign an unconscionable lease agreement” Were there other rental properties in NYC? 48

49. 49 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? 49

50. 50 Seabrook  Just what was unconscionable? Did the lessee know that the building was not completed when he signed the lease? 50

51. 51 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? 51

52. 52 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? 52

53. 53 Seabrook  If you thought that the lessor should have provided for a maximum period, is that the hindsight bias at work? 53

54. 54 Henningsen 1960 Plymouth 54 Look: Fins!!!

55. 55 Henningsen 1960 Plymouth … in two-tone! 55

56. 56 Henningsen With a push-button tranmission! 56

57. 57 And today? Chevrolet Spark

58. 58 Henningsen 1960 Plymouth 58

59. 59 Henningsen And what did they do with their car!! 59

60. 60 Henningsen  Are exemption clauses intrinsically suspect? 60

61. 61 Henningsen  A right to dicker? 61 “No bargaining is engaged with respect to it” $3.99? I think we can do better, don’t you?

62. 62 Henningsen  Why only a three months warranty on parts? 62

63. 63 Henningsen  Were the Big Three immune from competition? Look at the list on 506 63

64. 64 Henningsen  Were the Big Three immune from competition? 64

65. 65 Henningsen  Were the Big Three immune from competition? If so, why do you think that was? 65

66. 66 Henningsen  Were the Big Three immune from competition?  Is a similarity in prices or terms across a market evidence of cartelization or of a competitive market? 66

67. 67 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 a monopolist exploit his clout with prices and not terms? 67

68. 68 Henningsen  Would you expect to a monopolist exploit his clout with prices and not terms?  Is it different if the information about warranties is difficult to understand? 68

69. 69 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? 69

70. 70 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? 70

71. 71 Litigation or Regulation?  OIRA’s Mandate: Federal agencies should promulgate only such regulations as are required by law, are necessary to interpret the law, or are made necessary by compelling public need, such as material failures of private markets to protect or improve the health and safety of the public, the environment, or the well-being of the American people. In deciding whether and how to regulate, agencies should assess all costs and benefits of available regulatory alternatives, including the alternative of not regulating. 71

72. Federal Arbitration Act of 1925  Partial preemption of state law  Rent-a-Center v. Jackson at 513 72

73. 73 George Mason School of Law Contracts II Unconscionability Not to be shared © F.H. Buckley fbuckley@gmu.edu

74. 74 How thick are the fairness constraints?  Fairness in the 18 th, 19 th and 20 th centuries Thornborrow v. Whitacre Printing v. Sampson Henningsen 74

75. Next day  Add Scott 74-84 on conditions 75

76. 76 Fairness in the two-person bargaining game  The Edgeworth Box Function provided a bargaining model based on ordinal utility (indifference curves) 76

77. 77 Mary Bess A   B C D E  F  G    Recall the Contract Curve Indifference curve in commodity space

78. 78 The two-person bargaining game  The Edgeworth Box Function teaches us that bargaining is a non-zero sum game 78

79. 79 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 79

80. 80 Mary Bess A   B C D E  F  G    Recall the Contract Curve Indifference curve in commodity space

81. 81 A B C F G A is the endowment point Blowing up the bargaining lens

82. 82 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?

83. 83 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

84. 84 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

85. 85 Ordinal and Cardinal Utility  Ordinal numbers: First, second, third…  Cardinal numbers: 1, 2, 3 … 85

86. 86 Are you a cardinalist?  Yes, if you think interpersonal utility comparisons are meaningful 86

87. 87 Are you a cardinalist?  You are charged with designing a country’s welfare policy. Should wealth transfers be from rich to poor or the other way around? 87

88. 88 AG C We move from commodity to utility space Cardinalists assume we can measure utility levels

89. 89 AG C The units of measurement are now in “utils,” not commodities Cardinalists assume we can measure utility levels

90. 90 AG C Utility space Let’s suppose we can measure Mary’s utility levels

91. 91 AG C G'G' B Mary’s utility Bess’s utility Utility Space And suppose we can do the same for Bess

92. 92 0 1.0 Mary Bess To simplify we normalize the utility functions of both from 0 to 1.0

93. 93 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

94. 94 0 1.0 Mary Bess Mary insists on a payoff of.95.95 The hard bargainer

95. 95 0 1.0 Mary Bess Mary insists on a payoff of.95.95 Do we have fairness intuitions which think this unfair?

96. 96  We have $1,000 to divide between us.  I first decide how the money is to divided. The ultimatum game

97. 97  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

98. 98  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

99. 99  In the first round I choose $950, leaving you $50  Take it or leave it? The ultimatum game

100. 100  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?