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March 28, 2009

Unenforceable Contracts and the Economy of Trust

A fav blog brought me to Marie Cocco's blog entry, If You’re a Little Guy, a Contract Means Nothing. Excellent writing; she had me at Orwell.

I am not a lawyer (IANAL) and so I will leave the art of contract law to those professionals. But The nature of contracts in America has changed during recent (post-WW2) history and it has implications for where we go in the future.

Enforceable Contracts

A contract is an exchange of promises between two or more parties to do (or refrain from doing) an act which is enforceable in a court of law. It is a binding legal agreement. That is to say, a contract is an exchange of promises for the breach of which the law will provide a remedy. A contract requires agreement, consideration, intention, capacity, and formalities.

Why do we make contracts? Why does society define them? Because if you observe the rules, a contract is enforceable.

Bankruptcy and Assymetrically Enforceable Contracts

Cocco's article describes how, in current practice, contracts are only enforceable against the "little guys".

The practice of using bankruptcy laws to abrogate union contracts in aviation was the particular expertise of Frank Lorenzo, who ruined Texas Air, New York Air, Continental and Eastern, and left the technique of using strategic bankruptcy to void contracts as his legacy to the industry.

In Pittsburgh, USAirways made contracts with their employee unions and with the airport. Although the airline thought the contracts were a fair bargain when they entered into them, when the world and their priorities changed they felt it was a burden to honor the contracts - so they filed for bankruptcy, voided their contracts, repudiated their agreements, and left their contracting parties in the lurch.

Unenforceable Contracts

unenforceable contractThe extension of bankruptcy laws from the original concept (protection of creditors and assets) to the cancellation of contracts is an overwhelming change in our system of contract law. The result of this extension is that contracts are now asymmetrically unenforceable; the big party can play the bankruptcy card, and the little party has no significant recourse.


Used to be, when you entered into a contract for the next five years, you could reliably plan on the conditions of the contract unless there were extraordinary events (force majeure). Now, contracts with large entities are only valid as long as the entity finds it beneficial. It's a lot harder to plan in the face of such uncertainty.

Cocco points out the dialectic in our public posture on contracts. Contracts describing bonuses at AIG just had to be honored, in spite of the fact that the company was out of cash, received ma$$ive federal bailouts, and the President wanted them stopped. Contracts describing wages and benefits at GM plants for UAW members just had to be broken and rationalized in order for their jobs to exist for another year. Some contracts are enforceable, some are not, and the fickle capriciousness is unjustifiable.

Imposed Conditions as Pseduo-Contract

In the December 2008 showdown between Pittsburgh's PAT Authority and Local 85 (blog entry), the County withheld appropriated funds to contrive an artificial financial deadline, and then the Authority threatened to void the existing labor contract and impose new terms, which it referred to as a new contract. This is pure Newspeak; imposed working conditions do not meet the agreement / consideration / intention / capacity / formalities definition of a contract.

As contracts mean less, the benefits of making a contract are diminished, and the economic machine is damaged. Ask any USAirways pilot, whose retirement is gone and whose contract is gutted, how much they trust any contract or organization. Ask Captain Sullenberger.




The Economy of Trust



Frances Fukuyama's book, Trust: The Social Virtues and The Creation of Prosperity, talks about the role of culture and laws in establishing a culture of trust, and how prosperity and wealth increase in a society in which people and companies are comfortable undertaking risk mitigated by trust.

I think that the erosion of contract enforceability through bankruptcy laws, combined with capricious political decisions about which contracts cannot fail and which contracts must fail, reduce the culture of trust and will prevent the prosperity that depends on a culture of trust.

I take a shallow and mechanistic view of culture, and try to diagnose our maladies the way you'd troubleshoot a system. When something's not working the way it used to, I wonder: what was the point at which things changed? What was the event that set us on this new path? What changed that caused this problem?

Modern Origin of Unenforceable Contracts

When did contracts start becoming unenforceable? I believe it started way before Frank Lorenzo. I think it started when we liberalized divorce and made the marriage contract unenforceable - either party could get out easily, even if the other party objected. What could be the harm?

Sure, you had agreed to the marriage, in fact you'd sworn to specific terms -- but now you've grown as a person, you're beyond them, and so you file some forms and you're out of it, regardless of the other party's desire to keep the marriage contract together. Marriage was the first generally unenforceable contract in modern times, and now the concept is rippling through the rest of the economy.


A Pox Upon Their House

The dark part of me races to harsh thoughts, and I wonder about all the Captains Wannabees of Industry and Management who break contracts as a technique instead of working at their committments the old-fashioned way. I wonder what they do if they go home and the spouse says, I want to dissolve our marriage contract, it's not working for me anymore, you're not the MBA I married. I wonder if they say things like, "I trusted you. We had a deal. I've given you the best years of my life. I built you a midfield terminal house, and now I'll still have to pay it off and get no benefit from it."

I wonder if they'd appreciate the irony.

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