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Output and Requirement Contracts: Understanding the Incentives and Implications

This article explores the concept of output and requirement contracts, discussing their benefits, potential issues, and the role of good faith. It also analyzes a case study involving Eastern Air Lines and Gulf to examine the incentives of the parties involved.

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Output and Requirement Contracts: Understanding the Incentives and Implications

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

  2. Output and Requirement Contracts • Vas ist das?

  3. Output and Requirement Contracts • Vas ist das? • Output contract: producer agrees to sell his entire output to buyer

  4. Output and Requirement Contracts • Vas ist das? • Output contract: producer agrees to sell his entire output to buyer • Requirements contract: producer agrees to sell as much of his product as buyer requires 4

  5. Output and Requirement Contracts • Why enter into such agreements? • Output contract: producer locks in to sale, can safely bulk up on inventory

  6. Output and Requirement Contracts • Why enter into such agreements? • Output contract: producer locks in to sale, can safely bulk up on inventory • Requirements contract: buyer assures himself of supply 6

  7. Output and Requirement Contracts • Recognized in UCC 2-306 • Otherwise an indefiniteness problem

  8. What happened in Eastern?

  9. Eastern • Requirements contract where Gulf was to supply jet fuel

  10. So what happened to oil prices in 1974?

  11. So what happened to oil prices in 1974?

  12. 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 after the Yom Kippur Ware • Nov 27, 1973: Emergency Petroleum Allocation Act

  13. With predictable results… Gas lines at the pump, 1974

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

  15. 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.

  16. Eastern Why didn’t they base the price on Gulf’s costs? 16

  17. Eastern Air Lines • UCC § 2-306: good faith duties: were they implicated?

  18. Eastern Air Lines • UCC § 2-306: good faith duties: were they implicated? • Does good faith imply a price based on market or West Texas Sour? • Do abnormal price increases go to good faith?

  19. Eastern Air Lines • UCC § 2-306: good faith duties: were they implicated? • Does good faith imply a price based on market or West Texas Sour? • Was the contract meant to cover such price increases?

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

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

  22. Eastern Air Lines Who predicted the Yom Kippur War?

  23. Eastern • How was Eastern’s fuel freighting relevant?

  24. Eastern • How was Eastern’s fuel freighting relevant? • A breach of good faith or standard industry practice?

  25. Eastern • How was Eastern’s fuel freighting relevant? • A breach of good faith or standard industry practice? • Suppose Eastern had started to sell jet fuel to other airlines?

  26. Requirements ContractsPrice fluctuations and Incentives

  27. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  28. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  29. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  30. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  31. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  32. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  33. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  34. Eastern Air Lines • Suppose you could purchase gas at $1 per gallon. How much would you want to buy?

  35. Eastern Air Lines • Suppose you could purchase gas at $1 per gallon, but were not permitted to resell it. • Would this change your driving habits?

  36. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  37. Requirements ContractsPrice fluctuations and the Incentives of the Parties 37

  38. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  39. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  40. Requirements ContractsPrice fluctuations and the Incentives of the Parties 40

  41. Requirements ContractsPrice fluctuations and the Incentives of the Parties

  42. Requirements ContractsPrice fluctuations and the Incentives of the Parties • UCC § 2-306 (1): “no quantity • unreasonably disproportionate • to any stated estimate

  43. Requirements ContractsPrice fluctuations and the Incentives of the Parties

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

  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. 330

  47. Eastern Air Lines • Who was behaving opportunistically? • Cf. Orange and Rockland at p. 330 • Buyer increases consumption when gas prices go up, propelling itself to be a large seller of power to other utilities 47

  48. Empire Gas 320 • What was the contract?

  49. Empire Gas • What was the contract? • To buy propane solely from Empire • For approximately 3,000 conversion unites, more or less depending upon requirements of buyer

  50. Empire Gas • What was the contract? • Is the only purpose of the contract to provide the buyer with assurance of supply?

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