Friday, October 10, 2008

The Limits of Contract Law

In the past, Pericles has made statements to the effect (I may have this wrong as it may have been couched) that all law (at least his branch of law) has economic resolution. I am hoping Pericles or other fine readers of this blog are willing to discuss, what I found to be an interesting point:
Morgan Stanley's stock is now trading at 40% of the level Mitsubishi agreed to pay ($25). There has to be an "material adverse change" clause in the investment agreement, and a potential ratings downgrade is certainly a material adverse change. So is a 60% collapse in the stock and a major loss of clients (per the WSJ, 40% of Morgan's hedge-fund clients have bolted in the last few weeks).

Even if Mitsubishi decided it needed a legal defense for backing out of the deal, therefore, there are almost certainly provisions in the investment agreement that it could fall back on. And even if there is no legal defense, it's hard to see what Morgan Stanley could really do if MUFG just decided not to send the money. [Sue? With what?]

If a company is in jeopardy, and a timely investment deal comes along to reduce the likelihood of that jeopardy, the deal is now the linchpin to the former company's success. If the investing party decides it no longer wants to take part, it appears that they have a significantly reduced litigation risk and economic exposure from a similar deal between two healthy (ier?) companies, as one of the two parties would no longer have the means or the value to fight over if the deal does not close. I am certain there are more precise legal understandings of what I'm trying to get at, and I bet there are at least a few people who read this blog who can speak to them.

Thank you in advance for any enriching of my understanding.


  1. >>>"that all law (at least his branch of law) has economic resolution."<<<

    I do not understand what this means. As written, it is either unintelligible or a tautology. What are you trying to say?

  2. In previous conversations, you have made referenced to a "Chicago Law" concept, that ever dispute has an economic resolution. In particular, the conversation revolved around the concept that every contract is breakable, one simply must estimate whether or not the economic costs of breaking the contract are worthwhile.

  3. Yes. It's called the "efficient breach theory," and it is a self-evident proposition of contract law among the law and economics professors at the U. of C. law school. The theory is this: If an obligor can breach a contract, pay all damages necessary to make the obligee whole, and still turn a profit by committing contracted-for resources elsewhere, then the law should allow, even facilitate, the breach.

  4. What are the leading ideas in scenarios such as the one described? Summary as I'm reading it:

    A partner comes in, is critical to the life of the company, the deal has yet to close, and partner pulls out leaving the company to fail with limited resources for recourse.


Please post your comment(s) here. To reply to a specific comment, be sure to paste the appropriate @ displayed into the box below as the first line.