Braiding: The interaction of formal and informal contracting in theory, practice, and doctrine

Columbia Law Review

Volumn 110, Issue 6, 2010, Pages 1377-1447

  Gilson, Ronald J ^a   Sabel, Charles F ^a   Scott, Robert E ^a  

^a Och Spine at New York Presbyterian Hospitals

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EID: 78049345783     PISSN: 00101958     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (229)

1. See, e.g., Aaron S. Edlin & Stefan Reichelstein, Holdups, Standard Breach Remedies, and Optimal Investment, 86 Am. Econ. Rev. 478, 478 (1996) ("We investigate when simple fixed-price contracts, enforced with standard legal breach remedies, can provide efficient investment incentives. Our analysis reveals circumstances where contractually specified renegotiation processes are not necessary."); Sanford J. Grossman & Oliver D. Hart, The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration, 94 J. Pol. Econ. 691, 692 (1986) ("We develop a theory of integration based on the attempt of parties in writing a contract to allocate efficiently the residual rights of control between themselves."); Oliver D. Hart & John Moore, Property Rights and the Nature of the Firm, 98 J. Pol. Econ. 1119, 1120 (1990) (arguing that ownership of residual rights characterizes difference between intra- and interfirm transactions); Benjamin E. Hermalin & Michael L. Katz, Judicial Modification of Contracts Between Sophisticated Parties: A More Complete View of Incomplete Contracts and Their Breach, 9 J.L. Econ. & Org. 230, 231 (1993) (focusing "on contracts that are privately optimal given the information available to the parties at the time of signing"); Jean Tirole, Incomplete Contracts: Where Do We Stand?, 67 Econometrica 741, 744 (1999) (describing "sufficient conditions under which the indescribability of contingencies does not restrict the set of payoff outcomes that can be achieved through contracting between parties").
2. See, e.g., Benjamin Klein, Why Hold-Ups Occur: The Self-Enforcing Range of Contractual Relationships, 34 Econ. Inquiry 444, 444 (1996) ("Because private enforcement capital is limited and written contract terms are necessarily imperfect, transactors must optimally combine court-enforced written terms together with privately enforced unwritten terms to define what I call the self-enforcing range of their contractual relationship."); Janet T. Landa, A Theory of the Ethnically Homogeneous Middleman Group: An Institutional Alternative to Contract Law, 10 J. Legal Stud. 349, 349 (1981) (examining "how... traders cope with the problem of contract uncertainty in an environment where the legal framework is nonexistent or poorly developed"); Robert E. Scott, Conflict and Cooperation in Long-Term Contracts, 75 Calif. L. Rev. 2005, 2039-49 (1987) [hereinafter Scott, Conflict and Cooperation] (discussing how, where "the intervals between adjustment choices and the levels of reward and punishment vary[,]... parties must turn to supplemental enforcement systems in order to maintain the relative advantages of long-term cooperation over short-term evasion"). For an excellent survey of early informal enforcement mechanisms, see Avner Greif, Informal Contract Enforcement: Lessons from Medieval Trade, in 2 The New Palgrave Dictionary of Economics and the Law 287, 287-88 (Peter Newman ed., 1998).
3. For exceptions, see Robert E. Scott & Paul B. Stephan, The Limits of Leviathan: Contract Theory and the Enforcement of International Law 88-109 (2006) [hereinafter Scott & Stephan, Limits of Leviathan] (discussing rivalrous relationship between formal and informal enforcement in international law); George Baker, Robert Gibbons & Kevin J. Murphy, Relational Contracts and the Theory of the Firm, 117 Q.J. Econ. 39, 39 (2002) (explaining that "[e]ven ostensibly formal processes such as compensation, transfer pricing, internal auditing, and capital budgeting often cannot be understood without consideration of their associated informal agreements"); Ronald J. Gilson, Engineering a Venture Capital Market: Lessons from the American Experience, 55 Stan. L. Rev. 1067, 1076-92 (2003) [hereinafter Gilson, Engineering a Venture Capital Market] (examining mixed formal and informal contracting in venture capital); Robert E. Scott, A Theory of Self-Enforcing Indefinite Agreements, 103 Colum. L. Rev. 1641, 1675-92 (2003) [hereinafter Scott, Self-Enforcing Indefinite Agreements] (discussing relationship between formal and informal enforcement of deliberately indefinite agreements); George Baker, Robert Gibbons & Kevin J. Murphy, Contracting for Control 2 (May 14, 2006) (unpublished manuscript), available at http://www.stanford.edu/group/SITE/archive/ SITE_2006/Web%20Session%206/Gibbons.pdf (on file with the Columbia Law Review) (modeling allocation of decision rights in ways that support relational contracting).
4. See, e.g., Martin Brown, Armin Falk & Ernst Fehr, Relational Contracts and the Nature of Market Interactions, 72 Econometrica 747, 759-75 (2004) [hereinafter Brown, Falk & Fehr, Relational Contracts] (contrasting long-term effects of formal and informal contract enforcement on market interactions); Ernst Fehr & Klaus M. Schmidt, Adding a Stick to the Carrot? The Interaction of Bonuses and Fines, 97 Am. Econ. Rev. 177, 180 (2007) (showing through experiments that "[a]dding a stick (the fine) to a carrot (the bonus) has adverse incentive effects that may render a pure bonus contract more efficient than a combined contract"); Ernst Fehr, Alexander Klein & Klaus M. Schmidt, Fairness and Contract Design, 75 Econometrica 121, 122 (2007) (discussing experiments indicating "that the principals' contract choices differ from those predicted by the self-interest model because concerns for fairness strongly affect the incentive properties of the contracts"); see also Gary Charness, Responsibility and Effort in an Experimental Labor Market, 42 J. Econ. Behav. & Org. 375, 375 (2000) (demonstrating through experiments that "shifting responsibility for an outcome to an external authority dampens internal impulses toward honesty, loyalty, or generosity"); Ernst Fehr, Georg Kirchsteiger & Arno Riedl, Gift Exchange and Reciprocity in Competitive Experimental Markets, 42 Eur. Econ. Rev. 1, 3 (1998) (arguing "sellers' reciprocal behaviour need not be considered as irrational if one allows for interdependent preferences"); Ernst Fehr & Klaus M. Schmidt, Theories of Fairness and Reciprocity: Evidence and Economic Applications, in 1 Advances in Economics and Econometrics: Theory and Applications, Eighth World Congress 208, 210-11 (Mathias Dewatripont, Lars Peter Hansen & Stephen J. Turnovsky eds., 2003) [hereinafter Fehr & Schmidt, Fairness and Reciprocity] ("Compliance with contractual obligations... is strongly shaped by the perceived fairness of the allocation of material benefits and by issues of procedural justice."); Ernst Fehr & Armin Falk, Wage Rigidity in a Competitive Incomplete Contract Market, 107 J. Pol. Econ. 106, 112 (1999) [hereinafter Fehr & Falk, Wage Rigidity] (showing through experiments "that workers in fact choose low effort levels in response to low wages, although this is costly for them, and... this gives rise to downward wage rigidity"); Simon Gächter & Armin Falk, Reputation and Reciprocity: Consequences for the Labour Relation, 104 Scandinavian J. Econ. 1, 7-18 (2002) [hereinafter Gächter & Falk, Reputation and Reciprocity] (investigating interaction effects of reciprocity and repeated game incentives).
5. Justice Holmes is credited with the classic statement that contract law is best understood as giving the promisor an option between performing his promise or breaching and paying compensatory damages: Nowhere is the confusion between legal and moral ideas more manifest than in the law of contract. Among other things, here again the so called primary rights and duties are invested with a mystic significance beyond what can be assigned and explained. The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it,-and nothing else. Oliver Wendell Holmes, The Path of the Law, 10 Harv. L. Rev. 457, 462 (1897).
6. Compare the studies finding evidence of crowding out, including Iris Bohnet, Bruno S. Frey & Steffen Huck, More Order with Less Law: On Contract Enforcement, Trust, and Crowding, 95 Am. Pol. Sci. Rev. 131, 132 (2001) ("At intermediate levels [of enforcement], honesty is crowded out; more second movers breach, and resources are wasted in trials."), Edward L. Deci, Richard Koestner & Richard M. Ryan, A Meta-Analytic Review of Experiments Examining the Effects of Extrinsic Rewards on Intrinsic Motivation, 125 Psychol. Bull. 627, 659 (1999) ("[R]eward contingencies undermine people's taking responsibility for motivating or regulating themselves."), Uri Gneezy & Aldo Rustichini, A Fine is a Price, 29 J. Legal Stud. 1, 3 (2000) (arguing "the introduction of the fine changes the perception of people regarding the environment in which they operate," but does not necessarily reduce penalized behavior), Daniel Houser, Erte Xiao, Kevin McCabe & Vernon Smith, When Punishment Fails: Research on Sanctions, Intentions and Non- Cooperation, 62 Games & Econ. Behav. 509, 522 (2008) [hereinafter Houser et al., When Punishment Fails] ("Credible threats of sanctions often failed to produce cooperative behavior, and our evidence is that incentives, not intentions, underlie this effect."), and Ernst Fehr & Simon Gächter, Do Incentive Contracts Crowd Out Voluntary Cooperation? 26 (Ctr. for Econ. Policy Research, Discussion Paper No. 3017, 2001) [hereinafter Fehr & Gächter, Crowd Out], available at http://ssrn.com/abstract=289680 (on file with the Columbia Law Review) ("This paper shows that reciprocity-driven voluntary cooperation may indeed be crowded out by incentive contracts."), with several studies finding complementarity, including Sergio G. Lazzarini, Gary J. Miller & Todd R. Zenger, Order with Some Law: Complementarity Versus Substitution of Formal and Informal Arrangements, 20 J.L. Econ. & Org. 261, 290 (2004) ("[L]ow-cost contracts are important mechanisms to support cooperation when it is not very likely that parties will continue transacting in future periods."), and Mary Rigdon, Trust and Reciprocity in Incentive Contracting, 70 J. Econ. Behav. & Org. 93, 103 (2009) ("There is no evidence that motivating a worker solely by trusting him (a la Hank Scorpio) is more efficient than wielding a Carrot or a Stick or a cat o' nine tails (a la Monty Burns).").
7. For discussion of the core contractual features characteristic of these collaborative contracts, see Ronald J. Gilson, Charles F. Sabel & Robert E. Scott, Contracting for Innovation: Vertical Disintegration and Interfirm Collaboration, 109 Colum. L. Rev. 431, 458-71 (2009) [hereinafter Gilson, Sabel & Scott, Contracting for Innovation].
8. For examples of collaborative contracts and supporting sources, see infra note 79 and accompanying text.
9. We have previously described the character of the contracting problem facing parties in rapidly innovating industries: [T]he transactions governed by [contracts for innovation] share a number of characteristics. First, the primary output is an innovative "product," one whose characteristics, costs, and manufacture, because of uncertainty, cannot be specified ex ante. Second, neither party alone has the capacity to specify and develop the product's characteristics, costs, and methods of manufacture; hence, there must be collaboration among companies with different capabilities. Third, the process of specification and development will be iterative: Individual design elements will depend on the recurrent input from those working upstream or downstream and from those working on other design elements. Thus, central to these transactions are communication and cooperation across the two (or more) firms-the design, specification, and determination of manufacturing characteristics will be the result of repeated interactive collaborative efforts by employees of separate firms with distinct capabilities. Gilson, Sabel & Scott, Contracting for Innovation, supra note 7, at 448-51.
10. Id. at 435, 486-89 ("[B]raiding creates an interactive process that constrains opportunism as the parties' investments in detailed knowledge of each other's character and capabilities raise switching costs-the costs one party to a contract must incur in order to replace the other party to the contract.").
11. The concept of trust is famously hard to define. In this Article, we extend the generic term "trust" in two ways: first, to refer to the complementary combination of informal mechanisms-reputation, continuing relations, and reciprocity-that evolve through the actions of the parties in implementing their substantive goals under the agreement; and second, in the increasing confidence of each party in the ability of the other to actually perform as the agreement requires.
12. As we discuss below, there are two separate strands of the informal enforcement literature. One strand relies on reputation and/or the anticipation of future dealings. The other relies on character: either a taste for reciprocity independent of an economic return for reciprocal behavior, or an intrinsic refusal to behave opportunistically. See infra text accompanying notes 40-44 (describing three types of informal enforcement mechanisms); sources cited supra notes 2, 4 (examining informal enforcement). If one starts from an assumption that these factors are exogenous, then maintaining the distinction among each strand is relevant. But as we show, the key element in contracting for innovation is a braiding mechanism in which the various strands of informal enforcement evolve: They are endogenous and, as such, they are complementary. Thus, while the categories of informal enforcement mechanisms are conceptually distinct, because of their complementarity, they are not distinct in operation
13. As we describe in detail below, the braiding of formal and informal enforcement consists of two interrelated features, but is reducible to neither. First, the agreement to collaborate through mutual and iterative exchanges of private information is formally (that is, legally) enforceable, but only to the extent that one party blatantly (and thus verifiably) refuses to collaborate or otherwise wrongfully exploits the information gained in the collaboration. Second, the entire course of the collaboration-including the extent to which each party expends efforts by investing in the process of information exchange and collaboration-is enforceable only by the informal routines that the agreement itself creates. See infra text accompanying notes 72-79 (describing informal enforcement mechanisms in braiding and assumptions that have led theoretical literature to ignore them); infra Part III.A (discussing Lilly v. Emisphere).
14. The experimental literature has focused significant attention on so-called "gift exchange" relations. The gift exchange game, for example, demonstrates that a large number of responders will voluntarily reward actions that they perceive as generous or fair. For discussion, see Charness, supra note 4, at 376 ("Social norms and fairness are probably most salient in environments featuring a high degree of interpersonal interaction[,]... where perceptions of what constitutes appropriate behavior may well affect individual choices."); Fehr & Schmidt, Fairness and Reciprocity, supra note 4, at 208 ("The evidence suggests that many people are strongly motivated by other-regarding preferences, and that concerns for fairness and reciprocity cannot be ignored in social interactions."); Fehr & Falk, Wage Rigidity, supra note 4, at 109 ("Trust games... indicate the presence of a behavior that can be termed positive reciprocity. Positively reciprocal behavior is based on a willingness to pay in order to reward actions that are perceived as generous, kind, or fair... ."); Gächter & Falk, Reputation and Reciprocity, supra note 4, at 1-3 ("By paying generous wages and thereby appealing to the workers' reciprocity, firms can induce performance above the enforceable level.").
15. Economists call such qualified relations of reciprocity "quasi-gift" exchanges that use "low-powered" incentives to orient behavior toward ongoing collaboration as distinct from "high-powered" incentives that motivate parties to perform contractually specified tasks. For discussion, see David Guest, Management and the Insecure Workforce: The Search for a New Psychological Contract, in The Insecure Workforce 140, 141 (Edmund Heery & John Salmon eds., 2000) ("[T]o attract and, for a while at least, retain key employees, organizations must provide an environment which allows opportunities to enhance employability."); David Marsden, The 'Network Economy' and Models of the Employment Contract, 42 Brit. J. Indus. Rel. 659, 667 (2004) ("The longer the anticipated period of enhanced earnings, the greater the employee's corresponding loss if dismissed for poor performance-and also, arguably, the greater the 'quasi-gift exchange' to encourage above average performance."); Robert Gibbons, Incentives in Organizations, J. Econ. Persp., Fall 1998, at 115, 129 ("We have seen... how it may be useful to impose job restrictions to reduce an agent's distractions, and that reducing the agent's outside interests (such as through changing asset ownership) can play a similar role.").
16. As suggested by the discussion infra text accompanying notes 134-135, we mean to distinguish innovation from incremental improvements that grow out of existing technology or patterns.
17. See discussion infra Part IV.B-C (identifying braiding in preliminary agreements and corporate acquisition agreements).
18. See infra text accompanying notes 175-179, 198-202 (discussing examples of lowpowered enforcement).
19. See infra text accompanying notes 162-168, 200 (providing examples in which courts enforce obligations to take preliminary measures, but do not require parties to complete transactions).
20. The tendency for crowding out will become a near inevitability when, as is currently the case in Anglo American contract law, formal enforcement assigns responsibility for an eventual breach of the agreement to one and only one party. No party will want to bear the costs of being adjudged the sole breacher, so all will compete to show compliance with the express terms of the contract; this competition distorts actual behavior and perceptions of it, devaluing or crowding out informal observation of actions and intentions as a means of contractual enforcement. For discussion, see infra text accompanying notes 68-71.
21. See infra text accompanying notes 72-79 (explaining how braiding enhances collaboration and reduces risk of opportunism).
22. Reliance on preexisting culture obstructs the joint problem solving activities needed to build the mutual capacity for adaptation that is necessary for successful longterm relations. For discussion, see infra Part II.B.
23. See infra Part III (discussing Lilly v. Emisphere and FTC v. Intel Corp.).
24. See infra text accompanying notes 204-221 (discussing three court decisions that potentially undermine informal collaboration supported by braiding contracts).
25. For a representative sampling of the literature, see generally David Charny, Nonlegal Sanctions in Commercial Relationships, 104 Harv. L. Rev. 373, 375-79 (1990); Stewart Macaulay, Non-Contractual Relations in Business: A Preliminary Study, 28 Am. Soc. Rev. 55, 56-57, 62-63 (1963); John McMillan & Christopher Woodruff, Private Order Under Dysfunctional Public Order, 98 Mich. L. Rev. 2421, 2421 (2000); Scott, Conflict and Cooperation, supra note 2, at 2009-12; Scott, Self-Enforcing Indefinite Agreements, supra note 3, at 1641-42.
26. See, e.g., Grossman & Hart, supra note 1, at 716-18 (describing different situations that produce formal contracting and vertical integration); Hart & Moore, supra note 1, at 1149-53 (summarizing "theory of the optimal assignment of assets and [using theory] to understand the boundaries of the firm"); Benjamin Klein & Keith B. Leffler, The Role of Market Forces in Assuring Contractual Performance, 89 J. Pol. Econ. 615, 616 (1981) ("Market arrangements such as the value of lost repeat purchases which motivate transactors to honor their promises may be the cheapest method of guaranteeing the guarantee."); L.G. Telser, A Theory of Self-Enforcing Agreements, 53 J. Bus. 27, 30 (1980) (studying "two situations in which self-enforcing agreements may occur"); Oliver E. Williamson, Assessing Contract, 1 J.L. Econ. & Org. 177, 182-201 (1985) (contrasting "alternative conceptions of the process of contract and relat[ing] these to... the condition of asset specificity"); Oliver E. Williamson, Transaction-Cost Economics: The Governance of Contractual Relations, 22 J.L. & Econ. 233, 235-38 (1979) (distinguishing between discrete and relational contracting, and describing nature of situations in which particular contractual arrangements may arise).
27. See sources cited supra note 4 (analyzing relationship between formal and informal enforcement mechanisms).
28. See generally, Martin Dufwenberg & Georg Kirchsteiger, A Theory of Sequential Reciprocity, 47 Games & Econ. Behav. 268, 290-91 (2004) ("[R]eciprocity can explain why employers are reluctant to hire workers who offer to work at less than the prevailing wage, a phenomenon frequently observed in labor markets."); Ernst Fehr et al., Reciprocity as a Contract Enforcement Device: Experimental Evidence, 65 Econometrica 833, 856 (1997) [hereinafter Fehr et al., Reciprocity] ("[R]eciprocal motivations have important implications for the enforcement of contracts."); Ernst Fehr & Klaus M. Schmidt, A Theory of Fairness, Competition, and Cooperation, 114 Q.J. Econ. 817, 856 (1999) [hereinafter Fehr & Schmidt, A Theory of Fairness] ("[O]ur examination of the gift exchange game indicates that fairness considerations may give rise to stable wage rigidity despite the presence of strong competition among the workers."); David K. Levine, Modeling Altruism and Spitefulness in Experiments, 1 Rev. Econ. Dynamics 593, 595 (1998) (examining model in which players' "attitudes toward other players depend on how they feel they are being treated"); Mathew Rabin, Incorporating Fairness into Game Theory and Economics, 83 Am. Econ. Rev. 1281, 1282 (1993) (developing "game-theoretic framework for incorporating [certain] emotions into a broad range of economic models").
29. The discussion in this part draws on Scott & Stephan, Limits of Leviathan, supra note 3, at 84-109 (discussing rivalrous relationship between formal and informal enforcement in context of international law).
30. See infra text accompanying notes 32-33 (discussing reciprocal reinforcement of ability to verify and formal enforcement).
31. Arbitration is also a formal enforcement strategy. While arbitration displaces some of the legal rules associated with litigation, it still requires the intervention of the state to enforce the arbitration award.
32. For example, consider the spreading use of "instant replay" to supplement referees' information.
33. See Robert E. Scott & George G. Triantis, Anticipating Litigation in Contract Design, 115 Yale L.J. 814, 839-56 (2006) [hereinafter Scott & Triantis, Anticipating Litigation] (describing "means by which the parties define the domain or space within which the court selects proxies at litigation").
34. Id. To illustrate this point, assume the parties wish to pair particular future contingencies to corresponding performance obligations, i.e., when X occurs, the promisor must pay $Y. The parties can define X in several different ways. X may be a rule, i.e., a relatively specific fact, such as the delivery of a widget with a specified weight. Here the parties delegate to the court only the determination of what evidence is sufficient to satisfy X and trigger the promisor's payment obligation. Alternatively, X can be a standard, such as the delivery of a widget in excellent condition. Here the court must determine not only what evidence is sufficient to establish the weight of the widget, but also the degree to which weight is relevant to the determination of whether the widget satisfies the standard. Id. at 826.
35. Given these tradeoffs, parties who rely on formal enforcement face a fundamental choice. If conditions are unlikely to change much in the future (the level of uncertainty is low), and thus the ex ante cost of writing contract rules is low relative to the anticipated gains, the parties' most cost-effective strategy is to write a complex, rule-based contingent contract. Such a contract will contain precise terms-rules that pair particular contingencies with an appropriate contractual performance: If X occurs, a party will take Y action. Assuming that the parties to such a contract can forestall or otherwise control renegotiation, they will have an incentive to make jointly beneficial investments. In the jargon of economics, the contingencies and their respective performance obligations are "contractible." These complex contracts are well suited to formal enforcement because information concerning performance will be both observable and verifiable to the court at relatively low cost.
36. Courts do not, however, always accept the parties' invitation to devise proxies for high-level standards. Where the standard is so devoid of substance that the court has no basis for choosing among conflicting proxies, it may simply apply the standard quite narrowly and thereby advise contracting parties that it needs more detailed guidance. See Hexion Specialty Chems., Inc. v. Huntsman Corp., 965 A.2d 715, 739 (Del. Ch. 2008) ("[A]bsent clear language to the contrary, the burden of proof with respect to a material adverse effect rests on the party seeking to excuse its performance under the contract.").
37. See Charles J. Goetz & Robert E. Scott, Principles of Relational Contracts, 67 Va. L. Rev. 1089, 1099-1100 (1981) (discussing precise terms likely to be inefficient ex post when passage of time replaces uncertainty with fact).
38. To elaborate this point, parties can write simple contracts with hard terms that lump together many future states of the world and provide for the same obligations across the different states. But where the level of uncertainty is high, a simple contract containing only hard terms will likely be suboptimal ex post. This is so because the contract specifies the same obligation for many different possible contingencies that ideally would require different obligations if the states could be anticipated and matched with appropriate actions. Alternatively, parties may respond to this high level of uncertainty by writing a contract that contains many vague standards that delegate to courts the task of finding proxies for the relevant contingencies and their respective performances. As discussed above, soft-term contracts take advantage of a court's ability to assess the respective contract performances after all uncertainties have been resolved. But the costs of writing soft-term contracts are severe verification problems. Unless there are objective proxies for the performances in question, simple contracts with soft terms raise the moral hazard risk that the promisor will always choose the performance proxy that is the least costly for him even where an alternative proxy under the same broad standard would be jointly profitable. For discussion, see Alan Schwartz & Robert E. Scott, Contract Theory and the Limits of Contract Law, 113 Yale L.J. 541, 601-05 (2003) [hereinafter Schwartz & Scott, Contract Theory].
39. See Scott & Triantis, Anticipating Litigation, supra note 33, at 851-56 (providing examples "in which the contract's use of combinations of precise and vague terms can guide the court's future interpretation of the standard itself, as well as the accompanying rules").
40. See generally Robert Axelrod, The Evolution of Cooperation 27-54 (1984) (explaining success of tit-for-tat strategy-e.g., matching decision to cooperate or defect made by one's opponent in previous round-in multi-round prisoner dilemma "tournaments").
41. See sources cited supra note 2 (exploring effectiveness of private enforcement when formal enforcement is ineffective).
42. See, e.g., Fehr et al., Reciprocity, supra note 28, at 840 n.7 ("Although there is always a clear majority of 60-75 percent of the subjects that do behave reciprocally, between 15 and 25 percent of subjects make purely selfish choices."); Fehr & Schmidt, A Theory of Fairness, supra note 28, at 825-26 (summarizing results of "ultimatum game" experiments); Levine, supra note 28, at 594 (describing results of ultimatum and public goods experiments); Rabin, supra note 28, at 1283 ("[F]or most experiments of one-shot public-good decisions in which the individually optimal contribution is close to 0 percent, the contribution rate ranges between 40 percent and 60 percent of the socially optimal level."). For a review of the literature, see Fehr & Schmidt, Fairness and Reciprocity, supra note 4, at 210-18.
43. The experimental evidence on individuals' propensity to reciprocate yields two key findings. First, many people respond cooperatively to generous acts and, conversely, punish uncooperative behavior. Second, the observed preference for reciprocity is heterogeneous. Some people exhibit reciprocal behavior and others are selfish. Taking all the experiments together, the fraction of reciprocally fair subjects ranges from forty to sixty percent as does the fraction of subjects who are selfish. For discussion, see Fehr et al., Reciprocity, supra note 28, at 850 (finding roughly half of subjects punishing shirkers, and roughly half rewarding nonshirkers); Rabin, supra note 28, at 1283 (describing experiment showing contribution rate at forty to sixty percent of socially optimal level in one-shot public-goods decision games); Ernst Fehr & Simon Gächter, Fairness and Retaliation: The Economics of Reciprocity, J. Econ. Persp., Summer 2000, at 159, 162 ("Many studies have carried out detailed analyses of individual decisions and found that the fraction of subjects exhibiting reciprocal choices is between 40 and 66 percent."). For applications of this experimental evidence to contract theory, see Scott & Stephan, Limits of Leviathan, supra note 3, at 88-94, 122-27; Scott, Self-Enforcing Indefinite Agreements, supra note 3, at 1661-75.
44. See Schwartz & Scott, Contract Theory, supra note 38, at 557 ("[R]eputations work best in small trading communities, especially those with ethnically homogenous members, where everything that happens soon becomes common knowledge, and boycotts of bad actors are easy to enforce.").
45. As a familiar example of the point in text, reputational sanctions work well when other parties can conveniently observe which of the parties in a dispute was responsible for the breakdown in cooperation-which in turn requires a shared expectation of what constitutes performance-and are able to effectively disseminate this information to others. The prospect of a withdrawal of future beneficial relations disciplines a party who otherwise is inclined to shirk. For discussion, see Janet Tai Landa, Trust, Ethnicity, and Identity 110-11 (2001) (discussing how trading within their homogeneous ethnic group helps parties economize on information costs); Lisa Bernstein, Merchant Law in a Merchant Court: Rethinking the Code's Search for Immanent Business Norms, 144 U. Pa. L. Rev. 1765, 1788 (1996) ("[Contracting parties] may be moved to [renegotiate] by social norms, commercial custom,... or fear of nonlegal sanctions such as reputational damage or termination of a beneficial relationship."); Lan Cao, Looking at Communities and Markets, 74 Notre Dame L. Rev. 841, 887 (1999) ("In... closely knit communities, both predeal information gathering and postdeal enforcement will be relatively friction-free and cheap."); Avner Greif, Reputation and Coalitions in Medieval Trade: Evidence on the Maghribi Traders, 49 J. Econ. Hist. 857, 859 (1989) (describing coalitions in which reputation mechanisms prevented cheating); Eric A. Posner, The Regulation of Groups: The Influence of Legal and Nonlegal Sanctions on Collective Action, 63 U. Chi. L. Rev. 133, 140 (1996) (reviewing literature on "how people use organizational mechanisms to solve the prisoner's dilemma"); Barak D. Richman, Firms, Courts, and Reputation Mechanisms: Towards a Positive Theory of Private Contracting, 104 Colum. L. Rev. 2328, 2340 (2004) ("A merchant who is found by a private court to have breached a contract but fails to pay receives publicity as a bad actor, leading other merchants to respond to the public ruling by refusing to deal with the transgressor.").
46. Noise is defined as "discrepancies between intended and actual outcomes for an interaction partner due to unintended errors." Paul A.M. Van Lange, Jaap W. Ouwerkerk & Mirjam J.A. Tazelaar, How to Overcome the Detrimental Effects of Noise in Social Interaction: The Benefits of Generosity, 82 J. Personality & Soc. Psychol. 768, 768 (2002).
47. The literature is well developed and uncontroversial: Generous tit-for-tat strategies outperform simple tit-for-tat strategies in noisy environments. See, e.g., Robert Axelrod & Douglas Dion, The Further Evolution of Cooperation, 242 Science 1385, 1387 (1988) ("[F]or sufficiently small amounts of noise, unilateral generosity is the best response."); Jonathan Bendor, Roderick M. Kramer & Suzanne Stout, When in Doubt...: Cooperation in a Noisy Prisoner's Dilemma, 35 J. Conflict Resol. 691, 714 (1991) ("[G]enerosity emerged as an important ingredient of success in the present tournament."); H.C.J. Godfray, The Evolution of Forgiveness, 355 Nature 206, 207 (1992) ("[Generous tit-for-tat] is the eventual winner... thanks to the midwifery of tit-for-tat."); Martin A. Nowack & Karl Sigmund, Tit for Tat in Heterogeneous Populations, 355 Nature 250, 252 (1992) (describing evolution toward increased generosity); Van Lange, Ouwerkerk & Tazelaar, supra note 46, at 776 ("[A]dding generosity to reciprocity helps overcome the detrimental effect of noise on cooperation in social dilemmas.").
48. Sylvain Chassang makes a similar point: "Distinguishing the availability of information and the ability to interpret it introduces the possibility of learning in an imperfect monitoring context." Sylvain Chassang, Building Routines: Learning, Cooperation, and the Dynamics of Incomplete Relational Contracts, 100 Am. Econ. Rev. 448, 449 (2010). This learning then allows the relationship to better withstand "shocks"- significant changes in the economic environment that increase the difficulty of assessing counterparty's actions-because greater knowledge concerning the counterparty permits a strategy that is more patient than one that retaliates in response to every perceived opportunistic action. See id. at 460 ("As the players' joint history grows and information is revealed in equilibrium, player 1 learns how and when to expect cooperation, and the players are able to sustain cooperation without resorting to inefficient punishment.").
49. These experiments have compared the effort levels of subjects given a single, anonymous opportunity to respond to a generous offer with the effort levels in a similar game in which repeated interactions created an additional opportunity to retaliate against selfish behavior. Brown, Falk & Fehr, Relational Contracts, supra note 4, at 752; see also Charness, supra note 4, at 383 ("While benefits of enhanced pro-social behavior can be substantial in the static case, the potential impact... is greater in a dynamic context, particularly in economic environments featuring repeated personal interaction."); Fehr et al., Reciprocity, supra note 28, at 852 ("The shirking rate declined from 65 percent to 21 percent when a third stage was added."); Fehr & Schmidt, Fairness and Reciprocity, supra note 4, at 217 (interpreting difference between behaviors that subjects exhibit in one-shot interactions and those that they exhibit in repeated interactions); Gächter & Falk, Reputation and Reciprocity, supra note 4, at 2 ("In this paper we present an experiment that allows us to analyse how social norms and repeated game effects can help to overcome this inefficiency.").
50. Robert E. Scott & Paul B. Stephan, Self-Enforcing International Agreements and the Limits of Coercion, 2004 Wis. L. Rev. 551, 577-80 [hereinafter Scott & Stephan, SelfEnforcing International Agreements].
51. We acknowledge that we could cast our argument entirely in terms of the conditions under which a more forgiving form of the self-interested strategy of tit-for-tat displaces a less forgiving one, without reference to the conditions under which intrinsic or moral motives are crowded out by extrinsic, gain-oriented ones. For two reasons, we choose instead to combine the two forms of argument, and, as in the preceding discussion, even to underscore their complementarity. First, we are convinced by the experimental evidence that intrinsic motivation-particularly a propensity to reciprocity-is a fact of (some) human behavior. To be sure, we are a long way from understanding the operation and implications of such intrinsic motivation. Nonetheless, it seems odd to transcribe what we do know of it into a rational-choice vocabulary that denies, or least questions its existence. Second, to acknowledge the existence of intrinsic motivation is hardly to abandon the postulate of rational action in economic exchanges of the kind under consideration here. Rational actors are perfectly capable of making calculating decisions about when, and in relation to whom, to rely on intrinsic motivation. Indeed, a central claim in our braiding argument is that under uncertainty it is rational for actors to design institutions that allow them to develop a counterparty's propensity to reciprocity, along with her capacities. For an earlier effort to reconcile rational-choice and intrinsic approaches to trust, see generally Charles F. Sabel, Studied Trust: Building New Forms of Cooperation in a Volatile Economy, in Explorations in Economic Sociology 104 (Richard Swedberg ed., 1993). For a review of the persistent tension between rational-choice and intrinsic perspectives, see generally Christos J. Paraskevopoulos, Social Capital: Summing up the Debate on a Conceptual Tool of Comparative Politics and Public Policy, 42 Comp. Pol. 475 (2010). We are grateful to Yochai Benkler for reminding us of just how far we are from a full understanding of intrinsic motivation and its relation to institutional rather than individual behavior.
52. Scott, Self-Enforcing Indefinite Agreements, supra note 3, at 1679-80.
53. Indeed, the experimental evidence indicates that it can pay to write agreements based on observable but unverifiable conduct even where the promisee is uncertain whether the promisor is a fair or selfish type. If the population is heterogeneous (i.e., there is a significant fraction of parties with a taste for reciprocity in the population), informal enforcement yields better outcomes in experimental settings on average than does the alternative of formal enforcement. This result occurs because even selfish parties will respond reciprocally to an offer to enter into a trust contract where there is the positive probability that the counterparty will behave fairly. Theorists of cultural evolution also have adduced persuasive reasons why cultures generate norms of reciprocity. These norms are part of a process that selects for cooperative behaviors that favor particular groups or tribes over others. For a discussion of this literature and its implications, see Peter J. Richerson, Robert T. Boyd & Joseph Henrich, Cultural Evolution of Human Cooperation, in Genetic and Cultural Evolution of Cooperation 357, 368-72 (Peter Hammerstein ed., 2003). The existence of both persistent differences among groups and conformity within groups supports the hypothesis that groups with more cooperative norms are more likely to prevail in group conflict, and thus the hypothesis that evolutionary pressures will lead to the selection of their norms. Ernst Fehr & Urs Fischbacher, Social Norms and Human Cooperation, 8 Trends Cognitive Sci. 185, 189 (2004).
54. This insight was first explored in Stewart Macaulay's classic account of how commercial contractual relationships rely on informal enforcement even when the parties have entered into a formal, legally enforceable contract. Macaulay, supra note 25, at 62-65.
55. The analysis becomes much more complicated when the individual deciding whether to behave opportunistically is an employee acting on behalf of a firm. Then, the relationship between the employee and the firm is superimposed upon the relationship between the contracting parties. An individual employee thus has two ways in which to behave opportunistically in connection with a particular transaction. First, she may cheat the counterparty when it is in the firm's interest. Second, her personal incentive structure may cause her to cheat the counterparty even though doing so is not in the firm's interest because of the counterparty's retaliation. This latter conflict will exist, for example, where a system of annual bonuses is not tied to future periods when the retaliation against the firm will take place. Thus, David Kreps's classic characterization of a firm as a long-lived repository of reputation that can use informal contracting, see David M. Kreps, Corporate Culture and Economic Theory, in Perspectives on Positive Political Economy 90, 119 (James E. Alt & Kenneth A. Shepsle eds., 1990) ("[O]thers can see what the firm... did and decide whether to enter into similar transactions...."), requires the firm to have an internal corporate incentive system that aligns the individual employee's incentives with those of the firm. Ronald J. Gilson, Controlling Family Shareholders in Developing Countries: Anchoring Relational Exchange, 60 Stan. L. Rev. 633, 640-41 (2007). For an example of how the "nenko" system of lock-step employee promotion supports relationally- based exchange among Japanese corporations, see Ronald J. Gilson, Value Creation by Business Lawyers: Legal Skills and Asset Pricing, 94 Yale L.J. 239, 309-11 (1984).
56. See supra text accompanying notes 46-47 (discussing benefits of forgiving strategies in certain contexts).
57. See Scott & Stephan, Self-Enforcing International Agreements, supra note 50, at 569 ("[R]etaliation imposes stress on any ongoing relationship that may threaten its survival.").
58. See sources cited supra note 6 (describing evidence of crowding out).
59. Cf. Scott & Stephan, Self-Enforcing International Agreements, supra note 50, at 579-80 (listing possible explanations for why "reciprocal fairness and repeated interactions complement each other while reciprocal fairness functions as the rival of coercive enforcement"). A recent paper highlights the need to understand rather than merely describe the interaction of formal and informal contracting. Eileen Y. Chou, Nir Halevy & Keith Murnighan, The Hidden Costs of Contracts on Relationships and Performance (Int'l Assoc. of Conflict Mgmt., 23d Annual Conference Paper, 2010), available at http:// www.ssrn.com/abstract=1612376 (on file with the Columbia Law Review). The authors report the results of small, student-subject experiments and reach the conclusion that the negotiation and existence of contracts had "adverse effects... on relationship-formation, team performance, and cooperation levels." Id. at 11. The difficulty is that, in the absence of an underlying explanation for the observed phenomenon, one is left with neither a positive account of when parties successfully combine formal and informal contracting, nor a normative account of the techniques that accomplish this result.
60. The distinction between high-powered legal sanctions that drive out informal enforcement and low-powered sanctions that, we argue below, do not result in crowding out is critical to our theory of how braiding works. See infra text accompanying notes 131-133 (discussing Lilly v. Emisphere). High-powered enforcement consists of the imposition of standard breach of contract remedies for a failure to perform specified contractual obligations. High-powered enforcement, then, is tied to outcome variables and provides incentives that induce parties to take specified substantive actions designed to maximize expected surplus. Low-powered enforcement, in turn, consists of imposing sanctions only for verifiable failures to collaborate as promised, and not for failure of the parties to invest sufficiently in the collaboration process or for the process to yield particular outcomes.
61. Gneezy & Rustichini, supra note 6, at 13-14. An extensive literature in social psychology also considers the crowding out of intrinsic motivations. See Deci, Koestner & Ryan, supra note 6, at 658-59 ("[T]angible rewards tend to have a substantially negative effect on intrinsic motivation....").
62. Gneezy & Rustichini, supra note 6, at 13-14.
63. See, e.g., Bohnet, Frey & Huck, supra note 6, at 141 ("In a contractual relationship, economic incentives have a nonmonotonic influence on contract performance.").
64. Fehr & Gächter, Crowd Out, supra note 6, at 13-15. A similar result is reported by Houser et al., When Punishment Fails, supra note 6, at 522-23.
65. Fehr & Gächter, Crowd Out, supra note 6, at 15-17.
66. Daniel Houser, Erte Xiao, Kevin McCabe & Vernon Smith, When Punishment Fails: Research on Sanctions, Intentions, and Non-Cooperation 21 (June 8, 2005) (unpublished manuscript), available at http://ssrn.com/abstract=788204 (on file with the Columbia Law Review).
67. Scott & Stephan, Self-Enforcing International Agreements, supra note 50, at 580.
68. Scott & Stephan, Limits of Leviathan, supra note 3, at 106-08.
69. Two mandatory rules of contract law contribute to the conditions that typically impose high-powered sanctions for breach of a formally enforceable contract. First, parties are constrained by unconscionability and related process doctrines from setting damages "too low." See, e.g., U.C.C. § 2-718 cmt. 1 (2001) (noting unreasonably small stipulated damages "might be stricken under the section on unconscionable contracts"). Second, proportional responses to nonperformance are impeded by the "breacher-status" rule: There is only one breacher and the breacher is not only liable for compensatory damages, but also loses "an accrued interest in what may be extremely valuable return rights." Charles J. Goetz & Robert E. Scott, The Mitigation Principle: Toward a General Theory of Contractual Obligation, 69 Va. L. Rev. 967, 983 (1983) [hereinafter Goetz & Scott, The Mitigation Principle].
70. Scott, Conflict and Cooperation, supra note 2, at 2042-44.
71. In addition to the fact that only one party can breach and that material breach results in compensatory damages as well as loss of accrued contract rights, rules governing insecurity and anticipatory breach permit one party to threaten the other with these consequences whenever the other discloses anticipated difficulties in performance. The mitigation doctrine operates only once a party forfeits all rights by breaching. Until there is a breach, the counterparty can ignore requests for adjustments that might reduce the consequences of nonperformance. The threat of the ultimate sanction thus deters parties from voluntarily revealing the information needed for the counterparty to adjust informally. Goetz & Scott, The Mitigation Principle, supra note 69, at 1011-18.
72. Gilson, Sabel & Scott, Contracting for Innovation, supra note 7, at 476-89.
73. See infra Part II.A.2 (describing how braided contracts work).
74. See infra text accompanying notes 107-109 (describing Japanese and German approaches to raising switching costs).
75. See Gilson, Sabel & Scott, Contracting for Innovation, supra note 7, at 476-79 (discussing contractual requirement "that both parties invest in producing information").
76. Id. at 479-81.
77. See supra text accompanying note 12 (assessing experimental literature's assumption of exogeneity).
78. See supra text accompanying notes 58-70 (discussing where experimental literature has found evidence of crowding out).
79. A nonexhaustive and nonrandom sample of collaborative contracts that combine formal and informal elements can be found at onecle.com (http://www.onecle.com) and the Contracting and Organizations Research Institute (http://cori.missouri.edu). See, e.g., Boeing Co. & Spirit Aerosystems Inc., General Terms Agreement (June 30, 2006) (on file with the Columbia Law Review) (agreeing to general terms covering purchase orders by Boeing for particular product to be supplied by Spirit); Nanosys, Inc. & Matsushita Electric Works, Ltd., Development Agreement (Nov. 18, 2002) (on file with the Columbia Law Review) (agreeing to collaborate to develop photovoltaic devices with nano components in Asia); John Deere & Co. & Stanadyne Corp., Long Term Agreement (Dec. 14, 2001) (on file with the Columbia Law Review) (contracting for Deere to purchase fuel filtration systems, injection nozzles, and related products from Stanadyne for five years); Warner- Lambert Co. & Ligand Pharmaceuticals Inc., Research, Development and License Agreement (Sept. 1, 1999) (on file with the Columbia Law Review) (agreeing to collaborate on pharmaceutical research and development); AVSA S.A.R.L. & New Air Corp., Airbus A320 Purchase Agreement (Apr. 20, 1999) (on file with the Columbia Law Review) (agreeing for New Air Corp. to purchase aircraft from AVSA); Allstate Insurance Co. & Axciom Corp., Data Management Outsourcing Agreement (Mar. 19, 1999) (on file with the Columbia Law Review) (contracting for Axciom to develop data acquisition system to support Allstate's underwriting of new business in auto and property insurance); American Axle & Manufacturing, Inc. & General Motors Co., Component Supply Agreement (June 5, 1998) (on file with the Columbia Law Review) (contracting for AAM to supply motor vehicle components to GM); Apple Computer, Inc. & SCI Systems, Inc., Fountain Manufacturing Agreement (May 31, 1996) (on file with the Columbia Law Review) (agreeing for SCI to produce designated products at Fountain, Colorado plant); Phoenix Technologies Ltd. & Intel Corp., Supply Contract (Dec. 18, 1995) (on file with the Columbia Law Review) (contracting for Phoenix to be principal supplier of system-level software to Intel); see also George S. Geis, The Space Between Markets and Hierarchies, 95 Va. L. Rev. 99, 121-26 (2009) (citing examples of collaborative contracts).
80. Pharmacopeia, Inc. & Bristol-Myers Squibb Co., Collaboration & Licensing Agreement (Nov. 26, 1997) [hereinafter Pharma/BMS Agreement], available at http:// contracts.onecle.com/accelrys/bristol-myers.collab.1997.11.26.shtml (on file with the Columbia Law Review). We are grateful to Victor Goldberg, who made substantial contributions to the analysis of the Pharma/BMS Agreement.
81. For other exemplars of contracts that deploy a similar braiding strategy, see supra note 79.
82. "Products" are defined as any product incorporating an active compound, i.e., a library compound-either the Pharma library or collaboration library-with a set concentration of a patented compound and derivatives of these active compounds. Pharma/BMS Agreement, supra note 80, art. 1.30.
83. Id. art. 2.1.
84. Id. art. 2.2(b).
85. Id. art. 2.2(d).
86. Id. art. 10.1.
87. Id. art. 2.2(g).
88. Id. art. 2.7(b).
89. Id. art. 2.3.
90. Id. art. 1.1.6 ("'Initial Term' shall mean the period commencing on the Effective Date and terminating on the third anniversary thereof."); id. art. 2.4.2 ("The Research Term may be extended for up to two (2) years following the Initial Term.").
91. Id. art. 2.4.3.
92. Id. art. 2.4.4(a) (describing elimination of BMS's obligations); id. art. 2.4.4(b) (describing termination fee). BMS funds the research plan according to a schedule of research phases at $X per phase. Id. art. 7.2.1.
93. Id. art. 3.2.
94. Id. art. 3.1 (describing responsibilities); id. art. 3.3 (describing frequency of meetings).
95. Id. art. 3.4.
96. We have described this procedure as a "contract referee mechanism": This part of the governance structure typically combines three key elements: (a) the commitment to share and exchange information during the collaboration, (b) the assignment of decision rights to a joint project management team subject to a unanimity rule, and (c) the appointment of "referees"-representatives from each firm charged with resolving disputes. The contract referee mechanism has several effects. First, the referees provide information concerning the nature of a complex interaction that others cannot obtain directly. A referee can clarify misunderstandings early, avoiding false negatives-i.e., the interpretation of the other's behavior as a defection. When she finds that a defection has indeed occurred, a referee can, by "blowing the whistle" while providing for a fast and low-cost resolution to the dispute, forestall disproportionate responses by the aggrieved party.... The referee also serves as an informal disciplining mechanism... . The subordinates' job is to resolve problems, not escalate them. Gilson, Sabel & Scott, Contracting for Innovation, supra note 7, at 480-81. If the CEOs fail to resolve disagreements, ongoing disputes are first subject to mediation under the American Arbitration Association rules prior to binding arbitration (three expert arbitrators with streamlined procedures, all awards final and binding, no limitation or liquidation of damages). Pharma/BMS Agreement, supra note 80, art. 15.13.2.
97. Pharma/BMS Agreement, supra note 80, art. 6.1-6.3.
98. Id. art. 6.2.2. NDA filing and NDA approval refer to the New Drug Application and Approval processes of the Food and Drug Administration that are prerequisites to the marketing of a new drug therapy to the general public. Id. art. 1.23; see also 21 U.S.C. § 355 (2006) (outlining process for introducing new drugs into interstate commerce).
99. Pharma/BMS Agreement, supra note 80, art. 7.1 (describing license fee); id. art. 7.4.1 (describing royalties). "Net Sales" means "invoice price of Products sold." Id. art. 1.24. The parties agree that royalties are owed regardless of whether the product is covered by a patent since the principal contribution of Pharma is to accelerate the time to market. Id. art. 7.4.2.
100. Id. art. 9.1. Each firm owns the rights to intellectual property (IP) developed by their lab individually. Jointly developed IP is owned collectively. Id. art. 10.1. Each firm undertakes to prosecute patent applications for its own IP, to keep the other fully informed, and to pay its own out-of-pocket costs. Id. art. 10.2.1.
101. As the collaboration ends, the potential for opportunism reemerges, but the need for continuing the joint work, given the remaining uncertainty of outcome, prevents the anticipation of a final period from causing unraveling through backward induction. Once the collaborative research has ended, the parties must divide the surplus created, and the options are means to that end.
102. Id. art. 9.3.1.
103. Id. art. 9.3.2.
104. See Lisa Bernstein, Private Commercial Law in the Cotton Industry: Creating Cooperation Through Rules, Norms, and Institutions, 99 Mich. L. Rev. 1724, 1745-54, 1762-87 (2001) (discussing existence and importance of institutional dispute resolution conditions on reputation-based nonlegal sanctions in cotton industry).
105. See generally Peter A. Hall & David Soskice, An Introduction to Varieties of Capitalism, in Varieties of Capitalism: The Institutional Foundations of Comparative Advantage 1, 21-27, 33-36 (Peter A. Hall & David Soskice eds., 2001) (identifying Germany and Japan as "coordinated market economies," but noting Germany relies on "industry-based coordination," whereas Japan fosters "group-based coordination").
106. Cf. Wolfgang Streeck, Co-determination: After Four Decades, in Social Institutions and Economic Performance 137, 137 (1992) (discussing German policy of "co- determination," which requires "equal representation of capital and labor on the supervisory boards of coal and steel companies" and arguing that "co-determination... has contributed to creating and reinforcing a vested interest of workers in 'social partnership' and "cooperation' in the enterprise"); Wolfgang Streeck, Beneficial Constraints: On the Economic Limits of Rational Voluntarism, in Contemporary Capitalism 197, 201-04 (J. Rogers Hollingsworth & Robert Boyer eds., 1997) [hereinafter Streeck, Beneficial Constraints] (noting social constraints on employer action in Germany and Japan, and finding that "[s]ocial constraints on rational behavior can reinforce trust, and thus facilitate the rational pursuit of economic objectives, by reassuring potentially suspicious parties of continued adherence to reciprocity regardless of changes in circumstances").
107. Masahiko Aoki, Information, Incentives, and Bargaining in the Japanese Economy 119-20 (1988).
108. Gary Herrigel, Industrial Constructions: The Sources of German Industrial Power 83, 187 (1996).
109. See Streeck, Beneficial Constraints, supra note 106, at 201-04 (describing beneficial constraints on employers in Germany and Japan).
110. Ken-ichi Imai, Japan's Corporate Networks, in 3 The Political Economy of Japan 198, 217-18 (Shumpei Kumon & Henry Rosovsky eds., 1992).
111. See Mashiko Aoki, Toward an Economic Model of the Japanese Firm, 28 J. Econ. Literature 1, 9 (1990) [hereinafter Aoki, Economic Model] (noting importance of social changes in Japanese labor market); Hall & Soskice, supra note 105, at 50-54 (describing social policy regimes of "coordinated market economies in Germany and Japan and noting each country's political system complements its stakeholder structure).
112. Hall & Soskice, supra note 105, at 39-44.
113. For Germany, see Gary Herrigel, Manufacturing Possibilities: Creative Action and Industrial Recomposition in the United States, Germany, and Japan (forthcoming 2010) (manuscript at 196-97) [hereinafter Herrigel, Manufacturing] (on file with the Columbia Law Review) ("[I]n crucial ways [systemic reflexes] have not been enough for producers...."). For Japan, see Jean McGuire & Sandra Dow, Japanese Keiretsu: Past, Present, Future, 26 Asia Pac. J. Mgmt. 333, 342 (2009) (arguing demands from global financial stakeholders may lead to "weakening of keiretsu ties"); Sandra Dow, Jean McGuire & Toru Yoshikawa, Disaggregating the Group Effect: Vertical and Horizontal Keiretsu in Changing Economic Times, Asia Pac. J. Mgmt. Online First 19 (Aug. 1, 2009), at http:// www.springerlink.com/content/e752203516670x54/about/ (on file with the Columbia Law Review) ("[S]hifts away from both horizontal and vertical keiretsu affiliation were observed.").
114. Hideaki Miyajima & Fumaki Kuroki, The Unwinding of Cross-Shareholding in Japan: Causes, Effects, and Implications, in Corporate Governance in Japan 79, 117 (Masahiko Aoki, Gregory Jackson & Hideaki Miyajima eds., 2007).
115. Christina L. Ahmadijan & James R. Lincoln, Keiretsu, Governance, and Learning: Case Studies in Change from the Japanese Automobile Industry, 12 Org. Sci. 683, 692 (2001).
116. Id. at 685-86.
117. See id. at 686 (discussing deterioration of Toyota's keiretsu relationship).
118. See Herrigel, Manufacturing, supra note 113, at 191 (describing "very extensive study" conducted jointly by three German research institutes, which found "German suppliers were indeed being asked to participate in product development at much earlier stages than they had in the past").
119. Cressida Lui, Collaboration on Thin Ground: Contract Production Arrangements Between Taiwanese Firms and Their American MNC Customers in the Personal Computer Industry, ch. 7 p. 2 (Apr. 21, 2009) (unpublished Ph.D. dissertation, University of Wisconsin-Madison) (on file with the Columbia Law Review).
120. Id. at ch. 7 p. 5.
121. Id.
122. Interview with Gregg Kirchoffer, Partner, Kirkland & Ellis, in Chi., Ill. (Apr. 10, 2009) (on file with the Columbia Law Review).
123. Id.
124. Id.
125. See Aoki, Economic Model, supra note 111, at 23 ("[R]elatively dissimilar patterns in the West and Japan[] may have to do with historical, cultural, and regulation factors."); Paul Milgrom & John Roberts, Complementarities and Systems: Understanding Japanese Economic Organization, 9 Estudios Economicos 3, 36 (1994) ("[C]apital market conditions and practices have been key elements in the Japanese model.").
126. See infra text accompanying notes 162-166 (describing emerging case law that creates new rules for enforcing preliminary agreements).
127. 408 F. Supp. 2d 668 (S.D. Ind. 2006).
128. Id. at 671.
129. Id. The agreement provided, inter alia, that "Lilly shall not have
130. Id. at 680.
131. Id. at 689-91.
132. Id. at 697. A similar result was reached in an analogous case, Medinol Ltd. v. Boston Scientific Corp., 346 F. Supp. 2d 575 (S.D.N.Y. 2004). In Medinol, the parties entered into "a close and extensive contractual relationship, relating to research, development, manufacturing and distribution of stents." Id. at 581. Medinol was to manufacture the stents, and Boston Scientific was to sell them in the United States under license from Medinol. The parties agreed that Medinol would establish an "Alternative Line" for manufacturing stents, which Boston Scientific would be permitted to operate under license from Medinol so as to reduce the risk of supply disruptions. That license was limited to "the operation of the Alternative Line." Id. at 597. Boston Scientific then set up a secret manufacturing operation outside the scope of the Alternative Line. Although there was no express covenant against such manufacture, the court found that the parties' close collaborative relationship showed that the unauthorized manufacturing amounted to a breach of contract, id. at 598, without limiting Medinol to a patent infringement suit. The court further found that Boston Scientific's stealth and secrecy showed it had acted in bad faith by setting up the unauthorized line. Id. at 596. The court granted summary judgment for Medinol on liability for the breach, leaving only the issue of damages for trial. See also Shaw v. E.I. DuPont De Nemours & Co., 226 A.2d 903, 905-07, 909 (Vt. 1967) (affirming damage award for breach of implied covenant not to use patent beyond scope of license).
133. It is important to emphasize that what distinguishes low-powered from high- powered enforcement is not the character of the remedy that is imposed per se, but rather what kind of obligation is found to be enforceable. In Lilly v. Emisphere, the court had essentially three choices. First, the court could have granted Lilly's request to find the contract not legally enforceable and limit Emisphere to a suit for patent infringement. In that case, Emisphere would likely have been without any remedy as no patent was infringed. Second, the court could have chosen high-powered enforcement and held that Lilly had breached a contractual obligation to produce a successful chemical carrier compound, awarding damages for failure to perform the contract successfully. Third, the court could have held that the contract was enforceable but only to the extent that it barred Lilly from misappropriating private information shared during the collaboration. This last sanction-the one the court chose-is low-powered in that it requires only that Lilly not cheat; it does not obligate Lilly to affirmatively do anything. See supra note 60 (describing difference between low-powered and high-powered sanctions).
134. See Joseph Farrell & Philip J. Weiser, Modularity, Vertical Integration, and Open Access Policies: Towards a Convergence of Antitrust and Regulation in the Internet Age, 17 Harv. J.L. & Tech. 85, 90-96 (2003) (describing evolution towards open-access modular platform technology in three industries and noting modularity facilitates innovation by organizing independent, complementary, and specialized producers); cf. David S. Evans, The Antitrust Economics of Multi-Sided Platform Markets, 20 Yale J. on Reg. 325, 331-36 (2003) (describing economics and conditions of platform markets, which productively coordinate needs and abilities of complementary participants).
135. Gilson, Sabel & Scott, Contracting for Innovation, supra note 7, at 438-44.
136. Complaint at 2, In re Intel Corp., No. 9288, FTC (June 8, 1998) [hereinafter Complaint], available at http://www.ftc.gov/os/1998/06/intelcmp.pdf (on file with the Columbia Law Review); see generally Annabelle Gawer & Michael A. Cusumano, Platform Leadership: How Intel, Microsoft, and Cisco Drive Industry Innovation (2002) (describing how Intel, Microsoft, and Cisco became leading platforms and challenges they face as a result).
137. Gawer & Cusumano, supra note 136, at 16-17.
138. Complaint, supra note 136, at 1-3; see also Agreement Containing Consent Order at ¶ I.C, In re Intel Corp., No. 9288, FTC (Mar. 17, 1999) [hereinafter Consent Order], available at http://www.ftc.gov/os/1999/03/d09288intelagreement.htm (on file with the Columbia Law Review) (describing Advance Technical Information program).
139. Consent Order, supra note 138, ¶ I.C.
140. Complaint, supra note 136, at 3.
141. 141. Id. at 5.
142. Id.
143. Id. at 6.
144. Id.
145. Id. at 7.
146. Id. at 8.
147. Id. at 5, 8.
148. Id. at 7-8.
149. Consent Order, supra note 138, ¶ I.C.
150. Id. ¶ II.A.
151. Id. ¶ II.B.3.
152. Id. ¶ II.B.2.
153. Id. ¶¶ II.B.4-5.
154. FTC, Analysis of Proposed Consent Order to Aid Public Comment (March 17, 1999), at http://www.ftc.gov/os/1999/03/d09288intelanalysis.htm (on file with the Columbia Law Review).
155. See supra Part III.A (discussing Lilly v. Emisphere).
156. In construction, contractually specified information exchange regimes are now often used to facilitate coordination during complex projects, and especially to register emergent problems and respond effectively to them. See, e.g., Georgetown 19th Street Development, LLC & Turner Construction Co., Agreement (Apr. 1, 2003) (on file with the Columbia Law Review) (contracting for construction services). The Agreement provides: Throughout the Pre-Construction Services Phase and the Construction Services Phase of the Work, the Key Personnel, and the Construction Manager's Trade Contractors shall meet at least once a week (and more frequently if required by Owner) with Owner and the Architect for the purpose of (i) reviewing the Work, or any component thereof, in respect of design, construction, costs incurred and to be incurred, and progress, and (ii) preparing a list (to the extent reasonably foreseeable) of decisions or actions which Owner must make or take within the next sixty (60) Days to avoid delays in completion of the Work, or any component thereof. Id. art. 5.2. For a detailed account of how such mechanisms function in practice, see Atul Gawande, The Checklist Manifesto: How to Get Things Right 54-71 (2009). Similar collaborative arrangements appear to be proliferating in business process outsourcing. E.g., New Century Financial Corp. & Accenture LLP, The Professional Services Agreement (Jan. 25, 2006), available at http://contracts.onecle.com/new-century-financial/accenture- services-2006-01-25.shtml (on file with the Columbia Law Review). The Agreement provides that Accenture will supply and periodically improve defined human resource services to New Century. Id. art. 6.1 (contracting to provide services); id. art. 7.4 (contracting to improve them). Moreover, under the Agreement, Accenture will conduct surveys of New Century employees to determine their level of satisfaction with the services provided. Id. art. 7.6. Furthermore, If the results of any satisfaction survey... indicate that the level of satisfaction with Supplier's performance is less than the target level... Supplier shall promptly: (i) conduct a Root Cause Analysis as to the cause of such dissatisfaction; (ii) develop an action plan to address and improve the level of satisfaction; (iii) present such plan to New Century for its review, comment and approval; and (iv) take action in accordance with the approved plan and as necessary to improve the level of satisfaction." Id. art. 7.6(c).
157. See infra text accompanying notes 208-212 (discussing holding in Tan v. Allwaste, Inc. that failure to close on acquisition might breach duty to negotiate in good faith).
158. The award of expectation damages for breach of a braided contract would be speculative since the alleged breacher will have abandoned the collaboration before the ultimate project would have been finalized. Expectation damages purport to put the injured party in the position she would have been in had the collaborative exploration not only been successfully concluded, but a joint project also agreed upon and realized. See infra text accompanying notes 220-221 (discussing threat of crowding out posed by awarding expectation damages).
159. The discussion in this section draws on Alan Schwartz & Robert E. Scott, Precontractual Liability and Preliminary Agreements, 120 Harv. L. Rev. 661 (2007) [hereinafter Schwartz & Scott, Precontractual Liability].
160. In negotiating the terms of the ultimate contract, the division of the contractual surplus will not reflect the fact that one party has made specific investments that contribute to the surplus. Because the specific investments are sunk costs, the opportunistic party can compel the investing party to share the payoffs from her investment. For discussion, see Schwartz & Scott, Contract Theory, supra note 38, at 559-62.
161. For a formal model supporting this analysis, see Schwartz & Scott, Precontractual Liability, supra note 159, at 676-91.
162. Robert E. Scott & Jody S. Kraus, Contract Law and Theory 29-41, 299-303 (4th ed. 2007). [T]wo factual patterns typify unenforceable indefinite agreements at common law. The first, illustrated... by Varney v. Ditmars, [111 N.E. 822 (N.Y. 1916)] is the indefinite bonus contract. In Varney, the New York Court of Appeals held a bonus agreement for "a fair share of the profits" too indefinite and thus [un]enforceable. The second archetype is a variation on the first, extending the common law rule to agreements where essential terms were explicitly left to further negotiation. For example, in Petze v. Morse Dry Dock & Repair Co., 109 N.Y.S. 328 (App. Div. 1908), the New York appellate court held that an agreement providing that "the method of accounting to determine the net distributable profits is to be agreed upon later" was unenforceable under the indefiniteness rule. Common law courts thereafter have consistently held that such "agreements to agree" are unenforceable so long as any essential term was open to negotiation. Id. at 35.
163. The rule originated with the opinion of Judge Pierre Leval in Teachers Insurance & Annuity Ass'n of America v. Tribune Co., 670 F. Supp. 491, 498 (S.D.N.Y. 1987). Judge Leval identified two separate types of "preliminary agreements." Id. In Type I agreements, the parties have agreed on all material terms but have also agreed to memorialize their agreement in a more formal document. Disputes arise primarily because parties have failed to express clearly their intention as to when their arrangement would be legally enforceable. Here the question is solely one of timing: At what point have the parties manifested an intention to be legally bound? Id. In contrast, Type II agreements concern "a binding preliminary commitment." Id. These are the preliminary agreements we analyze here. In this latter case, the parties agree on certain terms but leave potentially important terms open to further negotiation. This requires courts to determine whether such an agreement had been made, what the duty to bargain in good faith entails, and which remedy should be awarded for breach of that duty. Id. This framework has been followed in at least thirteen states, sixteen federal district courts, and seven federal circuits. Schwarz & Scott, Precontractual Liability, supra note 159, at 664 n.7, 691-92.
164. See R.G. Group, Inc. v. Horn & Hardart Co., 751 F.2d 69, 74 (2d Cir. 1984) ("[I]f parties do not intend to be bound by an agreement until it is in writing and signed, then there is no contract until that event occurs.").
165. Tribune, 670 F. Supp. at 498.
166. Beazer Homes Corp. v. VMIF/Anden Southbridge Venture, 235 F. Supp. 2d 485, 491 (E.D. Va. 2002) (quoting Burbach Broad. Co. of Del. v. Elkins Radio Corp., 278 F.3d 401, 407 (4th Cir. 2002)).
167. See supra text accompanying notes 58-71 (describing experimental evidence of crowding out).
168. For discussion of what precisely is meant by the duty to negotiate in good faith, see infra Part IV.D.
169. See supra text accompanying notes 58-71 (recounting evidence of crowding out).
170. For an analysis of the litigated cases, see Schwartz & Scott, Precontractual Liability, supra note 159, at 691-702.
171. No. 97-8273 (SMB), 2002 WL 31528396 (Bankr. S.D.N.Y. Nov. 15, 2002).
172. See supra note 160 and accompanying text (predicting opportunistic behavior by parties to preliminary agreements). The court held: The rejection of the Vail application violated the Letter of Intent. The Letter of Intent granted Matterhorn the exclusive right to negotiate a lease in Vail despite Vail's geographical distance from Matterhorn's base of operation in the Northeast. Furthermore, it required Swatch to review the Vail application in good faith, and in a manner consistent with the criteria discussed above... [Swatch] unilaterally rescinded the exclusivity that the Letter of Intent had granted, and Swatch's [decision] to reject the Vail application was improper... In addition, Matterhorn sent the Vail letter of intent in late April 1996... . Swatch took four months to complete its processing of the application... . Accordingly, Swatch breached the Letter of Intent by rejecting the Vail application for improper reasons. In re Matterhorn, 2002 WL 31528396, at 16-17.
173. In re Matterhorn, 2002 WL 31528396, at 17; see also supra note 158 and accompanying text (arguing courts should not award expectation damages in similar circumstances).
174. No. M2000-02128-COA-R3-CV, 2002 WL 598567 (Tenn. Ct. App. Apr. 17, 2002).
175. Id. at 1. The contract contained the following provision: 10. Agreement to Negotiate in Good Faith Toward Purchase of Equity Ownership. The Employer agrees that in the event Employee remains continuously employed by Employer for a period of one (1) year and has achieved Board Certification through the American Board of Urology, Employer will negotiate in good faith with Employee to allow Employee to purchase from Employer that number of shares of Employer's stock which will permit Employee to own the same number of shares as the stockholder holding the most shares of Employer's stock at that time. Employer anticipates that the purchase price of such stock shall be based on the GAAP book value of the Employer as of the date of the purchase. Id. (quoting parties' contract) (emphasis added).
176. The parties agreed on many terms of the buy-in, such as the formula to be used in determining the amount of Dr. Kandel's compensation, the formula to be used to calculate the amount of Dr. Kandel's buy-in, and the terms of the covenant not to compete. The parties disagreed, however, on the method for calculating the stock redemption value. Id. at 2.
177. Note that in Kandel, the court found no bad faith. Id. at 7. The facts tended to support the inference that the partnership agreement failed to be consummated because of the divergence between Dr. Kandel's value to the firm and his opportunity cost. Cf. id. at 1-3 (describing monetary dispute between parties).
178. See Gilson, Sabel & Scott, Contracting for Innovation, supra note 7, at 458-71 (discussing contracts to innovate); supra Part IV.B.1 (discussing open-ended agreements that might lead to extended collaboration).
179. 965 A.2d 715, 746 (Del. Ch. 2008).
180. This discussion draws on Ronald J. Gilson & Alan Schwartz, Understanding MACs: Moral Hazard in Acquisitions, 21 J.L. Econ. & Org. 330, 333-40 (2005) [hereinafter Gilson & Schwartz, Understanding MACs].
181. Other subjects-like a contractual statute of limitation that specifies how long representations and warranties survive, or provisions regulating claims for breach-would still demand attention.
182. Gilson & Schwartz, Understanding MACs, supra note 182, at 334.
183. The post-execution/pre-closing activities in Hewlett-Packard's acquisition of Compaq illustrate the potential magnitude of transaction-specific investment integration efforts in a large transaction. Prior to closing, more than one thousand employees of both companies devoted more than one million hours to integration planning. Pui-Wing Tam & Scott Thurm, Married at Last, H-P, Compaq Face Real Test, Wall St. J., May 8, 2002, at B1. This effort included choosing which of the two companies' products would survive in each product line as well as developing three-year plans for each surviving line, with obvious effects on the lines that were to be discontinued. Pui-Wing Tam, Merger by Numbers: An Elaborate Plan Forces H-P Union to Stay on Target, Wall St. J., Apr. 28, 2003, at A1. At the employee level, the top three tiers of management were selected from among the two companies' managers well before closing. Id. At the same time, customers of both companies were the objects of intense attention from competitors. One customer recounted that "he gets as many as five calls a week from other computer makers. The pitches frequently aren't subtle. ""You may want to be aware that such-and-such H-P or Compaq product won't be a survivor of this deal,"' [the customer] quotes one rival sales rep as saying." Scott Thurm, Pui-Wing Tam & Gary McWilliams, Nail-Byter: H-P Claims Victory on Compaq Merger; Foe Doesn't Concede, Wall St. J., Mar. 20, 2002, at A1. To the same effect, a post-execution/pre-closing survey of Compaq Unix customers showed that many would be "less likely" to buy from the merged company. Scott Thurm, H-P, Compaq Plan the Details of Their Union, Wall St. J., Jan. 25, 2002, at A13.
184. 965 A.2d 715 (Del. Ch. 2008).
185. Id. at 721, 723. This figure includes Huntsman debt that would have been assumed by Hexion in the transaction. Id. at 723.
186. See supra text accompanying notes 72-79 (describing braiding strategy).
187. 965 A.2d at 724.
188. Id.
189. Id.
190. Id.
191. See Gilson & Schwartz, Understanding MACs, supra note 182, at 334-35 (explaining operation of material adverse change clause).
192. Huntsman, 965 A.2d at 736.
193. This narrowing of the MAC clause was accomplished by excluding from the exclusions changes that had a disproportionate effect on Huntsman compared to other chemical industry companies. Id. at 737. However, even this carve-out was ambiguous. For example, many exogenous changes would affect companies differently because of their capital structure. Should one control for capital structure in identifying disproportionate results because, presumably, the acquiring company knew the target's capital structure relative to the industry before the transaction? The Chancery Court's treatment of the material adverse change clause took up the bulk of the opinion. It did not address the application of the disproportionality exclusion to the exclusions from the MAC definition, holding that the seller first had to show there was a material adverse change before the court had to address whether an exclusion would have disarmed the MAC and the disproportionality exclusion would have disarmed that. Id. at 736-38. While analysis of the Chancery Court's treatment of the MAC clauses is outside of our focus here, it is worth commenting on the puzzle that this treatment poses for contract theory. As suggested earlier, parties face a choice between selecting rules or standards. Choosing a rule provides greater verifiability at the cost of turning out to be the wrong measure ex post, while choosing a standard accepts more uncertainty ex ante to get the benefit of the court having much better information when the standard ultimately is imposed ex post and thereby having the ability to select an accurate measure of the clause's operation. See supra text accompanying notes 34-36 (describing tradeoff between rules and standards). Acquisition lawyers plainly have chosen to use a standard-a material adverse change as opposed to, for example, numerical triggers keyed to revenue or profits. However, the Chancery Court has made plain that it will not accept the delegation by pointedly refusing to apply a MAC to relieve an acquiring company of its obligation not to close. As the court said in Huntsman, with some touch of pride: A buyer faces a heavy burden when it attempts to invoke a material adverse effect clause in order to avoid its obligation to close. Many commentators have noted that Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement. This is not a coincidence. 965 A.2d at 738 (footnote omitted). It is fair to say that Delaware courts have not offered a clear explanation for their hostility, which leaves two very interesting puzzles that would well warrant the attention of contract theorists who wish to engage with the real world of contracting. First, why is the court so reluctant to select a proxy for the occurrence of a MAC that does not, in effect, reduce to the search for a unicorn? We speculate that the courts view the standard chosen by the acquisition bar as "empty"-that is, giving courts no guidance at all about the proper proxy-and therefore causing the courts to decline to allow sophisticated lawyers and parties to entirely turf the matter to the court. Second, whatever the reason for the court's inaction, the fact that sophisticated lawyers and parties continue to contract in the same way, even knowing that courts will not take the MAC clause seriously, requires explanation, especially because it would not be difficult to either reduce the MAC to a series of rules or give the court more guidance about the choice of a standard. Put differently, why do sophisticated parties write less complete contracts when they plainly can write more complete contracts? In a very interesting paper, Patrick Bolton and Antoine Faure-Grimaud have begun analysis of the problem. See Patrick Bolton & Antoine Faure-Grimaud, Satisficing Contracts, 77 Rev. Econ. Stud. 937, 964 (2009) ("Equilibrium contracts in our model are incomplete for two reasons: first, the costs of thinking about how to complete them may exceed the expected benefits; and second, the costs of thinking about how to outwit the other agent also exceed the expected benefits.").
194. 965 A.2d at 749.
195. The court set out in great detail the facts supporting its conclusion that Hexion had breached its obligation to use its best efforts to secure financing. Central to its conclusion was that, from the first moment Hexion concluded that exogenous changes- which the court held did not amount to a material adverse change even without reference to the carve-outs from the definition of a MAC-had reduced the likely post-transaction value of Huntsman and so caused Hexion not to wish to close the transaction, Hexion directed its lawyers to establish a legal basis for its desired nonperformance. Its efforts to do so included securing an unfavorable solvency opinion and circulating that opinion to the banks that had issued the financing commitment, all without notice to Huntsman and with the knowledge that doing so would make securing financing unlikely. Id. at 749-51.
196. Id. at 749 (footnote omitted).
197. Id. at 750.
198. Id. at 759 ("[T]he court finds that, under the agreement, Huntsman cannot force Hexion to consummate the merger, but that Huntsman is entitled to a judgment ordering Hexion to specifically perform its other covenants and obligations.").
199. Jim Fotenos, Hexion v. Huntsman; The Settlement, M&A Litigation Commentary (Dec. 18, 2008, 9:51 AM), at http://mandalitigationcommentary.blogspot.com/2008/12/ hexion-v-huntsman-settlement.html (on file with the Columbia Law Review). In addition, Apollo, Hexion's controlling shareholder, agreed to purchase $250 million in Huntsman preferred stock that would be redeemed in ten years. Id.
200. Gilson, Sabel & Scott, Contracting for Innovation, supra note 7, at 458-71.
201. They may also be seen in other capital-related transactions. For discussion of braiding in a venture capital context, see Gilson, Engineering a Venture Capital Market, supra note 3, at 1091.
202. No. 96 C 3558, 1997 WL 337207 (N.D. Ill. June 11, 1997).
203. See supra note 185 (discussing risk to seller of competitors' actions between execution and closing of acquisition).
204. Sellers in these acquisition agreements may also invest in the synergies that result from integration. See Gilson & Schwartz, Understanding MACs, supra note 182, at 334 ("The standard acquisition agreement, we argue, creates an incentive for the seller to invest in synergy....").
205. In particular, plaintiffs noted the acquisition of Geotrack was to be debt-free, so Geotrack's tax liability should not have affected Allwaste's analysis of the deal. Plaintiffs also provided evidence that Allwaste simply decided not to conduct any more acquisitions. Id. Allwaste, however, might well have concluded that a counterparty that lied about its liabilities may have been lying about other matters, such as the condition of its assets or the nondebt aspects of its financial condition that a debt-free acquisition would not protect against.
206. The court appears to have concluded that if Allwaste declined to go forward with the acquisition because it "simply decided not to conduct any more acquisitions," a jury could conclude that it breached its preliminary agreement. Id. In other words, the court construed the obligation as prohibiting a change in one party's strategy.
207. The court did not limit potential damages to Geotrack's reliance costs, thus leaving open the possibility that Allwaste could be held to benefit-of-the-bargain damages. Id.
208. Id.
209. VS & A Commc'ns Partners v. Palmer Broad. P'ship, No. 12521, 1992 WL 339377, at 3 (Del. Ch. Nov. 16, 1992).
210. Venture Assocs. Corp. v. Zenith Data Sys. Corp., 96 F.3d 275, 279-80 (7th Cir. 1996).
211. The case is unusual. Typically, the buyer elects not to go forward.
212. VS & A, 1992 WL 339377, at9-10.
213. 96 F.3d at 275.
214. Id. at 279-80 (citations omitted). Judge Posner does not address the broader point made by Chancellor Allen that changed conditions that have affected prices would allow sellers in good faith simply to decline to complete transactions.
215. See supra text accompanying notes 58-71 (discussing evidence of crowding out).
216. Venture Assocs., 96 F.3d at 278.
217. See supra text accompanying notes 127-133 (discussing Lilly v. Emisphere).
218. See supra text accompanying notes 140-154 (discussing FTC v. Intel).
219. Schwartz & Scott, Precontractual Liability, supra note 159, at 675-76.
220. See Teachers Ins. & Annuity Ass'n of Am. v. Tribune Co., 670 F. Supp. 491, 500-01 (S.D.N.Y. 1987) (relying on context of negotiations to support conclusion that preliminary agreement bound parties).
221. Schwartz & Scott, Precontractual Liability, supra note 159, at 675-76.
222. Our principal concern has been the question of what it means to formally enforce these preliminary obligations. But, as noted above, the criteria for determining when parties have reached such an agreement are also needlessly vague. Since parties are always free to indicate their desire to be completely free from formal enforcement, courts should hold all commercial parties to an obligation to invest as promised whenever they agree to invest collaboratively in a letter of intent or other similar form of transaction.
223. As Durkheim wrote: But it is not only outside of contractual relations, it is in the play of these relations themselves that social action makes itself felt. For everything in the contract is not contractual. The only engagements which deserve this name are those which have been desired by the individuals and which have no other origin except in this manifestation of free will. Inversely, every obligation which has not been mutually consented to has nothing contractual about it. But wherever a contract exists, it is submitted to regulation which is the work of society and not that of individuals, and which becomes ever more voluminous and more complicated.... To be sure, when men unite in a contract, it is because, through the division of labor, either simple or complex, they need each other. But in order for them to co-operate harmoniously, it is not enough that they enter into a relationship, nor even that they feel the state of mutual dependence in which they find themselves. It is still necessary that the conditions of this co-operation be fixed for the duration of their relations. Emile Durkheim, The Division of Labor in Society 211-16 (George Simpson trans., Macmillan Co. 1933) (1893); see also Jens Beckert, The Great Transformation of Embeddedness: Karl Polanyi and the New Economic Sociology 20 (Max Planck Inst. for the Study of Soc'ys, Discussion Paper No. 07/1, 2007) ("The development of modern capitalist societies, however, tends to destroy the contexts of trust that support cooperation in exchange in traditional societies... . These changed macrosocial conditions necessitate the development of new forms of embeddedness that are able to support trust between exchange partners.").
224. Later variants of Durkheim's insight include Polanyi's idea that market relations can only be effectively regulated when "embedded" in society, Karl Polanyi, The Great Transformation: Economic and Political Origins of Our Time 57 (1944), and Bell's concern that capitalism is imperiled by a "cultural contradiction," as the self-seeking encouraged by market participation inexorably undermines the solidarity values on which markets ultimately depend, Daniel Bell, The Cultural Contradictions of Capitalism, 6 J. Aesthetic Educ. 11, 38 (1972).