Incomplete Contracts: You will Pay me what I tell you to pay me, after you sign

October 10, 2008

All contracts are not the same.

Most people think of contracts as a “promise for a promise” and that’s not a bad rule-of-thumb. Sort of “I agree to pay $x for you to perform y service for me.” This is what is called a complete contract.

So far so good.

However, some contracts aren’t so simple and they tend to cause all kinds of grief. They’re are called incomplete contracts.

They in effect say: I will tell you what you will pay me, when I (maybe, unilaterally) decide to.

  • Sounds pretty dodgy, doesn’t it?
  • Who in their right mind would sign such a deal?

However, there are very good, sound reasons for entering into an incomplete contract. The strength of franchising is its ability to adapt to changing market conditions. This is the ability that you are paying for.

There is a defined reliance nature (superior:subordinate roles in both economic power and information) that creates a risk of overreaching or opportunism by the dominant party.

There is nothing personal or brand-specific about it: It’s just the nature of the beast. All franchisors are carnivores. Some have better table manners, that’s all

  • This is where the core problems in franchising arise and why there is so much trouble.

Without understanding the difference between a complete and incomplete contract, discussing potential remedies is foolhardy.

The definitive academic work in this field continues to be Problematic Relations: Franchising and the Law of Incomplete Contracts by Gillian K. Hadfield.

Download Problematic Relations

The problem is the regulators and Courts (because they are not given specific enough instruction by law-makers) only see the one-sided contract and interpret narrowly only what is within the “four corners of the contract”, to predictably one-sided results.

Hadfield:

Predictably, the franchise disputes that appear in court center on the franchisor’s exercise of its significant, relationally constrained but formally unfettered powers. And unfortunately, drawn to the model of the complete contract, courts tend to view the formal written contract as representing the entirety of the commitments structuring the franchise relationship. In practice, this approach amounts to a “business judgment” rule of enforcement: Provided that franchisor articulates some plausible business rationale for its actions, courts will not interfere.

In doing so, however, the courts fail in their traditional task of enforcing the true exchanges reached by the contracting parties.

There are solutions to this short-sightedness but they require tremendous discernment by parliamentarians.

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