Today's case, Feld v. Henry S. Levy & Sons, concerns breadcrumbs. Not the kind that fall off slices of bread as you eat it, but rather industrial made, machine ground bread crumbs. Feld's Company, the Crushed Toast Company, entered into a contract with Levy & Sons Bakery to buy all of the breadcrumbs they would produce in the upcoming year. With the contract set to renew every year unless one party gave the other six months notice. Over the course of the year, Levy & Sons produced and sold more than 250 tons of breadcrumbs. But over that time, they decided that six cents per pound, they had agreed to in the contract, was too low. They tried to get Feld to agree to a price increase of seven cents per pound. But when he refused, they shut down their breadcrumb making operation and dismantled all of the machinery involved. The stale loaves of bread that they would have used making crumbs, they instead sold for animal feed. Once they did this, they stopped selling any crumbs to the Crushed Toast Company, as their output was now zero. Feld then sued, considering this to be a breach of their contract. We're looking at the decision from the New York Court of Appeals, on appeal from denial of both parties motion for summary judgment. And so the underlying procedural question, is whether there is a question of material fact for a jury to decide in this case. In order to answer this question, Judge Cooke, looks at the substantive legal question of whether the seller was required to produce breadcrumbs, or if Levy & Sons could satisfy its obligation by handing over the zero breadcrumbs it produced. Judge Cooke relies on the uniform commercial codes rules for output and requirements contracts. We've encountered these sort of contracts before, for example, in the Sooner Sand case but it's worth a quick refresher. In an output contract as we have in this case, the buyer agrees to purchase all of the given product that the seller makes. In the requirements contracts on the other hand, the seller agrees to make as much of a given product as the buyer requires or needs. Note that in each of these types of contracts, one party has discretion over the quantity of goods sold. In output contracts, it's the seller, while in requirement contracts, it's the buyer. What we have in this case is an output contract since Levy & Sons is obliged to sell its entire output to the Crushed Toast Company. The agreement is only exclusive in one direction though, the Crushed Toast Company is allowed to buy crumbs from others. The key provision of the UCC is Section 2-306. Subsection 1 informs us that the party with discretion does not have unlimited discretion. They must determine the quantity in good faith in accordance with their actual output or requirements, and that quantity cannot be unreasonably disproportionate to what the parties estimated or expected. Courts have generally prioritized the good faith requirement over the prohibition of unreasonably disproportionate amounts. Output and requirement contracts give us another context to learn what the law demands in terms of good faith. You should see these discretionary quantity cases, that they generally fit into the categories that judges Souter and Posner called discretionary performance, as opposed to good faith information or in terminations. But this particular case is more of a good faith than terminations, since Levy & Sons, by choosing to cease production is also in essence terminating the contract. Judge Cooke looks at what the UCC provision means for the case at hand. He finds that under New York law, good faith cessation of production terminates any further obligations, and excuses further performance. So, the simple fact that Levy & Sons ceased producing breadcrumbs, is not sufficient for Feld to win the case. The question is whether the seller acted in good faith. Levy & Sons says, that producing breadcrumbs was economically not feasible. But that's too vague and permissive a test for Judge Cooke. We need to look at the motives. Cooke finds that it's not enough for a seller to simply find that it is making less profit than expected, rather continued production must actually imperil the business's continued operation, or push it into bankruptcy. Otherwise, they are bound by the price they agreed to when they formed the contract. Even with Judge Cooke's clarification, this rule is not obvious. It's not clear why bankruptcy should be sufficient. Leveraged buy-outs may leave businesses with very little room for reduced profitability. But that shouldn't affect their obligations to contractual partners. One possible economically sensible rule would be to excuse performance when the joint profits of the seller and buyer combined are negative. That's one of the party's losses exceed the other party's gains from the transaction. This case however, looks pretty clearly like bad faith, at least on the facts we have here. The bakery only dismantled its machinery after its attempts to extort a higher price from the buyer were unsuccessful. The court remands so that the ultimate decision on this factual question will be made by the jury. This decision is one of several areas where courts have conditioned a corporation's legal duties on whether fulfilling the duty would drive the firm into bankruptcy. For example, if a set of disabled employees request reasonable accommodation, an employer is less likely to need to grant the request, if doing so would drive the employer into bankruptcy. But in today's world of modern finance, the risk of bankruptcy can be somewhat under the firm's own control. And in part, a function of how the firm chooses to finance itself. Highly leveraged firms that are financed more with debt than equity, will be more susceptible to bankruptcy. But bankruptcy in that case, in the case of a highly leveraged firm, doesn't mean the firm isn't viable economically. It just means that the firm will have to reorganize and the erstwhile bondholders will become the new shareholders of the post-bankrupt firm. Imagine two identical firms that produce widgets. Both are wholly financed by equity or stock, and both are worth a $100 million. They'd have to lose a lot of money before they hit the bankruptcy point. But now, imagine that one firm decides to do a leveraged buyout, where it borrows a bunch of money by issuing bonds and uses this money to buy back almost all of its shares. The firm is still worth a 100 million, but now it's possible that 99 million of it will be owned by the bondholders and just one million by the remaining shareholders. After the leveraged buyout, the second firm is much closer to the point of bankruptcy. But should the law allow the second firm to have lower duties with regard to output contracts and duties of reasonable accommodation? Economists would say no, and instead argue that the viability of the bread production should turn more on the joint profitability of production for the buyers and the sellers. Let's take a quick look at Subsection 2 of Section 2-306 as well. This provision says that when the buyer and seller have a contract with an exclusive dealing provision, they must unless otherwise agreed, use best efforts. The duty of making best efforts is usually seen as a default duty to the other side of a contract when there is exclusive dealing. Lady Duff Gordon for example, promised to deal exclusively with Wood, and Wood in exchange implicitly promised to use best efforts to promote her endorsements. Here, Levy & Sons agreed to sell exclusively to Feld, but we don't really need Feld's promise of best efforts. So, we might think that Feld would promote the sale of breadcrumbs because Feld had already committed to buy all of Levy's output. And the parties in making an output contract are not expecting the seller to make best efforts to supply the good. Just an effort to supply an amount that is in good faith. So let's try a quiz. Imagine we had the same contract as in this case, but as the year comes to an end, Levy & Sons realizes that this contract is extremely profitable. The following year, instead of 250 tons, they produce 5000 tons of breadcrumbs. Does Feld have a suit for breach of contract? Well, probably yes. Feld would have a case. In this scenario, Levy & Sons produces 20 times the amount of breadcrumbs, he would have expected based on the first year. And the jury would likely conclude that this amount is unreasonably disproportionate under Subsection one of 2-306. So let's recap. We have seen that when parties enter an output or requirements contract, the party that has discretion over the quantity of goods sold must act in good faith, and not impose a quantity unreasonably disproportionate to what the other party would expect, either based on an explicit estimate or based on past or normal behavior.
