Abstract

Most scholars would agree that a merger between General Motors and Ford should not be judged solely by Delaware corporate law, even if both firms are incorporated in Delaware. Leaving the standards governing such mergers to state law would assuredly produce a race to the bottom that would result in unduly permissive treatment of such transactions. Similarly, if the two firms agreed to divide markets, most would agree that some regulatory authority other than Michigan or Delaware should have the final word on the agreement. Thus, in order to forestall monopoly or its equivalent, the national government must itself exercise a monopoly-currently through the Sherman Act-over the production of rules governing such transactions. This is not to say that the national government should exercise a monopoly with respect to all commercial transactions with some interstate nexus. Assume, for instance, that a contractor from North Carolina promises to build an addition to my house in Virginia before the winter and completes ninety percent of the project-all except the roof-by November 15. Assume further that the contractor threatens not to complete the project, knowing that I cannot find satisfactory substitute performance, and thus secures my "agreement" to an increase in the contract price. Most scholars would agree that state contract law should govern my claims for relief, and that competition between the states regarding the standards governing such conduct would not result in a race to the bottom. Therefore, no federal monopoly is necessary. This essay examines a class of cases that stands somewhere between the merger of Ford and General Motors, on the one hand, and the threatened breach by the contractor on the other: franchisor opportunism. These cases are similar to the hypothetical merger or cartel involving Ford and General Motors in that the "offending" parties are large, often multinational corporations that do business in all fifty states. However, they are also like the threatened breach by the contractor in that they involve opportunism in two-party, buyer-seller relationships, opportunism that seems redressable under traditional contract law doctrines. The hybrid nature of such cases presents a puzzle for courts and policymakers who must decide which institution-federal monopoly or competition between the states - should generate the rules governing these transactions. This essay suggests that the federal government should not, under the aegis of the Sherman Act, displace competition among the states for the production of rules governing purported franchisor opportunism. As shown below, the case for Sherman Act intervention to combat franchisor opportunism turns on the existence of transaction costs, costs that would prevent franchisees from protecting themselves in advance by contract or exit. Indeed, the treble-damage remedy of the Sherman Act can be characterized as a liability rule that obviates the market failure that transaction costs would otherwise engender. Those who have advocated Sherman Act regulation in this context have treated transaction costs as a given - exogenous to the legal system. However, as shown below, these costs are in fact a function of the institutional framework, which is constructed in part by various rules of contract law. By adjusting these common law rules by judicial decision or statute, states can alter the institutional framework, reduce the cost of transactions, and thus undermine the case for Sherman Act intervention. The mere fact that state courts and legislatures could generate rules that deter franchisor opportunism does not mean that they will. Delaware, after all, could produce corporate law that deterred all wealth-destroying mergers, though one doubts it would do SO. Still, given state law's potential for preventing franchisor opportunism, advocates of federal intervention in this area must demonstrate that competition between states to produce the institutional framework governing such behavior is beset by a market failure that will produce a race to the bottom. No such demonstration has been made, and preliminary analysis suggests that competition between the states will not, in fact, produce a race to the bottom in this context.

Document Type

Article

Publication Date

Fall 1999

Publication Information

23 Harvard Journal of Law and Public Policy 61-87 (1999)

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