Dividing the Surplus upon Termination: The Case of Relational Contracts

• Author: Ofer Grosskopf
• Date: 01 March 2011
• DOI: http://doi.org/10.1111/j.1744-1714.2010.01110.x
• Published date: 01 March 2011

Dividing the Surplus upon Termination:

The Case of Relational Contracts

Ofer Grosskopf

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INTRODUCTION

Relational contracts

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typically create value that survives the end of the

contractual relationship. Married couples accumulate matrimonial prop-

erty that remains valuable long after they cease to value each other. Em-

ployees perform tasks that still benefit their employers long after they

move to another workplace. Agents and distributors develop the markets

for the products they distribute, thus creating goodwill that will outlast

their commercial relationships with the manufacturers. In all such cases, a

similar question arises: how to divide the value that survives after the con-

tractual relationships are dissolved.

Consider the following hypothetical.

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AAA Labs, a large medical

equipment producer located in Europe, decides to enter the U.S. market.

After researching different venues to achieve its target, AAA Labs contacts

a respected American physician, Dr. T, with an offer to serve as its U.S.

distributor. Dr. T agrees, and the parties enter into a commercial agency

r2011 The Author

American Business Law Journal r2011 Academy of Legal Studies in Business

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American Business Law Journal

Volume 48, Issue 1, 1–26, Spring 2011

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Judge, Central District Court, Israel. I thank Nina Zaltzman for her inspiration and Ben-

jamin Alarie, Barak Medina, Jody Kraus, two anonymous referees, and participants at the

‘‘Contract Law: Interdisciplinary Perspectives’’ Conference in the Hebrew University of

Jerusalem and the 2009 Rome-Siena-Tel-Aviv-Toronto Law & Economics Workshop for

helpful comments and suggestions.

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Throughout the article, I will assume that the term ‘‘relational contracts’’ refers to long-term

contracts that aim to ensure cooperation between the parties, and not merely an exchange of

goods and risks between them. Cf. Melvin Eisenberg, Relational Contracts, in GOOD FAITH AND

FAULT IN CONTRACT LAW 291, 291–96 (Jack Beatson & Daniel Friedmann eds., 1994) (discuss-

ing possible definitions of ‘‘relational contract’’).

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The hypothetical is loosely modeled after the Israeli case CA 442/85 Zohar v. Travenol Labs

[1990] IsrSC 44(3) PD 661.

agreement that is indefinite in duration. In the following years, Dr. T in-

vests all of her abilities and charm into marketing AAA Labs’ products to

American health service providers. Dr. T is very successful, and she

achieves an excellent penetration rate into the American market. How-

ever, after seven years of collaboration with Dr. T, AAA Labs makes a re-

assessment of its worldwide distribution strategy and decides to establish

subsidiaries in all of its destination markets, including the United States.

Consequently, AAA Labs notifies Dr. T that, regrettably, it must terminate

their agreement. Assuming that AAA Labs’ decision to reorganize its mar-

keting operation is a legitimate one, how should the law account for the

value that survives after the end of the beneficial commercial relationship

between AAA Labs and Dr. T? Does this value, namely the American

goodwill of AAA Labs products, belong to Dr. T, to AAA Labs, or is it to be

divided between them? Need one of them compensate the other for gain-

ing this surviving surplus? Questions of allocation such as these, when they

arise in the context of relational contracts, are the subject of this article.

Apparently, the question of allocating the surplus upon termination is

common to all forms of contracts, discrete and relational alike.

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However,

upon a closer look, there seem to be certain features common to most re-

lational contracts that may justify treating them differently from any other

form of contracting. These characteristics are: first, relational contracts are

usually long-term contracts in which people invest a considerable part of

their lives, and they are often indeterminate in duration (at least as far as

the parties’ expectations are concerned); second, the parties typically enter

such relationships for the benefits they gain while thecontract is in force and

thus tend to underestimate the importance of the surplusupon termination;

and third, discussing at the negotiation stage the allocation of profits upon

termination may lower the likelihood of achieving cooperation and trust,

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The distinction between relational and discrete contracts is one of the most fundamental

distinctions in modern contract law. Ian Macneil is the most prominent contributor to the

development of this distinction. See generally IAN MACNEIL,THE NEW SOCIAL CONTRACT:AN

INQUIRY INTO MODERN CONTRACTUAL RELATIONS (1980); IAN MACNEIL,THE RELATIONAL THEORY

OF CONTRACT:SELECTED WORKS OF IAN MACNEIL (David Campbell ed., 2001); Ian Macneil, The

Many Futures of Contracts,47S.C

AL.L.REV.691 (1974). Other notable contributors include

Charles Geotz, Robert Scott, Robert Gordon, and Stewart Macaulay. See generally Charles Goetz

& Robert Scott, Principles of Relational Contracts,67V

A.L.REV. 1089 (1981); Robert Gordon,

Macaulay, Macneil, and the Discovery of Solidarity and Powerin Contract Law, 1985 WIS.L.REV. 565;

Stewart Macaulay, Non-contractual Relations in Business: A Preliminary Study,28AM.SOC.REV.55

(1963).

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