Unions and the duty of good faith in employment contracts.

• Author: Bagchi, Aditi

1. INTRODUCTION

   Some American scholars of law and economics have expressed dismay at the anticompetitive and illiberal body of legal doctrine that is labor law. (1) Their respondents, often in other fields if not other countries, have defended unions and the laws that support them on both economic and ethical grounds. On the one hand, unions may contribute to efficient workplace governance and correct the monopsony power of employers in imperfect labor markets. (2) On the other hand, by increasing workers' bargaining power vis-a-vis firms, unions may effectuate distributive social policies by winning workers a larger fraction of firms' surplus. By affording employees more control over their work, unions may also leave them less alienated in the production process. (3) I will offer another account of the function of labor law that appeals to both efficiency and equity principles: Unions correct for the unique opportunities for bad faith in the employment relationship.

   The duty of good faith is a background condition imposed on all contracts that limits the negative effects of unequal bargaining power, but its enforcement is particularly challenging in the context of most employment relationships. I will argue first that the duty of good faith is not self-enforcing between worker and firm. I will then argue that third-party enforcement is not a viable alternative. Finally, I will present unions as an institutional means by which the duty can be enforced at low cost, and compare the American and German systems as variations on that possibility. In Germany, collective bargaining remains the predominant means by which the employment relationship is regulated. By contrast, in the United States, the decline of unionism has been matched with a rise in administrative regulation. Although collective bargaining is not without its own difficulties, substantive standards are neither an efficient nor a complete response to the problems of good faith explored in this Note.

   My account of the role that labor law plays in the employment relationship is consistent with other sympathetic accounts. In fact, there is substantial overlap insofar as much of the employer behavior that results in inefficient or inequitable bargains for workers can be characterized as bad faith. The argument here differs from those dominant in the existing literature, however, in two respects. First, the problem it addresses is not just economic but also legal. Evaluating the individual employment relationship from the standpoint of contract law sheds light on the dilemmas courts face in the absence of collective bargaining. The alternative to collective bargaining principles is not, after all, an unregulated labor market. All employment contracts are subject to certain universal, immutable contract rules, including the duty of good faith. The inadequacy of individual employment contracting reflects legal as well as market failure.

   Understanding employment contracts as legal as well as economic instruments is more foreign to the literature than one would expect. The tools of economics do incorporate problems of interpretation, but they are incorporated as transaction costs not qualitatively different than the cost of paper; the purpose of economic analysis is to assess contractual efficiency. Political and ethical analysis of the employment relationship, on the other hand, ultimately appeals to fairness--for example, in the form of norms about control, distributive justice, or property rights. No commentator can be fairly assigned to one camp or the other, since no argument that fails to address both fairness and efficiency is plausible. Torn between two isolated principles, observers can do little more than strike an (ultimately subjective) balance between these competing values. The advantage of a self-consciously legal analysis, focused on the challenges posed by employment contracts from the perspective of lawyers, is that these values have already been incorporated into a single framework: the common law. For example, these values are two interpretive aspects of the duty of good faith, which cannot properly be understood without reference to both. (4) Although the common law no longer governs many terms of employment, due to both collective bargaining and an array of employment legislation, it nevertheless provides a useful framework by which to assess the difficult task any alternative legal regime must perform.

   My second departure from prevailing accounts lies in an attempt to assess the interaction between an inequality of bargaining power, on the one hand, and information and monitoring costs, on the other. Bargaining power is an important part of the story behind the intervention of labor law, but it is only part of that story. It interacts with other features of the employment relationship to complicate workers' capacity to protect their interests on an individual basis. Standing alone, the consequences of bargaining-power disparity are not obvious; although all else equal it will result in a less equal distribution of the gains of trade, the weaker party's loss could be offset by her (albeit small) share of transaction-cost savings. If employers and employees were equally invested in each other, they would be situated in a bilateral monopoly. This normally results in high bargaining costs because each party knows that the other cannot easily go elsewhere. In the employment context, however, workers cannot afford to hold out inefficiently and prolong negotiations about each exercise of discretion by the employer that the worker considers a modification of the original contract. Unequal bargaining power means less bargaining, and where bargaining is costly, workers' absolute share of transaction-cost savings may offset a decline in their relative share of total gains from the employment contract. Clear legal allocation of discretion to the employer may have the sanguine effects associated with bright-line property entitlements (as opposed to fuzzy entitlements protected by liability rules).

   Unequal bargaining power may also reduce transaction costs and underinvestment by workers and employers if discretion and penalties are specified contractually at the outset. Some commentators suggest that parties can anticipate attempts to renegotiate or shirk by allocating all discretion to one party and providing for a positive default level of trade or employment. (5) Workers may underinvest or demand renegotiation if, as a result of employer exercise of discretion, their returns to investment (effort, years, training) decline over time. If their contract, however, guarantees them some default "average" employment terms, they are more likely to invest--in the event of employer abuse, they can invoke those inflexible terms. Employers have incentive to agree to such defaults, even where they have all the bargaining power, as a mechanism to reduce shirking. Although the background problem of shirking recognizes that effective monitoring is impossible, this model of efficient bargaining inequality presumes that parties are able to specify efficient and enforceable default terms.

   A final benefit of bargaining-power disparity may result if employer discretion increases production quality and flexibility; workers' wage gains may eventually reflect their increased marginal productivity. While this implies that workers would voluntarily curb their demands even if they had bargaining power, they might not if their short-term loss was certain while their wage gains depended on other workers similarly cooperating. The concentration of decisionmaking in the employer resulting from its bargaining power could effectively resolve a collective action problem among workers.

   The indirect effects of unequal bargaining power therefore complicate its aggregate effect on workers' returns. But its indirect effects do not all lower transaction costs. The costs of information gathering and monitoring are actually greater in the face of an imbalance in bargaining power. Moreover, the costs are more likely to be borne by workers because of this imbalance.

   In the following discussion, I introduce a number of stylized assumptions about the labor market. Not all labor markets are characterized by the imbalance of bargaining power and high transactions costs discussed here. The costs of information and monitoring vary and are not always borne by the employee. For example, law students working at corporate law firms are provided with information few workers could assemble on their own. And at least when they start, entrants into the law job market appear to enjoy substantial bargaining power. It is not surprising, then, that law students do not organize themselves into unions. (6) The same is true to varying degrees of most professions. When employers invest in individual employees and employees are mobile--due to high skills, tight labor markets, or a strong social wage (government-provided safety net)--much of the argument does not apply.

   In the labor markets I have in mind, employees' work products are fairly homogenous and a single firm employs a large number of people engaged in similar work. This applies to much of the manufacturing sector and a significant portion of the low-skilled service sector. In these labor markets, nonunionized workers are "price takers"--employers can always find ready substitutes at their named price. Under these conditions, workers do not have a credible threat of exit for any but the grossest of employer abuses; they lack credible, graded threats with which they can respond to lesser violations. (7) These are essentially the markets in which unions have historically been active. The argument here is intended to explain the role that unions play and may be used to predict which markets will be most receptive to unionization; I am not making any empirical claim about the proportion of the total work force to which these assumptions...