31 July 2012

Soft Contracts

The insightful 'Hollywood Deals: Soft Contracts for Hard Markets' (USC Legal Studies Research Papers Series No. 12-15) by Jonathan Barnett notes the observation by Ninth Circuit Judge Alex Kozinski comment in Effects Assoc., Inc. v. Cohen 908 F.2d 555 (9th Cir. 1990) that “Moviemakers do lunch, not contracts” before commenting that
Hollywood film studios, talent and other deal participants regularly commit to, and undertake production of, high-stakes film projects on the basis of unsigned “deal memos,” informal communications or draft agreements whose legal enforceability is uncertain. These “soft contracts” constitute a hybrid instrument that addresses a challenging transactional environment where neither formal contract nor reputation effects adequately protect parties against the holdup risk and project risk inherent to a film project. Parties negotiate the degree of contractual formality, which correlates with legal enforceability, as a proxy for allocating these risks at a transaction-cost savings relative to a fully formalized and specified instrument. Uncertainly enforceable contracts embed an implicit termination option that provides some protection against project risk while maintaining a threat of legal liability that provides some protection against holdup risk. Historical evidence suggests that soft contracts substitute for the vertically integrated structures that allocated these risks in the “studio system” era.