Tuesday, March 17, 2009

YOU CAN'T BREAK A CONTRACT? OH YES YOU CAN

AN ESSAY

Yesterday I satirized AIG’s Financial Products Executives for receiving colossal bonuses from government bailout money despite their active roles in ruining the economy last year. Two days ago, the New York Times revealed that AIG executives received over $165 million in manager bonuses. Although that amount pales in comparison to the $150 billion allotted to rescue AIG, it is the insolence that offends. At a time when most Americans struggle to find work in a toxic economy, these rapacious executives award themselves huge bonuses with government money intended to help the weak. It is something akin to stealing welfare money to buy a yacht. Yet here we see the institutional problems associated with the government bailout plan. We have given out so much money to so many private companies. Obviously we cannot account for all of it. And private companies are private companies; we cannot rightly be shocked that some executives will “take a little extra for themselves.” For wealthy corporate leaders, money is the ultimate temptation. Put them in a room with money and they will not keep their hands off.

But I do not write today simply to criticize rich corporate people. I enjoy doing that, but I recognize that it can easily descend into shrillness. Rather, I want to address a more troubling legal aspect to this bonus boondoggle: The contract issue.

Who allowed AIG executives to receive their bonuses at a time like this? Did anyone consider how bad it looks to hand government bailout money to wealthy executives, especially the ones who created the problem in the first place? Why is government allowing this? Yesterday, President Obama reacted to the outrage over the bonuses by swearing to stop the payments. But a different administration spokesman said he could do nothing to stop the payments, because AIG was “contractually obligated” to pay them. Lawrence Summers, Obama’s Director of the National Economic Council, said: “We are a country of law. There are contracts. The government cannot just abrogate contracts. Every legal step possible to limit those bonuses is being taken by Secretary Geithner and by the Federal Reserve system.” In other words, as wretched and tasteless as the bonuses may be, the government could do nothing, because these executives signed contracts with AIG last year, and now AIG must pay the bonuses. After all, according to Mr. Summers, we are a “country of law,” and a “country of law” does not intervene to break promises made between two private parties.

I beg to differ. Our “country of law” enforces contracts between private individuals by sovereign grace. Courts may weigh legal fineries in order to determine who owes whom what. Indeed, scholars and jurists have penned endless tomes concerning the ornate technicalities of individual contractual obligation. But in the final analysis, a judge’s words mean nothing without the sovereign’s sword to enforce them. For example, a company may promise to deliver 40,000 tons of steel in return for another company’s promise to pay $40,000,000. If the selling company fails to deliver, the aggrieved buyer can go to court and sue for contract breach. He may obtain a judgment entitling him to money damages or specific performance. In other words, the law fully supports the buyer’s position. But once the judgment issues, it falls to the sovereign to force the seller to pay money or deliver the goods. If the sovereign says: “I will not enforce this judgment,” the buyer has no remedy. In this example, we see that contract law means absolutely nothing without brute executive force. In reality, the executive overwhelmingly enforces legal decrees involving contracts because it wants people to feel assured in their bargains. Yet that does not change the fact that the executive retains the final discretion whether to enforce a contractual obligation. After all, the law deals with compulsion. No one feels compelled to do anything unless a stronger party puts a gun in his face or twists his arm with sufficient strength. The executive has the guns and the arm-twisters. Without it, courts mean nothing.

Mr. Summers said: “There are contracts. The government cannot just abrogate contracts.” Yes it can. If President Obama really wanted to, he could stop the payments to AIG’s executives. True, he would face enormous opposition from lawyers and jurists, but as a practical matter, he has the power to interfere with private contracts. Courts would rule in the executives’ favor. If AIG refused to pay the bonuses, the executives could sue AIG for breach; and they would win. After all, the law favors vested contract rights; and vested contract rights favor those with superior bargaining power. But after the executives win, they would have to turn to the executive to force AIG to pay. Here, President Obama (or his State law counterpart: The Governor of New York) could intervene. He could order the Sheriff to stand down and refuse to enforce the Court’s judgment against AIG. At that point, the executives would probably try to sue the executive on constitutional grounds. They would argue that the President’s action deprived them of “property” without Due Process under the Fourteenth Amendment, or that the State Governor’s action “impaired the Obligation of Contracts” under Article I § 10. The Supreme Court would probably agree with the AIG executives, since Chief Justice Roberts and his Republican majority invariably support business and contract rights. Again, however, the Court would have to turn to the executive to enforce its long-winded legal reasoning. Do you think the executive would take action against itself? Of course not.

This is not as radical a position as it sounds. There is precedent to support a President’s refusal to heed the Supreme Court’s conclusions. In 1832, the United States Supreme Court held unanimously that President Andrew Jackson could not relocate the Cherokee Nation to Oklahoma from its ancestral home in Georgia and Tennessee. Worcester v. Georgia, 31 U.S. 515 (1832). The Court reasoned that the United States entered into a treaty with the Cherokee, and the treaty forbade such territorial incursions. The President said: “John Marshall made his decision; now let him enforce it!” Jackson sent an army into the Cherokee Nation and evicted the natives from their homes. The Supreme Court’s judgment had no practical effect, even though the law favored the Cherokee. This example shows how a determined executive can utterly ignore judicial pronouncements, even if he acts contrary to law. Again, we see that law depends on force, and only the executive controls State-sanctioned force. If the executive wants to ignore the law, there is little the other branches can do. Congress could try to impeach the President. But impeachment has less to do with the law or the Constitution than with political favoritism. If the President has enough allies in Congress, he will not face impeachment. Andrew Johnson faced impeachment in 1867 because a Republican majority in Congress detested his Reconstruction Policy. Bill Clinton faced impeachment in 1998 because a Republican majority in Congress did not like him as a person and because he was a Democrat. Neither President committed a gross infraction against the Constitution; politicians in Congress simply did not like them.

President Obama enjoys immense support in Congress. Nancy Pelosi and the Democrats would never take action against him if he intervened to stop bonus payments to AIG’s executives. In fact, such a move would be entirely consistent with the President’s mission to “clean up Wall Street.” The AIG executives would whine and moan and wave the Constitution in the air. But Presidents must think beyond the law. President Obama is trying to rebuild trust in an economy that nearly destroyed itself through avarice. Men like the AIG executives are prime suspects in this meltdown. While those executives technically hold enforceable rights to bonuses under established contract law, this is a case in which the law stands at odds with historical circumstances. If contract law simply functions “according to plan” in these circumstances, the men responsible for destroying the economy—and triggering the bailout—will actually receive a windfall at taxpayer expense. In other words, these men would not have gotten any bonuses if AIG collapsed last year, but because they acted wrongly, they prompted a government bailout. And now the bailout lets them get their bonuses. This is a perverse result; but it is also the legal result. I argue that the President has discretion to set aside “normal legal procedure” when “normal legal procedure” would fatally undermine public confidence in the entire system. This is precisely such a case.

Process-minded legal theorists will undoubtedly disagree with this approach. They will argue that legal rules—especially contract rules—can never be relaxed, no matter how ridiculous (or even ironic) their consequences. Contract rules are intended to provide predictability and reliability in commerce, and if the government denies their effect in one case, then commercial men will never again take chances because they will never know whether the State will uphold their bargains. In this case, they would say that AIG must pay the executives’ bonuses because “bargains are bargains,” and our economy depends on confidence that the law will honor every private bargain. Process theorists would likely agree that it looks terrible to pay bonuses to men whose conduct caused the economic crisis, but they would say that maintaining faith in legal process is more important than averting a perverse result.

I do not eschew legal process. It plays an essential role in our constitutional order. But I venture that blindly following legal rules in every circumstance is more dangerous than making prudent exceptions when real crisis beckons. Today, we find ourselves in a unique moment. Never before has government so massively intervened to prop up private enterprise. This is a new adventure for government, and it will not succeed unless the People have faith in its purposes. If the economy collapses, neat contract rules will mean nothing. To that extent, maintaining public trust in government action should be the President’s foremost concern. The public rightly loses trust when it sees scoundrel executives taking government money to pay for their bloated bonuses. Although the executives may have contractual rights to their money, honoring those rights may do more harm than good to the overall recovery effort. I argue that maintaining public trust in the recovery effort takes precedence over private contract rights in these limited circumstances. If the recovery effort fails, everyone loses. But if the government stops AIG executives from receiving their bonuses in this unique case, only those few men lose money they do not even need. Balancing those harms against each other, I conclude that the President should refuse to enforce the executives’ contractual claims for bonuses. I am strengthened in my conclusion that the executive has even greater discretion because the AIG managers would not even have been in the position to receive bonuses if the government had not supplied the bailout money to pay them. He who pays the piper calls the tune, and in this case, that means the government can impose some restrictions on pre-existing contract rights.

There is nothing sacred about contract rights. Government compels private parties to adhere to their contractual obligations because that is the most efficient policy for society, not because some magical force animates private promises. Commerce functions best when people do what they promise. But there is nothing intrinsically good or noble about contracts. They function by sovereign grace, not a priori principle. Thus, there is no fundamental truth to the assertion that “contracts are contracts.” Contracts are valid only to the extent that the executive is willing to enforce legal decrees. And the executive has many duties beyond enforcing private contract judgments. Today, the executive confronts a massive financial crisis that threatens countless Americans. It is attempting to redress that crisis through bold, general action. That general action will inevitably impact some specific rights.

President Obama should not miss the forest for the trees in this situation. He can deny effect to these executives’ contracts without undermining faith in contract law as a whole. I think most Americans would understand his reasons if he did exactly that. Permitting the executives to benefit from government bailout money in this case sends a far worse social message than interfering with a particularly unjustifiable private bargain. After all, these bargains would have meant nothing if the government had not supplied the money to honor them. In that light, can the executives really complain that the government modifies those bargains?

These scoundrels are still getting their massive salaries. They still have homes, high-paying jobs and nice things. That is a whole lot more than most people have as they struggle to cope with this crisis. Frankly, their whining about “contract rights” falls especially flat when I consider just how many other advantages they enjoy. In a crisis like this, government must make exceptions that will anger a few private interests. That does not mean the government does not care about the law. In fact, sometimes a government best preserves faith in the law by refusing to apply it in cases in which it arouses public disgust. This is exactly such a case.

1 comment:

SteveW said...

This is a nice legal lesson for people, but unfortunately irrelevant in the present case. The outrage is already generated, but it was by the people that CANNOT just break a contract - ie the company. The time for the executive to step in and prevent this was before the payment.

I think it's interesting that you pick a moment of national shame as the point of comparison here. I would think, looking at the Jackson example, we should be more likely to say "never again" rather than to say "aha - that's how to do it". Of course laws are not enforceable against the sovereign. The big change with America and individual rights is that the sovereign acts accountable to the law anyway, even though there is no higher authority to coerce that. If we violate that principle for a trifling $165 million, what other times and purposes will we find it convenient to engage in that principle?

There is something else disturbing in this whole thing. In the industry, "bonuses" are a huge portion of the salary, and meeting only modest targets (obviously) triggers the "bonuses". Here is the disturbing part - with the exception of the top people, most of these folks getting paid are getting the bulk of their money (for their legitimate labors) through these bonuses, and most of the folks getting paid have little strategic responsibility for the AIG mess. Essentially, AIG is guilty of losing a rhetorical beauty contest, because if they had called this "salary" there would be no outrage. We're going to have Congress spend more than $165 million to go after maybe 20 top executives and then 120 or so little guys, taking their wages after the fact, because AIG couldn't think of a creative name that wouldn't have made such an easy target.

I don't think this is any way to run a country.