Monday, March 23, 2020

Corona and Contract

Ian Ayres

I once sued Yale for closing down its facilities. The year was 1984 and the University, in the midst of a 10-week clerical workers’ strike, had closed its dining halls, stopped cleaning the dormitory bathrooms, shut down the gym and moved hundreds of classes off-campus.

That shut down is very different from Yale's current suspension of campus activities – this time due to concerns over the spread of coronavirus.  For one thing, the 1984 crisis was at least partly of Yale’s own making, as the University President A. Bartlett Giamatti refused to budge week after week from his initial offer to the clerical union.  In contrast, colleges are obviously not responsible for the coronavirus pandemic that is threatening our country.

The differences in these disruptions also help show that service providers should be relieved of the normal legal obligation to refund consumer prepayments in many circumstances today. 

Businesses across the country are confronting the difficult question of whether to pay refunds when they cancel pre-planned events.  Should gyms refund membership fees?  Should Broadway refund ticket prices?  And closer to home, should universities refund dormitory and dining charges?

Several universities around the country that have moved to online classes are nonetheless keeping their dorms and dining halls open – in part this may be an attempt to avoid the devastating financial burden of refunding millions of dollars in room and board to their students.  If institutions give students the option of coming back to campus, then they won’t have to refund any money. 

Of course, it might be safer for some students whose homes regions are already heavily impacted by coronavirus to remain on campus to shelter in place.  But avoiding refunds shouldn’t be part of the calculus on whether to keep dining halls or concert halls open.

The aversion that businesses have to paying refunds may be endanger public health. 

Under ordinary circumstances, if a university closes its dormitories, it must refund fees and deposits, but if a student decides it’s just not safe stick around, then they must forfeit the fees and deposits already paid. This incentivizes an irresponsible game of chicken – the party who cancels first bears the loss, even though making the decision to cancel may be best for public health and safety.

Contract law already has a seven-syllable solution – the doctrine of “impracticability.”  Now is a good time to remind the market, that under the common law tradition, promisors have a right to cancel contracts when their performance becomes impossible or impracticable

Of course, businesses shouldn’t be able to profit from cancelling their services.  One reason I sued Yale was that it was saving millions of dollars a week in union salaries but was only refunding students a pro-rata share of its dining hall revenue.  Just as we prohibit “price gouging” during times of crisis, we should also force sellers to disgorge profits if they fail to perform.

But universities and other service providers that are continuing to pay their workers and have substantially the same costs during this crisis should be able to suspend their services without refunding revenue to their customers.

Indeed, removing the legal obligation to pay refunds allows struggling organizations to keep paying salaries to employees.  On Twitter, artists are imploring patrons of cancelled performing arts events to “consider donating your ticket rather than requesting a refund.”  For many non-profits and small businesses, COVID-19 represents an existential risk.  When the alternatives to suspending refunds are massive layoffs or folding shop, contract law wisely relieves merchants of the duty to perform or pay damages.

As consumers, it’s natural to balk at this result.  Why shouldn’t I get my money back if I can’t use the gym?  Why shouldn’t the University pay me a refund if my daughter can’t eat at the dining hall?
An answer is that making sellers refund money distorts their incentives to do what’s right for our safety. 

It is right that our government is picking up the cost of coronavirus testing because we don’t want economics to play a role in whether someone decides to get tested or treated.  We should similarly eliminate refund costs from a seller’s decisions about whether to go forward with a conference, concert or sporting event.

Arthur Leff famously defined an “act of God” as an act that “no reasonable God would do.”  But contracts don’t have to have explicit “force majeure” clauses for the law to provide relief.  We would be wise to remember that contract law traditionally excuses contractual performance rendered impracticable by natural disasters.

After the 1984 strike finally settled, the plaintiffs chose to dismiss their complaint before a court decided the merits.  Still our suit had an impact on the University.  The next year the undergraduate regulations included a new provision that still exists to this day expressly renouncing the university's obligation to pay any refund for strike related disruptions:

[N]o rebates of tuition or any other fees will be given to a student, nor may any room contract be rescinded, on account of the interruption, as the result of a strike, work stoppage, "job action," etc., of any services customarily furnished by the University or of any activities customarily conducted by or at the University.

The same regulations do, however, give the University discretion to  make appropriate refunds:
In the unlikely event that public health or other significant safety or security concerns cause the University temporarily to suspend University programs and operations, the University will make arrangements for appropriate refunds, consistent with the principles enunciated in these Regulations, as may in its judgment be warranted in light of all the circumstances of the suspension and consistent with applicable law and regulations. 

Given Yale's substantial endowment, it might be wise for it to chose to exercise its discretion to refund fees even if the law does not require it.  Other non-profits and small businesses are not as well-healed and, if they are continuing to pay their employees, have a stronger rationale for cancelling contracts without refunds.    

We as a society are just beginning to experience the manifold sacrifices from our efforts at socially distancing.  Asking consumers to step up and bear some of the cost of cancellation offers a reasonable path forward that is consistent with our common law tradition.

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