Question

1. Manufacturer Limited ("Manufacturer") is a dealer in carbon fiber. Stick Limited ("SL") makes hockey sticks. On Tuesday, Manufacturer and SL enter into a contract in which Manufacturer agrees to deliver 100 units of carbon fiber to SL on Thursday and SL agrees to pay $3.00 per unit. One unit of carbon fiber can be converted into one hockey stick.

Manufacturer’s cost of delivering the carbon fiber is $200.

SL’s cost of converting the carbon fiber into hockey sticks is $100, $50 of which must be spent on Thursday morning before the carbon fiber is delivered and which cannot be recovered if no carbon fiber arrives.

If no carbon fiber arrives on Thursday, SL must wait until Friday to purchase carbon fiber on the spot market for $6.00 per unit. SL can sell their hockey sticks for $10.00 per unit (assume that if Manufacturer breaches, SL is required to go to the spot market).

Assume that Manufacturer collects payment at the time the contract is entered into. Just before delivering the carbon fiber on Thursday, Manufacturer gets a call from CompetitorCo. ("Comp") who desperately needs carbon fiber. Comp needs 100 units of carbon fiber immediately and is willing to pay $8.00 per unit.

1. 1. Is it efficient for Manufacturer to breach the contract?
2. 2. Under what measures of damages will efficient breach/performance be achieved

Now assume that Comp only offers to pay $4.00 per unit.

1. 3. Is it efficient for Manufacturer to breach the contract? (3 points)
2. 4. Under what measures of damages will efficient breach/performance be achieved?

Answer 1

Here is the response:

Is it efficient for Manufacturer to breach the contract?

Yes, it is efficient for manufacturer to breach the contract.

Cost of carbon fiber is $300 (100 units @ $3 per unit)

SL’s cost of converting the carbon fiber into hockey sticks is $100

Cost of delivering carbon fiber is $200.

So, total cost of manufacturing 100 sticks = (300+100+200)/100 = $6.

Selling price is $10.

So, if all is well with supply, then SL makes a profit of $4 per stick.

Now, if manufacturer breaches the contract,

Cost of carbon fiber is $600.

$50 is wasted in preparations which cannot be recovered since material didn’t arrive.

SL’s cost of converting the carbon fiber into hockey sticks is $100.

So, now the manufacturing cost = (600+50+100+200)/100 = $9.5

So, the profit which SL makes a profit of $0.5 which is less than the profit made otherwise.

If manufacturer collects $500 at the time of making the contract, but does not deliver, and instead goes with competitor who is offering $8 per unit, then the manufacturer earns $800 in the trade of 100 units. So, even if the manufacturer repays $500 back to SL, there is still a profit to manufacturer. Assuming that SL or competitor pays for cost of delivery ($200).

Under what measures of damages will efficient breach/performance be achieved

Now assume that Comp only offers to pay $4.00 per unit.

Is it efficient for Manufacturer to breach the contract? (3 points)

If manufacturer collects $500 at the time of making the contract, but does not deliver, and instead goes with competitor who is offering $4 per unit, then the manufacturer earns $600 in the trade of 100 units. So, even if the manufacturer repays $500 back to SL, there is still a profit to manufacturer. $100 is the profit to the manufacturer.

SL must protect itself by adding a penalty clause – if the manufacturer collects money upfront at the time of contracting, then, there should be a clause which enables SL to collect penalty if delivery will not be met.

Yes, it is always efficient for manufacturer to breach the contract if it is based on the cost of a single unit alone.

Under what measures of damages will efficient breach/performance be achieved?

Penalty clauses encountered on the manufacturer due to delay or no delivery will help protect the hockey sticks producers.

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