How Binding Are Employment Contracts?

One of the first things you learn in business is that capitalism doesn’t work without a strong rule of law. How can business operate unless contracts are enforceable?

In this time of great financial upheaval, we’re seeing contracts come under fire. In the wake of gigantic AIG bonuses, we’ve becoming ammenable to the idea of altering employment agreements. After all, it’s not fair to pay those bonuses for a job NOT well done, is it?

Is breaking contracts a necessary action to avoid excessive transfer of taxpayers dollars to possibly corrupt corporate officers (as in the case of AIG), or is it a frightening precedent that undermines our legal system?

David A. Skeel, law professor at the University of Pennsylvania, is quoted in the New York Times today:

“We run roughshod over some contracts and not over others. Right now, employment contracts seem to be the type of contract that is viewed as eminently rewritable.”

Breaking contracts is not just for corporations. Vallejo, California has received permission in bankruptcy court to invalidate its contracts with firefighters. Other municipalities may follow this lead. The city of Pontiac has been put under emergency financial management due to excessive costs for police, fire and trash collection services. There is some confusion over what law actually governs contracts. In the case of the Vallejo, California fire fighters, their union claims that state labor laws protected the contracts. However, federal judge Michael S. McManus wrote that federal bankruptcy law trumped the state labor law.

The Treasury Department will work toward broad power to modify contracts of the financial institutions it takes over with the goal of speeding up reaction time to crises. Lisa Hill Fenning, a retired bankruptcy judge who now practices at Dewey & LeBoeuf in Los Angeles told the New York Times:

“Traditional ways of dealing with these problems are too complicated and would take too long. They’re trying to cut through red tape.”

We still don’t know how the auto industry will be restructured. After coming under such criticism for the millions paid out in AIG bonuses, President Obama’s auto task force will be scrutinzing G.M. and Chrysler’s union and executive contracts.

Is the slow, democratic rule of contract law important or outdated?

Image Source: woodleywonderworks, Flickr