[MUSIC PLAYING]

CHARLES FRIED: Hoffman against Red Owl was

an example of how negotiations-- even negotiations
that do not end in an agreement, in a bargain, in a contract--
may, nevertheless, make one party-- Red Owl,
in that case-- responsible for the losses that the other party suffered
in the course of the negotiation.
We might call that a case of reckless negotiating.
In Pennzoil against Texaco, we saw that a party can get into great trouble--
$11 billion worth of trouble-- when it doesn't think its negotiations have yet
ended up in a bargain, but the other side, and the court, think they have.
In this unit, we turn to problems that come up
when it looks as if there's an agreement, but on later inspection,
it turns out that there was a flaw that prevents one or the other party
from enforcing it.
We will examine mutual mistake, unilateral mistake, and fraud.
I start with a famous old case, the facts of which
are almost too good to be true-- but they are true.
Back in the 19th century-- before instant telegraphic communication--
traders dealing in commodities, with widely fluctuating prices,
sought to hedge against the risks of those fluctuations.
Cotton was a commodity whose prices varied greatly.
A particularly destabilizing factor was the American Civil War.
The southern states produced a vast amount of cotton
for the world markets, especially the great English textile mills.
But with the coming of the Civil War and the Union Blockade of Southern Ports,
the supply of southern cotton to the markets became unstable--
and so did the prices.
India was an alternative source of supply.
One kind of arrangement would allow a buyer,
simply to make an offer to whoever had supplies of cotton
in his warehouse in England.
So a cotton manufacturer could simply go to the market,
see you had the cotton it needed in its warehouse,
and buy it and get it then and there.
Those prices fluctuated.
That's what's called the spot market.
Some people worried that the war would go on, the blockade would continue,
and the supply of cotton would be unsure for a long time.
So those who needed cotton for their operations
did what users of fluctuating commodities have always done
and do now.
They made futures contracts, forward contracts.
Buyers would buy, and sellers would sell,
cotton that was not yet in hand-- in much the same way as a large flour mill
might buy quantities of flour before it is harvested at a given price,
hedging against the possibility that the price might go up
because of a drought or a sudden surge in demand
while realizing that a glut on the market might cause prices to go down.
But the flour mill, or the textile mill here,
needs to know in advance what its cost will be.
So they hedge and buy goods that do not yet exist at a price
that they know they can afford and rely on,
even if it is a little higher than what the price might actually
turn out to be.
Other buyers and sellers of those commodities are not end users.
They are just traders or speculators.
They gamble that the price will go up or down,
and hope they have a better sense of the direction of the market,
and hope to make money that way.
And that's the setting of the case of Raffles against Wichelhaus.
Raffles was a seller of cotton who imported it from India,
and Wichelhaus was a buyer.
Now the ships that transported cotton from India
took about four or five months to arrive in Liverpool.
And Wichelhaus, the buyer, gambling or hedging,
concluded that a price of 17 and 1/4 pennies per pound
was a reasonable price to pay.
The contract he made with Raffles was that he would pay 17 and 1/4 pennies--
actually pence, but let's say pennies-- per pound
for some 50,000 pounds of cotton from a certain ship leaving
Bombay-- a ship called the Peerless.
That was the contract.
In today's money, that is a deal worth over half a million dollars.
The ship, Peerless, arrived in April of 1864.
And the seller, Raffles, notified the buyer, Wichelhaus,
that his cotton was there and he should arrange to pay for it and pick it up.
The buyer refused.
That's not the cotton I bought, he said.
The cotton I bought was from a ship called
Peerless that sailed in October from Bombay
and arrived months ago in February.
Now you may guess why Wichelhaus didn't want the cotton.
The cotton was exactly the same quality, quantity-- everything was fine.
What wasn't fine is that, between February and April, the price of cotton
had gone down.
In fact, the price of cotton in April-- on what we would call,
the spot market-- if you just went into a warehouse somewhere in Liverpool
and tried to buy it, was well below 17 and 1/4 cents per pound.
But here was the problem.
There were two ships Peerless, both of them registered in Liverpool,
and both working the route between Bombay and Liverpool.
In fact, the name Peerless was quite a popular name for a ship-- a bit
like Fido for a dog.
At that time, there seemed to be 17 ships Peerless,
plying the oceans of the world.
The seller had cotton on the later Peerless, the one that sailed
in December and arrived in April.
The buyer wanted-- or at least said he wanted-- cotton
from the October Peerless, which had arrived earlier in February.
The cotton, as I said, was the same quantity and quality,
and the only identification of it was that it was from the ship, Peerless.
The date of sailing was not mentioned in the contract.
The name of the captain, who might have identified the ship, was not mentioned.
Where was the meeting of the minds?
At the time they made their contract originally, it seemed to both of them
that they were contracting about the same thing, and most importantly,
that they were contracting about the same risk.
They were contracting about the risk of price fluctuations relative to cotton
aboard a ship called the Peerless.
The only problem was that the buyer thought-- or at least
said he thought-- that he was contracting and assuming
the risk of price fluctuations of cotton shipped from India in October,
and the seller thought he was contracting about, and hedging,
the price of cotton sailing from India in December.
The difference was a fair bit of money.
What was the court to do?
It reached a perfectly logical conclusion.
What would you do?