Contractarianism in the Business Associations Classroom: The Puzzling Case of Kovacik V. Reed and the Allocation of Capital Losses in Service Partnerships

Abstract

Prepared for a symposium on teaching corporate law, this essay is an exercise in applied theory of the firm. The essay focuses on a well-known California Supreme Court partnership law decision, Kovacik v. Reed, which deals with the allocation of capital losses in a dissolving partnership in which one of the partners contributed only capital and the other contributed only services. Although the Uniform Partnership Act requires both partners to share capital losses equally, absent contrary agreement, the California court relieved the service partner of any obligation to contribute towards capital losses. Using the hypothetical bargain methodology, as well as other familiar contractarian analytical tools, the essay concludes that there is no compelling economic justification for the Kovacik result. To the contrary, the arbitrariness of the line drawn by Kovacik, the resulting tertiary costs, and the (limited) bargain-forcing potential of the UPA regime all point towards the latter as the preferable default. To be sure, the question remains a close one. Indeed, that very closeness is precisely why Kovacik is such a wonderful pedagogical tool. It allows one to explore the nexus of contracts model in a close and critical fashion. In keeping with the theme of the conference for which it is intended, the emphasis in this essay is on Kovacik as a classroom tool for evaluating the utility of contractarianism. As such, it will be of interest to legal educators interested in law and economics-based pedagogy. In addition, because the problem has considerable doctrinal interest in its own right, the analysis should be of interest to legal scholars interested in partnership law.