Variable payment structures: A teaching example, courtesy of the Third Circuit

A Third Circuit opinion issued yesterday provides a teaching example of how a contract can be drafted to vary payment obligations in ways that motivate particular behavior.

From the opinion:

The Port Authority leases many of its marine terminal facilities at the Port of New York and New Jersey to private companies like Maher, which in turn directly manage the terminals and provide stevedoring services to ships using those terminals.

In October 2000, Maher signed a thirty-year lease with the Port Authority to rent the largest marine terminal at Port Elizabeth, consisting of 445 acres of improved land including structures and a berthing area.

The Lease divides Maher’s rent into two categories. 

First, the “Basic Rental” charges Maher a fixed rate per acre of the terminal. When the complaint was filed in 2012, the Basic Rental was $50,413 per acre, totaling $22,433,612 for the year.

The second form of rent—and this is the crux of the case—is the “Container Throughput Rental” (“Throughput Rental”), which is a variable charge based on the type and volume of cargo that is loaded and unloaded at Maher’s terminal.

For the first eight years of the Lease’s term, Maher was exempted from paying any Throughput Rental. [DCT question: What business considerations might have motivated the parties to agree to this?]

Since 2008, the Throughput Rental has been calculated based on the following formula:

• the first 356,000 containers loaded and unloaded by Maher are exempted from any fees;

• for containers 356,001 to 980,000, Maher pays a per-container fee set forth by a schedule in the Lease ($19.00 per container when the complaint was filed); and

• for each container over 980,000, Maher pays a lower fee ($14.25 per container when the complaint was filed).  [DCT question:  What incentive does this create for Maher?  As Charles Munger says, always look for the incentives.]

In addition,

• Maher must load and unload a minimum amount of cargo annually as a condition of maintaining the Lease (420,000 containers when the complaint was filed, which is subject to increase to 900,000 containers upon completion of certain harbor improvements), and

• Maher must pay an annual guaranteed minimum Throughput Rental equivalent to loading and unloading 775,000 containers (subject to the exemption for the first 356,000 containers), regardless of the number of containers Maher actually handles.

Maher Terminals, LLC v. Port Authority, No. 14-3626 (3d Cir. Oct. 1, 2015) (affirming dismissal of complaint for lack of standing) (emphasis, extra paragraphing, and bullets added).

Lesson: Contract drafters can be creative in setting up payment arrangements, with:

• Fixed payments, possibly with scheduled permissible increases;
• Payments based on some variable metric, in this case the number of containers handled;
• Variable rates to incentivize behavior;
• Minimum-payment obligations that, if not met, can result in the paying party losing rights.