1 George Mason School of Law Contracts II MW 1000 – 1115 Hazel 121 F.H. Buckley

2 George Mason School of Law 1.Why Enforce Contracts

3 George Mason School of Law 1.Why Enforce Contracts 2.Where Contracts Should Not Be Enforced

4 George Mason School of Law 1.Why Enforce Contracts 2.Where Contracts Should Not Be Enforced 3.The Content of the Contract 1.Conditions 1.Promissory and Non-promissory 2.Warranties

5 George Mason School of Law 1.Why Enforce Contracts 2.Where Contracts Should Not Be Enforced 3.The Content of the Contract 4.Breach and Remedies for Breach

6 George Mason School of Law 1. Why Enforce Contracts 2.Where Contracts Should Not Be Enforced 3. The Content of the Contract 4. Breach and Remedies for Breach Plus or minus…

7 A Law and Econ Perspective Le mot de Tony Kronman Dean Henry Manne, George Mason Insider Trading and the Stock Market 1965

8 A Law and Econ Perspective Le mot de Tony Kronman Ronald Coase, U. of Chicago The Problem of Social Cost 1960 Dean Henry Manne, George Mason Insider Trading and the Stock Market 1965

9 A Law and Econ Perspective Le mot de Tony Kronman Ronald Coase, U. of Chicago The Problem of Social Cost 1960 Dean Henry Manne, George Mason Insider Trading and the Stock Market 1965 Hon. Richard Posner University of Chicago Economic Analysis of Law 1973

A Preliminary Question  Who cares if we enforce contracts?  The nihilism of the 1970s: What’s wrong with this contract? “If one person does not lose, the other does not gain.” Augustine The rise of consumerism 10

11 So why enforce contracts?  Casebook suggests two principles The Efficiency Norms of Law and Economics An “Autonomy Principle”  Vas ist das?

Autonomy  My personal freedom expands when I have the freedom to bind myself Rousseau: people must be forced to be free Now: must people be free to be forced?  They can only be subject to contractual fetters if the institutions of promising and contract law exist

Autonomy  So why is it desirable that promissory institutions exist? Can’t breach a contract without them

Autonomy  So why is it desirable that promissory institutions exist? Can’t breach a contract without them And I can’t slide home without the game of baseball So how to come up with an argument for either institution, without attributing some outside value to the game? Suppose it was shown that contractual enforcement made everyone miserable?

Could promising exist without promissory institutions? 15 The Kingdom of Tonga

The Queen of Tonga With the Queen Mother at the Coronation,

The Queen of Tonga With her Prime Minister, Coronation

Tonga Where People Don’t Promise  There is no word for “promise” in Tonganese  “I intend to do x, but if I change my mind, well, then was then, now is now.” 18

Tonga Where People Don’t Promise  There is no word for “promise” in Tonganese  “I intend to do x, but if I change my mind, well, then was then, now is now.”  In such a place, is an autonomy analysis of promises intelligible? 19

David Hume 20 “A promise is not intelligible naturally, nor antecedent to human conventions.”

Hume didn’t think that all morality is conventional  Non-conventional Natural vs. Conventional Artificial duties  Can you suggest some examples of non-conventional rules? 21

Some examples of non- conventional rules?  Consider: “You think that killing x is wrong, but that’s just because you have a convention that x count as people.”  Is that persuasive? 22

Promising, on the other hand, rests on a language convention  How could I will myself to be bound by a promise in Tonga?  Hume: There is no mental act that creates an obligation, or that need accompany it. 23

Promising, on the other hand, rests on a language convention  Which raises the question: Are such institutions desirable?  If so, we have an answer why people should perform their promises  Otherwise they would subvert a valuable institution 24

Promising, on the other hand, rests on a language convention  So just what is the benefit afforded by promissory institutions? A greater assurance of performance  Which is strengthened when contractual sanctions are added to moral ones. 25

26 Does the sanction provided by promissory institutions suffice?  Men being naturally selfish, or endow'd only with a confin'd generosity, they are not easily induc'd to perform any action for the interest of strangers, except with a view to some reciprocal advantage

27 Contracts in the State of Nature Hobbes, Leviathan (1651)  If a covenant be made wherein neither of the parties perform presently, but trust one another, in the condition of mere nature (which is a condition of war of every man against every man) upon any reasonable suspicion, it is void…  For he that performeth first hath no assurance the other will perform after, because the bonds of words are too weak to bridle men's ambition, avarice, anger, and other passions, without the fear of some coercive power; which in the condition of mere nature, where all men are equal, and judges of the justness of their own fears, cannot possibly be supposed. And therefore he which performeth first doth but betray himself to his enemy.

28 The Prisoners’ Dilemma Hobbes’ Insight  A simple game that has become the dominant paradigm for social scientists since it was invented about  How the game works – and why didn’t it work for Dilbert

29 PD games help to explain why we do dumb things  Over-fish lakes and oceans  Pollute  Arms race  Fail to exploit bargaining gains

30 Modeling PD games  Game theoretic problems: payoffs for each player depend on actions of both

31 Hollywood gets in the act Russell Crowe as John Nash in “A Beautiful Mind”

32 The need for poetic license

33 Modeling PD games  Game theoretic problems: payoffs for each player depend on actions of both  Two possible strategies: A party cooperates when he performs value- increasing promises, and defects when he breaches

34 Cooperate Player 1 Modeling Two-party choice

35 Defect Player 1 Modeling Two-party choice

36 Cooperate Player 2 Modeling Two-party choice: Player 2

37 Defect Player 2 Modeling Two-party choice Player 2

38 CooperateDefect Cooperate Both cooperate Defect Player 2 Player 1 Modeling Two-party Choice Both Cooperate

39 CooperateDefect Cooperate Defect Both defect Player 2 Player 1 Modeling Two-party Choice Both Defect

40 CooperateDefect Cooperate Player 1 cooperates, Player 2 defects Defect Player 2 Player 1 Modeling Two-party Choice Sucker’s payoff for Player 1

41 CooperateDefect Cooperate Defect Player 1 defects, Player 2 cooperates Player 2 Player 1 Modeling Two-party Choice Player 1’s temptation to defect

42 CooperateDefect Cooperate Both cooperate Player 1 cooperates, Player 2 defects Defect Player 1 defects, Player 2 cooperates Both defect Player 2 Player 1 Modeling Two-party Choice

43 CooperateDefect Cooperate Joint cooperation Player 1: sucker’s payoff Defect Player 2: Sucker’s payoff Joint defection Player 2 Player 1 Bargains as a Prisoner Dilemma game Cooperation: Promise and Perform Defect: Promise and Breach

44 CooperateDefect Cooperate Both promise and perform Player 2 breaches, Player 1 performs Defect Player 1 performs, player 2 breaches Both defect: No one performs Player 2 Player 1 Let’s apply this to promising

45 CooperateDefect Cooperate3, 3-1, 4 Defect4, -10, 0 Player 2 Player 1 Plugging in payoffs First number is payoff for Player 1, Second number is payoff for Player 2

46 CooperateDefect Cooperate3 Defect40 Player 1 Defection dominates for Player 1 

47 CooperateDefect Cooperate34 Defect0 Player 2 Defection dominates for Player 2  

48 The possibility of defection destroys trust Your corn is ripe today, mine will be so tomorrow… (Hume’s Treatise III.ii.V)

49 The paradox of the PD game  While cooperation is collectively rational, defection is individually rational.  The undersupply of cooperation is “the tragedy of the commons.” Garrett Hardin, The Tragedy of the Commons (1968).

50 CooperateDefect Cooperate Both cooperate Defect Player 2 Player 1 Modeling Two-party Choice Both Cooperate

51 Joint Cooperation Everyone promises and performs I’m worried about Tessio… The food is better at the Tattaglias…

52 CooperateDefect Cooperate Defect Both defect Player 2 Player 1 Modeling Two-party Choice Both Defect

53 Joint defection Can these gentlemen be acting efficiently? An inefficient honor code

54 CooperateDefect Cooperate Player 1 cooperates, Player 2 defects Defect Player 2 Player 1 Modeling Two-party Choice Sucker’s payoff for Player 1

55 Sucker’s payoff Sucker performs, other party defects GONERIL Hear me, my lord; What need you five and twenty, ten, or five, To follow in a house where twice so many Have a command to tend you? REGAN What need one? KING LEAR O, reason not the need…

56 CooperateDefect Cooperate Defect Player 1 defects, Player 2 cooperates Player 2 Player 1 Modeling Two-party Choice Player 1’s temptation to defect

57 Defector’s Payoff Defector breaches, sucker performs Gov. Earl K. Long "Don't write anything you can phone. Don't phone anything you can talk. Don't talk anything you can whisper. Don't whisper anything you can smile. Don't smile anything you can nod. Don't nod anything you can wink." "I can make them voting machines sing Home Sweet Home."

58 The Tragedy of the Commons and the Law of the Sea )

59 War as a Prisoner’s Dilemma Problem So why doesn’t the Coase Theorem Work? )

60 All we are saying is … Give Contracts a Chance Iranians employing the defect strategy

61 An application: Marriage Rembrandt, The Jewish Bride 1666 Marriage is more than a contract; it’s a covenant…

62 An application: Marriage Rembrandt, The Jewish Bride 1666 But it’s less than a contract if the parties have unilateral exit rights under no-fault divorce laws

63 Marriage, Divorce, Natality  What did no-fault divorce do to the cost of matrimonial fault?

64 Marriage, Divorce, Natality  What did no-fault divorce do to the cost of matrimonial fault?  How do you think no-fault divorce laws affected divorce levels? Bring and Buckley, 18 Int. Rev. Law & Econ. 325 (1998)

65 Marriage, Divorce, Natality  How would you expect the parties to react to the increased probability of divorce?

66 Marriage, Divorce, Natality  How would you expect the parties to react to the increased probability of divorce?  Fewer marriages  Increased female participation in the labor force  Increased human capital investments by women

67 Children as marriage-specific assets Divorce rate ——— Natality rate for married couples ———

68 Where Promises Can’t Be Relied on Akerlof, The Market for Lemons, 84 Q.J. Econ. 488 (1970)

69 The Market for Lemons What would you pay?  Of the remaining 1956 Fords, half are worth nothing (“lemons”) and the other half are worth $5000 (“beauts”)  The seller knows which kind of car he has but you can’t tell them apart  What would you pay?

70 The Market for Lemons What would you pay?  Of the remaining 1956 Fords, half are worth nothing (“lemons”) and the other half are worth $5000 (“beauts”)  The seller knows which kind of car he has but you can’t tell them apart  The trick: Seller’s willingness to sell is a signal

71 The Market for Lemons What would you pay?  Of the remaining 1956 Fords, half are worth nothing (“lemons”) and the other half are worth $5000 (“beauts”)  The seller knows which kind of car he has but you can’t tell them apart  Question: Is the seller satisfied with this result?

72 Contract Law as a solution  Suppose that the defector is penalized through legal sanctions so that the incentive to defect disappears.