George Mason School of Law

George Mason School of Law
Contracts I B. Why Enforce Contracts F.H. Buckley

The Drafting Problem: How the Walker-Thomas Security Interest would work with FIFO
Sale Payment FIFO Good I FIFO Good II 100 --- 50 Security Interest I: First in, First Out

How the cross-collateral clause works
Sale Payment Security Interest Good I Security Interest Good II 100 --- 50 Cross-collateral clause

When there’s a full paydown
Sale Payment FIFO Cross-collateral 100

Corrective and Distributive Justice
What are Aristotle’s two kinds of justice?

Distributive Justice “Aristotle showed that Walker-Thomas was wrongly decided.” Comment

Distributive Justice How would Aristotle allocate goods as a matter of distributive justice?

Distributive Justice How would Aristotle allocate goods as a matter of distributive justice? Democrats identify merit with the status of freeman, supporters of oligarchy with wealth (or with noble birth), and supporters of aristocracy with excellence.

Corrective Justice How would this apply in contract law?
The justice in transactions between man and man is a sort of equality indeed, and the injustice a sort of inequality

Corrective Justice How would this apply in tort law?
This kind of injustice being an inequality, the judge tries to equalize it; for in the case also in which one has received and the other has inflicted a wound, or one has slain and the other been slain, the suffering and the action have been unequally distributed; but the judge tries to equalize by means of the penalty, taking away from the gain of the assailant….

These names, both loss and gain, have come from voluntary exchange; for to have more than one's own is called gaining, and to have less than one's original share is called losing, e.g. in buying and selling and in all other matters in which the law has left people free to make their own terms; but when they get neither more nor less but just what belongs to themselves, they say that they have their own and that they neither lose nor gain. Therefore the just is intermediate between a sort of gain and a sort of loss, viz. those which are involuntary; it consists in having an equal amount before and after the transaction.

Does this imply that bargains are always zero-sum transactions?

A presumption of enforceability
Let’s start with the presumption that contracts should be enforceable And why this is so can be understood from the perspective of law-and-economics

The Law and Economics movement
Henry Manne Richard Posner

Law and Economics: Understand the world through numbers
Can we count up pleasures and pains?

By numbers: Jeremy Bentham’s hedonic calculus
The principle of utility is the foundation of the present work: it will be proper therefore at the outset to give an explicit and determinate account of what is meant by it. By the principle of utility is meant that principle which approves or disapproves of every action whatsoever, according to the tendency which it appears to have to augment or diminish the happiness of the party whose interest is in question: or, what is the same thing in other words, to promote or to oppose that happiness. I say of every action whatsoever and therefore not only of every action of a private individual, but of every measure of government. Principles of Morals and Legislation (1789)

By numbers: Jeremy Bentham’s hedonic calculus
The principle of utility: Utilitarianism Do we have a problem with counting utils? With interpersonal utility comparisons?

Jeremy Bentham—really… The “auto-icon”
Founder of University College, London

Economic Analysis of Contract Law
Economics as an explanation for contract enforcement

The evolution of contract law
First edition, 1826 Blackstone, 1765

GDP per capita England

Economics as an explanation for contract enforcement
Printing & Numerical v. Sampson Sir George Jessel, M.R

Printing & Numerical v. Sampson
What was the impugned promise and what was the argument that it was against public policy?

What was the impugned promise and what was the argument that it was against public policy? Did the inventor sell his idea twice? Changes that are neither an infringement nor an improvement

When, per Jessel, should public policy be invoked to bar enforceability?

If there is one thing which more than another public policy requires it is that men of full age and competent understanding shall have the utmost liberty of contracting, and that their contracts when entered into freely and voluntarily shall be held sacred and shall be enforced by Courts of justice.

Who benefits in a case such as this from contract enforcement?

Who benefits? A man who is a needy and struggling inventor may well agree either for a present payment in money down, or for an annual payment, to put his intellectual gifts at the service of a purchaser.

Promising and Efficiency
The benefit afforded by promissory institutions is a greater assurance of performance

Why enforce contracts? Contract enforceability promotes societal wealth which promotes happiness, which is the ultimate desideratum for utilitarians

Contract enforceability is an element of the Rule of Law

And the Rule of Law promotes societal wealth
The World Bank estimates that natural and capital assets amount to only 23 percent of a country’s riches. The rest is intangible assets, the difference in institutions, of which the most important element is adherence to the rule of law: equality before the law, an efficient and honest judicial system and the absence of corruption. Remarkably, that accounts for 44 percent of a country’s total wealth according to the World Bank.

Wealth promotes happiness
Survey reports of subjective well-being “Would you say that you are very happy, pretty happy, or not too happy?”

The Happy Zone (upper right)
What else do the countries in the Happy Zone have in common?

Where does contract law come in?
Sanctity of Contract promotes the Rule of Law The Rule of Law makes people wealthier And Wealth makes people happier

Contracting as a solution to the Prisoners’ Dilemma game
A simple game that has become the dominant paradigm for social scientists since it was invented about 1960. How the game works – and why did not work for Dilbert

The paradox of the PD game
While cooperation is collectively rational, defection is individually rational.

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

The need for poetic license

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

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

Modeling Two-party choice
Cooperate Player 1

Modeling Two-party choice
Defect Player 1

Modeling Two-party choice: Player 2
Cooperate

Modeling Two-party choice Player 2
Defect

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

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

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

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

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

Plugging in payoffs First number is payoff for Player 1, Second number is payoff for Player 2
Cooperate Defect 3, 3 -1, 4 4, -1 0, 0 Player 1

What should Player 1 do if he knows Player 2 will cooperate?
3 Defect 4 Player 1

3 Defect 4 Player 1 Player 1 gets 3 if he cooperates and 4 if he defects So he defects…

3 Defect 4 Player 1 

What should Player 1 do if he knows Player 2 will defect?
Cooperate -1 Player 1

Cooperate -1 Player 1 

Defection dominates for Player 1
Cooperate Defect 3 -1 4 Player 1  

Defect 3 4

Defect 3 4 

Cooperate Defect -1

Cooperate Defect -1 

Defection dominates for Player 2
Cooperate Defect 3 4 -1  

Defection dominates for both Players
Cooperate Defect

While cooperation is collectively rational, defection is individually rational.

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).

The Tragedy of the Commons and the Law of the Sea
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The Tragedy of the Commons: Ranchers (open land) vs farmers (private property)
The Man Who Shot Liberty Valance (1962)

Two-party Choice in Contracting
Player 2 Cooperate Defect Joint cooperation: Both perform Player 1 performs, Player 2 breaches Player 1 breaches, Player 2 performs Both defect: Neither performs Player 1

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

Joint Defection Player 2 Player 1 Cooperate Defect Joint cooperation:
Both perform Player 1 performs, Player 2 breaches Player 1 breaches, Player 2 performs Both defect: Neither performs Player 1

Joint defection Can these gentlemen be acting efficiently?
In what sense is this joint defection?

The Sucker’s Payoff Player 2 Player 1 Cooperate Defect
Joint cooperation: Both perform Player 1 performs, Player 2 breaches Player 1 breaches, Player 2 performs Both defect: Neither performs Player 1

The 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…

The Defector’s Payoff Player 2 Player 1 Cooperate Defect
Joint cooperation: Both perform Player 1 performs, Player 2 breaches Player 1 breaches, Player 2 performs Both defect: Neither performs Player 1

The Defector’s Payoff Defector breaches, sucker performs
"I can make them voting machines sing Home Sweet Home." "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." Gov. Earl K. Long

PD games help to explain why we do dumb things
Over-fish lakes and oceans: The Tragedy of the Commons

Over-fish lakes and oceans Pollute

Over-fish lakes and oceans Pollute Arms race

Over-fish lakes and oceans Pollute Arms race Failure to exploit bargaining gains

The Tragedy of the Commons
What’s the solution in promising?

What if contracts are prohibited?

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

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

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

What did no-fault divorce do to the cost of matrimonial fault? Under fault, the straying party pays if he wants a divorce—or if his spouse seeks one So fault is costly in a fault regime

How would you expect the parties to react to the increased probability of divorce?

How would you expect the parties to react to the increased probability of divorce? Fewer marriages

How would you expect the parties to react to the increased probability of divorce? Fewer marriages Increased female participation in the labor force

How would you expect the parties to react to the increased probability of divorce? Fewer marriages Increased female participation in the labor force And what about kids?

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

Brinig and Buckley, 18 Int. Rev. Law & Econ. 325 (1998) Subsidize something (or reduce costs) and you get more of it

Contractarianism As a model for all of law? Corporate Bankruptcy Tort?
Family? Constitutional?

Contractarianism What might constrain the parties from entering into a bargain?

Contractarianism What might constrain the parties from entering into a bargain? Illegal Contracts Article 9 barriers to security interests in consumer goods Waivers of divorce rights

Contractarianism What might constrain the parties from entering into a bargain? Transaction Costs

Contractarianism The Coase Theorem: Parties will enter a binding contract to exploit all bargaining games unless prevented from doing so by transaction costs Ronald Coase

Contractarianism The Coase Theorem: A legal irrelevance proposition
Ronald Coase

So what are transaction costs?
Give examples of things that get in the way of bargaining

Too many parties. Eg, pollution

Emergencies: No time to bargain

Information processing problems

War as a Coasian Problem: Why no peace treaty?
Uccello, Battle of San Romano

War as a Bargaining Problem
The Absence of a Bargaining Space President Bashar al-Assad (and family?) in Vogue

Too many parties?

War as a Bargaining Problem Informational Problems
So you’re telling me there’s something wrong with attacking uphill and across a river? Ambrose Burnside December 1862

War as a Bargaining Problem Agent Misbehavior
What was Sir Charles Napier’s explanation for his capture of Sindh in 1843?

Agent Misbehavior Peccavi.

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

Is there no cooperation without binding contracts?

Cooperation without Law?
Voting as an economic puzzle

Voting No littering

It’s There are two plans for an online dictionary. One is Encarta, promoted by Microsoft, which hires editors. The other relies on individuals to submit entries for free…

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