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George Mason School of Law

Contracts II

MW 1000 – 1115Hazel 121

F.H. Buckley

fbuckley@gmu.edu

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George Mason School of Law

1. Why Enforce Contracts

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George Mason School of Law

1. Why Enforce Contracts

2. Where Contracts Should Not Be Enforced

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George Mason School of Law

1. Why Enforce Contracts

2. Where Contracts Should Not Be Enforced

3. The Content of the Contract1. Conditions

1.Promissory and Non-promissory

2. Warranties

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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

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George Mason School of Law

1. Why Enforce Contracts2. Where Contracts Should Not Be

Enforced3. The Content of the Contract4. Breach and Remedies for Breach

Plus or minus…

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A Law and Econ PerspectiveLe mot de Tony Kronman

Dean Henry Manne,George Mason Insider Trading and the Stock Market 1965

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A Law and Econ PerspectiveLe mot de Tony Kronman

Ronald Coase, U. of ChicagoThe Problem of Social Cost 1960

Dean Henry Manne,George Mason Insider Trading and the Stock Market 1965

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A Law and Econ PerspectiveLe mot de Tony Kronman

Ronald Coase, U. of ChicagoThe Problem of Social Cost 1960

Dean Henry Manne,George Mason Insider Trading and the Stock Market 1965

Hon. Richard PosnerUniversity of ChicagoEconomic 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.” AugustineThe rise of consumerism

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So why enforce contracts?

Casebook suggests two principles

The Efficiency Norms of Law and Economics

An “Autonomy Principle”Vas ist das?

AutonomyOne way of understanding it

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?

Paradoxical?

AutonomyOne way of understanding it

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

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?

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The Kingdom of Tonga

The Queen of Tonga With the Queen Mother at the Coronation, 1953

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The Queen of Tonga With her Prime Minister, Coronation 1953

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TongaWhere 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.”

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TongaWhere 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?

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David Hume

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“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?

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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?

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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.

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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

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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.

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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

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Contracts in the State of NatureHobbes, Leviathan 14.18 (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.

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The Prisoners’ DilemmaUnderlies Hobbes’ Insight

A simple game that has become the dominant paradigm for social scientists since it was invented about 1960.

How the game works – and why didn’t it work for Dilbert

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PD games help to explain why we do dumb things

Over-fish lakes and oceans

Pollute

Arms race

Fail to exploit bargaining gains

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Modeling PD games

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

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Hollywood gets in the act

Russell Crowe as John Nash in “A Beautiful Mind”

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The need for poetic license

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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

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Cooperate

Player 1

Modeling Two-party choice

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Defect

Player 1

Modeling Two-party choice

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Cooperate

Player 2

Modeling Two-party choice: Player 2

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Defect

Player 2

Modeling Two-party choicePlayer 2

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Cooperate Defect

CooperateBoth cooperate

Defect

Player 2

Player 1

Modeling Two-party Choice Both Cooperate

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Cooperate Defect

Cooperate

Defect Both defect

Player 2

Player 1

Modeling Two-party ChoiceBoth Defect

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Cooperate Defect

Cooperate

Player 1 cooperates, Player 2 defects

Defect

Player 2

Player 1

Modeling Two-party ChoiceSucker’s payoff for Player 1

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Cooperate Defect

Cooperate

Defect

Player 1 defects, Player 2 cooperates

Player 2

Player 1

Modeling Two-party ChoicePlayer 1’s temptation to defect

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Cooperate Defect

CooperateBoth cooperate

Player 1 cooperates, Player 2 defects

Defect

Player 1 defects, Player 2 cooperates

Both defect

Player 2

Player 1

Modeling Two-party Choice

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Cooperate Defect

CooperateJointcooperation

Player 1: sucker’s payoff

DefectPlayer 2: Sucker’s payoff

Jointdefection

Player 2

Player 1

Bargains as a Prisoner Dilemma game Cooperation: Promise and PerformDefect: Promise and Breach

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Cooperate Defect

CooperateBoth

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

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Cooperate Defect

Cooperate 3, 3 -1, 4

Defect 4, -1 0, 0

Player 2

Player 1

Plugging in payoffsFirst number is payoff for Player 1,Second number is payoff for Player 2

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Cooperate Defect

Cooperate 3 -1

Defect 4 0

Player 1

Defection dominates for Player 1

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Cooperate Defect

Cooperate 3 4

Defect -1 0

Player 2

Defection dominates for Player 2

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The possibility of defection destroys trust

Your corn is ripe today, mine will be so tomorrow… (Hume’s Treatise III.ii.V)

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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).

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Cooperate Defect

CooperateBoth cooperate

Defect

Player 2

Player 1

Modeling Two-party Choice Both Cooperate

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Joint Cooperation Everyone promises and performs

I’m worried about

Tessio…

The food is better at

the Tattaglias…

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Cooperate Defect

Cooperate

Defect Both defect

Player 2

Player 1

Modeling Two-party ChoiceBoth Defect

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Joint defection Can these gentlemen be acting efficiently?

An inefficient honor code

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Cooperate Defect

Cooperate

Player 1 cooperates, Player 2 defects

Defect

Player 2

Player 1

Modeling Two-party ChoiceSucker’s payoff for Player 1

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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…

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Cooperate Defect

Cooperate

Defect

Player 1 defects, Player 2 cooperates

Player 2

Player 1

Modeling Two-party ChoicePlayer 1’s temptation to defect

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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."

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The Tragedy of the Commons and the Law of the Sea

)

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War as a Prisoner’s Dilemma ProblemSo why doesn’t the Coase Theorem Work?

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All we are saying is …Give Contracts a Chance

Iranians employing the defect strategy

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An application: Marriage

Rembrandt, The Jewish Bride 1666

Marriage is more than a contract; it’s a covenant…

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An application: Marriage

Rembrandt, The Jewish Bride 1666

But it’s less than a contract if the parties have unilateral exit rights under no-faultdivorce laws

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Marriage, Divorce, Natality

What did no-fault divorce do to the cost of matrimonial fault?

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Marriage, Divorce, Natality

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

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Marriage, Divorce, Natality

What did no-fault divorce do to the cost of matrimonial fault?

So how do you think no-fault divorce laws affected divorce levels? Bring and Buckley, 18 Int. Rev. Law & Econ. 325 (1998)

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Marriage, Divorce, Natality How would you expect the parties to

react to the increased probability of divorce?

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Marriage, Divorce, Natality How would you expect the parties to

react to the increased probability of divorce? Fewer marriages

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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

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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 And what about kids?

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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 And what about kids?

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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Series1

Series2

Children as marriage-specific assets

Divorce rate 1965-83 ———Natality rate for married couples 1965-83 ———

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

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The Market for LemonsWhat 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

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The Market for LemonsWhat 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 for one?

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The Market for LemonsWhat 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

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The Market for LemonsWhat 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?

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Contract Law as a solution

Suppose that the defector is penalized through legal sanctions so that the incentive to defect disappears.

Does that mean that promissory societies are to be preferred?

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Tonga Beach

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