Contract Law Cont. Flashcards
Invalid Contracts
Contracts are usually upheld by law but may be invalidated to either (i) protect parties inside a contract (from exploitative terms) or (ii) protect parties outside a contract (from externalities arising from the contract action). Contracts may be invalidated if the following can be convincingly demonstrated:
Invalid Contracts: Formation Defense
A claim that the requirements for a valid contract are not met.
Formation Defense: Derogation of Public Policy
Performance of the contract violates or circumvents the law.
When either (i) both parties are informed about the illegality of the contracted action or (ii) when only the promisee is informed about the illegality of the contracted action, the promisor cannot be held liable for breach.
When only the promisor is informed about the illegality of the contracted action, the promisor may still be held liable for breach.
Formation Defense: Incompetence
Individuals agreeing to the contract were not rational at the time.
Parties are often not held liable for decisions made by ”irrational/incompetent” agents (e.g. children), both for reasons of paternalism and of efficiency.
Irrationality/incompetence resulting from personal choice (e.g. drinking) is generally not protected. Doing so would encourage inefficient contract formation (e.g. inefficiently high monitoring expenses).
Formation Defense: Dire Constraints
Contract was signed under necessity or duress.
Necessity: Applies when the contracting party IS NOT responsible for the dire situation. When incentives for efficient activity are misaligned for parties making a contract, ex-ante optimal terms are more likely to achieve efficiency than terms negotiated under necessity
Duress: Applies when the contracting party IS responsible for the dire situation. Enforcing contracts made under duress would (dynamically) incentivize activity which places parties in dire situations
Invalid Contracts: Performance Excuse
A claim that a properly-formed contract should not be enforced due to changed circumstances.
Performance Excuse: Impossibility
Circumstances make it impossible to perform on the contract
Usually, contract specifies liability. Otherwise uses the default rule.
Efficiency requires assigning liability to the party that bears the risk at leas cost.
Performance Excuse: Frustration of Purpose
A change in cirumstances made the contract pointless
Invalid Contracts: Bad Information
Contracts signed when one or both parties possess bad information may be invalidated
Bad Information: Fraud
One party deliberately tricked the other
Bad Information: Failure to Disclose
One party failed to disclose critical infromation to the other.
Under Civil Law, parties have a duty to disclose important information
Under Common Law, generally only safety risks need to be disclosed. Exceptions include new products which come with an “implied warranty of fitness,” and (some) large transactions where full disclosure is often necessary for efficient contract formation.
Bad Information: Mutual Mistake
Both parties made a mistake, without which the contract would not have been signed.
Bad Information: Unilateral Mistake
One party has mistaken information.
These contracts are typically upheld, as they incentivize the efficient collection of information.
Bad Information: Vague Contract Terms
Ambiguity in the terms of a contract.
Similar to penalty defaults, refusing to enforce vague contracts incentiveizes careful contract formation.
Notes on Invalid Contracts: Bad Information
Efficiency genrally requires “uniting knowledge and control,” putting control in the hands of the party iwth the most efficiency-enhancing information.
Cooter and Ulen argue that contracts based on one party’s knowlege of productive (wealth-increasing) information should be enforced, while contracts based on one party’s redistributive (wealth-shifting) information should not.
