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.
Invalid Contracts: Monopoly Defenses
A monopolist is the only seller of a product for which no close subsititues exist and can dictate the price and nonprice terms of the contract offered to many buyers. The buyer must respond by accpeting the monopolisit’s offer or doing without the good. Some extreme contract terms (often arising from monopoly power) may be invalidated
Monopoly Defenses: Contract of Adhesion
Contracts offered as “take-it-or-leave-it” deals, where terms are non-negotiable, are genrally upheld.
Some states void terms of a contract which would not have been agreed to had they been noticed
Monopoly Defenses: Unconscionability/Lesion
Overly one-sided contracts may not be upheld
“Absense of meaningful choic” on the part of one party may be grounds for invalidation in the presnece of unequal bargaining power
Note on Invalid Contracts: Monopoly Defenses
Contracts are genrally not binding if one party had no opportuity to review it.
Remedies for Breaching Contract
Damages awarded when contracts are breached may either be specified within contracts or issued by courts.
Party-Designed Remedies
Damages are specified in a contract for particular scenarios
Party-Designed Remedies: Liquidated Damages
Damages which reasonably approximate actual harm done by breach.
Typically upheld by courts on efficiency grounds.
Party-Designed Remedies: Penalty Damages
Damages imposed are greater than the value of actual harm.
Often not upheld by courts
Penalty damages may approximate subjective harm in such a way that the contract would not have been signed without it.
However, the dynamic incentives created by pentalty damages can be matched by performance bounesses, which are upheld by courts.
Court-Imposed Damages
Damages are not specified in a contract, but are issued by a court.
Court-Imposed Damages: Expectation Damages (“Positive Damages”)
Makes the promisee indifferent between performance and breach
Court-Imposed Damages: Reliance Damages (“Negative Damages”)
Restores the promisee to the same level of well-being they had before signing the contract
Court-Imposed Damages: Opportunity Cost Damages
Makes the promisee indifferent between breach and performance of the next-best alternative
Rational agents should always choose the option which maximizes utility first
Ranking Court-Imposed Damages
Expectation Damages > Opportunity Cost Damages > Reliance Damages
Other Remedies
Other court-mandated damages are less-common and situation specific
Other Remedies: Restitution
A party must return money that was already received
Other Remedies: Disgorgement
A party must give up wrongfully-gained profits
Other Remedies: Specific Performance
Forces the breaching party to live up to the terms specified in the contract
Routinely used in Civil Law Courts
Often not upheld by Common Law courts, even when Specific Performance is explicitly written into the contract
The Paradox of Compensation
Contracts between two parties generally cannon incentivize efficient reliance, efficient investment in performance, and efficient breach simultaneously
If expected damages increase with reliance investments, this creates an incentive to over-rely.
If expected damages do not increase with reliance investments, this creates an incentive to under-invest in performance and an incentive to breach more than the efficient amount
Note on The Paradox of Compensation
The fundamental problem in the Paradox of Compensation is the existence of a single price. “Anti-Insurance” can solve the Paradox of Compensation by driving a wedge between the amount paid by the promisor and the amount received by the promisee
Overview: The Purposes of Contract Law
(a) Encourage cooperation
(b) Encourage efficient disclosure of information
(c) Secure optimal commitment to performance
(d) Secure efficient reliance
(e) Provide efficient default rules and regulations
(f ) Foster enduring relationships
