Econ 522 Economics of LawGradingContracts: the story so far…Slide 3Default Rules versus RegulationsOne example of a regulation/immutable rule: derogation of public policySlide 7Derogation of public policyExpectation damages: default rule or immutable rule?Slide 10Slide 10Formation Defenses and Performance ExcusesIncompetenceWhat if you signed a contract while drunk?Slide 15Slide 16Slide 17Slide 18Slide 19Dire constraintsFriedman on duressSlide 22What about necessity?Slide 24Friedman’s pointSlide 26More general pointReal duress versus fake duressExampleSlide 30Slide 31Next week: more doctrines for invalidating contracts, and other stuffEcon 522Economics of LawDan QuintFall 2009Lecture 112HW 1: end of class todayMidterm: hopefully TuesdayGrading3Why do we need contracts?Which promises should be enforced?First purpose: enable cooperationSecond purpose: efficient disclosure of informationThird purpose: optimal commitment to performanceCost < promisee’s benefit: efficient to performCost < promisor’s liability: promisor will performFourth purpose: optimal relianceReward any reliance overrelianceHadley v Baxendale, foreseeable relianceFifth purpose: efficient default rules and regulationsGaps, efficient (majoritarian) defaultsPenalty defaults (Ayres and Gertner)Contracts: the story so far…4Regulations5Default rules only apply in situations the contract doesn’t addressRegulations are mandatory – can’t be overruled in contractCoase: if individuals are rational and there are no transaction costs, voluntary negotiations/contracting will lead to efficiencySo additional rules/prohibitions can only make things worseBut if individuals aren’t rational or there are transaction costs, regulations may helpDefault Rules versus Regulations6Derogate, verb. detract from; curtail application of (a law)Contracts which derogate public policy – that is, contradict a law or regulation – are not enforceableContracts which could only be performed by breaking a lawContracts whose effect is to circumvent a lawOne example of a regulation/immutable rule: derogation of public policyB(union)C(ownership)A(other factory)“if I ever work for C for less than $15/hr, I’ll work for you for $1/hr”7Derogate, verb. detract from; curtail application of (a law)Contracts which derogate public policy – that is, contradict a law or regulation – are not enforceableContracts which could only be performed by breaking a lawContracts whose effect is to circumvent a lawOne example of a regulation/immutable rule: derogation of public policyB(union)C(ownership)A(other factory)“if I ever work for C for less than $15/hr, I’ll work for you for $1/hr”8In general: contracts which can only be performed by breaking the law are not enforceableBut…“A married man may be liable for inducing a woman to rely on his promise of marriage, even though the law prohibits him from marrying without first obtaining a divorce.”“A company that fails to supply a good as promised may be liable even though selling a good with the promised design violates a government safety regulation.”“A company that fails to supply a good as promised may be liable even though producing the good is impossible without violating an environmental regulation.”“A promisor should be liable for breach if he knew that the promise was illegal”Derogation of public policy9Peevyhouse v Garland Coal and Mining Co(OK Supreme Court, 1962)Garland contracted to strip-mine coal on Peevyhouse’s farmContract specified Garland would restore property to original condition; Garland did notRestoration would have cost $29,000……but “diminution in value” of farm only $300Original jury awarded $5,000 in damages, both parties appealedOklahoma Supreme Court reduced damages to $300Expectation damages: default rule or immutable rule?10Seems like classic case of efficient breachPerforming last part of contract would cost $29,000Benefit to Peevyhouses would be $300Efficient to breach and pay expectation damages, which is what happenedBut…Most coal mining contracts: standard per-acre diminution paymentPeevyhouses refused to sign contract unless it specifically promised the restorative workDissent: Peevyhouses entitled to “specific performance”Expectation damages: default rule or immutable rule?11Ways to get outof a contract12Formation defenseClaim that a valid contract does not exist(Example: no consideration)Performance excuseYes, a valid contract was createdBut circumstances have changed and I should be allowed to not performMost doctrines for invalidating a contract can be explained as either…Individuals agreeing to the contract were not rational, orTransaction cost or market failureFormation Defenses and Performance Excuses13Courts will not enforce contracts by irrational individualsChildrenLegally insaneDoctrine of incompetenceOne party was not competent to enter into contractInvalidates contracts which are not in best interest of that partyWhat if you signed a contract while drunk?You need to have been really, really, really drunk to get out of a contractIncompetence14Only unenforceable if you were “intoxicated to the extent of being unable to comprehend the nature and consequences of the [contract]”Lucy v Zehmer (VA Sup Ct, 1954)What if you signed a contract while drunk?15Only unenforceable if you were “intoxicated to the extent of being unable to comprehend the nature and consequences of the [contract]”Lucy v Zehmer (VA Sup Ct, 1954)What if you signed a contract while drunk?16Only unenforceable if you were “intoxicated to the extent of being unable to comprehend the nature and consequences of the [contract]”Lucy v Zehmer (VA Sup Ct, 1954)What if you signed a contract while drunk?17Only unenforceable if you were “intoxicated to the extent of being unable to comprehend the nature and consequences of the [contract]”Lucy v Zehmer (VA Sup Ct, 1954)What if you signed a contract while drunk?18Only unenforceable if you were “intoxicated to the extent of being unable to comprehend the nature and consequences of the [contract]”Lucy v Zehmer (VA Sup Ct, 1954)The Borat lawsuitsWhat if you signed a contract while drunk?19Only unenforceable if you were “intoxicated to the extent of being
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