Econ 522 Economics of LawLogisticsLast time…Slide 3Dire constraintsFriedman on duressSlide 7What about necessity?Slide 9Friedman’s pointSlide 11More general pointReal duress versus fake duressExampleSlide 14Next doctrine for voiding a contract: impossibilitySlide 17Slide 18Important general conceptSlide 19MisinformationFraud and Failure to DiscloseFrustration of PurposeMutual MistakeAnother principle: knowledge and controlUnilateral mistakeSlide 27Unilateral mistake: Laidlaw v Organ (U.S. Supreme Court, 1815)Unilateral mistake: productive versus redistributive informationMore on duty to discloseSlide 31Slide 31Vague contract termsFairnessAdhesion and unconscionabilitySlide 36Unconscionability: Williams v Walker-Thomas Furniture (CA Dist Ct, 1965)Slide 38Slide 39Slide 39MidtermEcon 522Economics of LawDan QuintSpring 2010Lecture 122Midterm will be returned at end of lectureHW2 is online, due in two weeks (Wed Mar 17)Second midterm Wed Mar 24Cumulative, through end of contract lawLogistics3Default rulesWhy are gaps left in contracts?What rules should be applied to fill those gaps?C&U: use terms most parties would have chosen (efficient terms)Ayres and Gertner: under some conditions, use default rules which penalize one or both parties for concealing informationRegulationsExample: derogation of public policyWays to get out of a contractFormation defenses (“no contract exists”)Performance excuses (“circumstances have changed”)One formation defense: incompetence (but not drunkenness)Last time…4Another formation defense:dire constraints5NecessityI’m about to starve, someone offers me a sandwich for $10,000My boat’s about to sink, someone offers me a ride to shore for $1,000,000Contract would not be upheld: I signed it out of necessityDuressOther party is responsible for situation I’m inSomeone makes me an offer I can’t refuseDire constraints6ExampleMugger threatens to kill you unless you give him $100You write him a checkDo you have to honor the agreement?“Efficiency requires enforcing a contract if both parties wanted it to be enforceable”He did – he wants your $100You did – you’d rather pay $100 than be killedSo why not enforce it?Makes muggings more profitable leads to more muggingsTradeoff: don’t enforce Pareto-improving trade, in order to avoid incentive for bad behaviorFriedman on duress7ExampleMugger threatens to kill you unless you give him $100You write him a checkDo you have to honor the agreement?“Efficiency requires enforcing a contract if both parties wanted it to be enforceable”He did – he wants your $100You did – you’d rather pay $100 than be killedSo why not enforce it?Makes muggings more profitable leads to more muggingsTradeoff: don’t enforce Pareto-improving trade, in order to avoid incentive for bad behaviorFriedman on duress8Same logic doesn’t work for necessityYou get caught in a storm on your $10,000,000 sailboatTugboat offers to tow you to shore for $9,000,000(Otherwise he’ll save your life but let your boat sink)Duress: if we enforce contract, incentive for more crimesHere: if we enforce contract, incentive for more tugboats to be available for rescues – how is that bad?Social benefit of rescue: value of boat, minus cost of towSay, $10,000,000 – $10,000 = $9,990,000If tugboat gets entire value, his private gain = social gainSo tugboat captain would invest the efficient amount in being available to rescue youSo what’s the problem?What about necessity?9What about your decision: whether to sail that day1 in 1000 chance of being caught in a stormIf so, 1 in 2 that a tugboat will rescue youPrivate cost of sailing: 1 in 2000 you lose boat, 1 in 2000 you pay tugboat captain value of boat$10,000,000/2000 + $10,000,000/2000 = $10,000So you’ll choose to sail if your value is above $10,000Social cost: 1 in 2000 boat is lost, 1 in 2000 boat is rescued$10,000,000/2000 + $10,000/2000 = $5,005Efficient to sail when your value is above $5,005When your value from sailing is between $5,005 and $10,000, you undersailIf the price of being towed was just the marginal cost, you would sail the efficient amountWhat about necessity?10Same transaction sets incentives on both partiesPrice that would be efficient for one decision, is inefficient for other“Put the incentive where it would do the most good”Least inefficient price is somewhere in the middleAnd probably not the price that would be negotiated in the middle of a storm!Friedman’s point11Same transaction sets incentives on both partiesPrice that would be efficient for one decision, is inefficient for other“Put the incentive where it would do the most good”Least inefficient price is somewhere in the middleAnd probably not the price that would be negotiated in the middle of a storm!So makes sense for courts to overturn contracts signed under necessity, replace them with ex-ante optimal termsFriedman’s point12Single price can create multiple incentivesOften impossible to set them all efficientlyAlready saw this with remedy for breachExpectation damages: efficient breach, but inefficient signingInclude gains from reliance: overrelianceExclude gains from reliance: inefficient breachMore general point13Court won’t enforce contracts signed under threat of harm“Give me $100 or I’ll shoot you”But many negotiations contain threats“Give me a raise, or I’ll quit”“$3,000 is my final offer for the car, take it or I walk”The difference?Threat of destruction of value versus failure to create valueA promise is enforceable if extracted as price of cooperating in creating value; not if it was extracted by threat to destroy valueReal duress versus fake duress14Alaska Packers’ Association v Domenico (US Ct App 1902)Captain hires crew in Seattle for fishing expedition to AlaskaIn Alaska, crew demands higher wages or they’ll quitCaptain agreesBack in Seattle, refuses higher wages, claiming duressExample15A performance excuse:impossibility16When performance becomes impossible, should promisor owe damages, or be excused from performing?A perfect contract would explicitly state who bears each riskContract may give clues as to how gaps should be filledIndustry custom
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