1. 1 George Mason School of Law Contracts I II.Why Enforce Contracts F.H. Buckley fbuckley@gmu.edu

2. 2 Contracts I 1.Why Enforce Contracts

3. 3 Contracts I 1.Why Enforce Contracts 2.Formation of Contracts 3.Consideration 4.Relational Contracts

4. 4 The two ways to understand the world

5. 5 By stories By numbers

6. 6 By stories: Dickens Hard Times: Coketown

7. 7 Lloyds Bank v. Bundy [1973] 3 All E.R. 757 (C.A.) Broadchalke is one of the most pleasing villages in England. Old Herbert Bundy, the defendant, was a farmer there. His home was at Yew Tree Farm. It went back for 300 years. His family had been there for generations. It was his only asset. But he did a very foolish thing. He mortgaged it to the bank. To the very hilt. Per Lord Denning M.R.

8. 8 By numbers: Jeremy Benthams hedonic calculus The principle of utility is the foundation of the present work: it will be proper therefore at the outset to give an explicit and determinate account of what is meant by it. By the principle of utility is meant that principle which approves or disapproves of every action whatsoever, according to the tendency which it appears to have to augment or diminish the happiness of the party whose interest is in question: or, what is the same thing in other words, to promote or to oppose that happiness. I say of every action whatsoever and therefore not only of every action of a private individual, but of every measure of government. Principles of Morals and Legislation (1789)

9. 9 Jeremy Benthamreally… The auto-icon

10. Numbers today The Law and Economics movement 10 Henry ManneRichard Posner

11. Economic Analysis of Contract Law Economics as an explanation for contract enforcement 11

12. Economic Analysis of Contract Law Economics as an explanation for contract enforcement Economics as an explanation for the contours of contract law Positive and normative 12

13. Economic Analysis of Contract Law Economics as an explanation for contract enforcement Economics as an explanation for the contours of contract law Contractarianism: The expansion of free bargaining 13

14. Economics as an explanation for contract enforcement Printing & Numerical v. Sampson 14 Sir George Jessel M.R

15. Printing & Numerical v. Sampson What was the promise and what was the argument that it was against public policy? 15

16. Printing & Numerical v. Sampson What was the promise and what was the argument that it was against public policy? The droit dauteur 16

17. Printing & Numerical v. Sampson What was the promise and what was the argument that it was against public policy? And why did Jessel M.R. reject this? 17

18. Printing & Numerical v. Sampson What was the promise and what was the argument that it was against public policy? And why did Jessel M.R. reject this? What happens when an academic promises to assign rights to his future invention to his university? 18

19. They didnt much care about this in the 1970s Whats wrong with this contract? Aristotles zero-sum world: If one person gains, another person has lost 19

20. The nihilism of the 1970s Whats wrong with this contract? Consumerism: Its always Williams v. Walker-Thomas 20

21. 21 So why enforce contracts? Casebook suggests two principles The Efficiency Norms of Law and Economics An Autonomy Principle – which well look at later

22. Promising and Efficiency The benefit afforded by promissory institutions is a greater assurance of performance Which is strengthened when contractual sanctions are added to moral ones. 22

23. Promising and Efficiency The benefit afforded by promissory institutions is a greater assurance of performance So why is that important? 23

24. Promising and Efficiency Lets assume (for the moment) that contract enforceability has something to do with societal wealth 24

25. Promising and Efficiency Lets also assume (with Bentham) that happiness is a desirable goal 25

26. Promising and Efficiency So is happiness correlated with societal wealth? 26

27. 27

28. The Happiness Literature Survey reports of subjective well-being Would you say that you are very happy, pretty happy, or not too happy? And why that matters… 28

29. The Happiness Literature The Easterlin paradox: The Hedonic Treadmill For countries and individuals, a regression to the mean over time Adaption set-points? Aspiration levels change? 29

30. The Happiness Literature But the relationship holds for a snapshot at a single time 30

31. 31

32. The Happiness Literature The omitted variable problem: What about happiness and freedom? 32

33. 33

34. Heritage Ranking of Economic Freedom 2011 CountryScoreCategory 1 Hong Kong89.7Free 2 Singapore87.2Free 3 Australia82.5Free 4 New Zealand82.3Free 5 Switzerland81.9Free 6 Canada80.8Free 7 Ireland78.7Partly Free 8 Denmark78.6Partly Free 9 United States77.8Partly Free 34

35. The earths economic center of gravity 35 Weighing locations by GDP and projecting to the earths surface

36. Where does contract law come in? So if wealth makes people happy, does contract law make people wealthy? 36

37. Where does contract law come in? How about bare promises without contract enforcement? 37

38. 38 Contracting as a Prisoners Dilemma A simple game that has become the dominant paradigm for social scientists since it was invented about 1960. How the game works – and why did not work for Dilbert

39. 39 The paradox of the PD game While cooperation is collectively rational, defection is individually rational.

40. 40 Hollywood gets in the act Russell Crowe as John Nash in A Beautiful Mind

41. 41 The need for poetic license

42. 42 Modeling PD games Game theoretic problems: payoffs for each player depend on actions of both

43. 43 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

44. 44 Cooperate Player 1 Modeling Two-party choice

45. 45 Defect Player 1 Modeling Two-party choice

46. 46 Cooperate Player 2 Modeling Two-party choice: Player 2

47. 47 Defect Player 2 Modeling Two-party choice Player 2

48. 48 CooperateDefect Cooperate Both cooperate Defect Player 2 Player 1 Modeling Two-party Choice Both Cooperate

49. 49 CooperateDefect Cooperate Defect Both defect Player 2 Player 1 Modeling Two-party Choice Both Defect

50. 50 CooperateDefect Cooperate Player 1 cooperates, Player 2 defects Defect Player 2 Player 1 Modeling Two-party Choice Suckers payoff for Player 1

51. 51 CooperateDefect Cooperate Defect Player 1 defects, Player 2 cooperates Player 2 Player 1 Modeling Two-party Choice Player 1s temptation to defect

52. 52 CooperateDefect Cooperate Joint cooperation Player 1: suckers payoff Defect Player 2: Suckers payoff Joint defection Player 2 Player 1 Bargains as a Prisoner Dilemma game Cooperation: Promise and Perform Defect: Promise and Breach

53. 53 CooperateDefect Cooperate3, 3-1, 4 Defect4, -10, 0 Player 2 Player 1 Plugging in payoffs First number is payoff for Player 1, Second number is payoff for Player 2

54. 54 Cooperate 3 Defect4 Player 1 What should Player 1 do if he knows Player 2 will cooperate? Player 2

55. 55 Cooperate 3 Defect4 Player 1 What should Player 1 do if he knows Player 2 will cooperate? Player 2 Player 1 gets 3 if he cooperates and 4 if he defects So he defects…

56. 56 Cooperate 3 Defect4 Player 1 What should Player 1 do if he knows Player 2 will cooperate?

57. 57 Defect Cooperate Defect0 Player 1 What should Player 1 do if he knows Player 2 will defect?

58. 58 Defect Cooperate Defect0 Player 1 What should Player 1 do if he knows Player 2 will defect?

59. 59 CooperateDefect Cooperate3 Defect40 Player 1 Defection dominates for Player 1

60. 60 CooperateDefect Cooperate34 Defect Player 2 What should Player 2 do if he knows Player 1 will cooperate?

61. 61 CooperateDefect Cooperate34 Defect Player 2 What should Player 2 do if he knows Player 1 will cooperate?

62. 62 CooperateDefect Cooperate Defect0 Player 2 What should Player 2 do if he knows Player 1 will defect?

63. 63 CooperateDefect Cooperate Defect0 Player 2 What should Player 2 do if he knows Player 1 will defect?

64. 64 CooperateDefect Cooperate34 Defect0 Player 2 Defection dominates for Player 2

65. 65 CooperateDefect Cooperate Defect 0 Player 2 Defection dominates for both Players

66. 66 The paradox of the PD game While cooperation is collectively rational, defection is individually rational.

67. 67 The paradox of the PD game While cooperation is collectively rational, defection is individually rational. The undersupply of cooperation isthe tragedy of the commons. Garrett Hardin, The Tragedy of the Commons (1968).

68. 68 The Tragedy of the Commons and the Law of the Sea )

69. 69 The Tragedy of the Commons: Ranchers (open land) vs farmers (private property) ) The Man Who Shot Liberty Valance (1962)

70. 70 CooperateDefect Cooperate Joint cooperation: Both perform Player 1 performs, Player 2 breaches Defect Player 1 breaches, Player 2 performs Both defect: Neither performs Player 2 Player 1 Two-party Choice in Contracting

71. 71 Joint Cooperation Everyone promises and performs Im worried about Tessio… The food is better at the Tattaglias…

72. 72 CooperateDefect Cooperate Joint cooperation: Both perform Player 1 performs, Player 2 breaches Defect Player 1 breaches, Player 2 performs Both defect: Neither performs Player 2 Player 1 Joint Defection

73. 73 Joint defection Can these gentlemen be acting efficiently? In what sense is this joint defection?

74. 74 CooperateDefect Cooperate Joint cooperation: Both perform Player 1 performs, Player 2 breaches Defect Player 1 breaches, Player 2 performs Both defect: Neither performs Player 2 Player 1 The Suckers Payoff

75. 75 The Suckers 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…

76. 76 CooperateDefect Cooperate Joint cooperation: Both perform Player 1 performs, Player 2 breaches Defect Player 1 breaches, Player 2 performs Both defect: Neither performs Player 2 Player 1 The Defectors Payoff

77. 77 The Defectors 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."

78. 78 PD games help to explain why we do dumb things Over-fish lakes and oceans Pollute Arms race

79. 79 PD games and Constitutional Law Let us suppose you are charged with writing a constitution…

80. 80 PD games and Constitutional Law Let us suppose you are charged with writing a constitution… Your first question, logically, is why should a state exist

81. 81 PD games and Constitutional Law Let us suppose you are charged with writing a constitution… Your first question, logically, is why should a state exist Hint: what were the first four Federalist Papers about?

82. 82 Military Expenditures: NATO countries

83. 83 PD games help to explain why we do dumb things Over-fish lakes and oceans Pollute Arms race Fail to exploit bargaining gains

84. 84 What if contracts are prohibited?

85. 85 What if contracts are prohibited? Rembrandt, The Jewish Bride 1666 Marriage is more than a contract; its a covenant…

86. 86 What if contracts are prohibited? Rembrandt, The Jewish Bride 1666 But its less than a contract if the parties have unilateral exit rights under no-fault divorce laws

87. 87 Marriage, Divorce, Natality What did no-fault divorce do to the cost of matrimonial fault?

88. 88 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 divorceor if his spouse seeks one So fault is costly in a fault regime

89. 89 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) Subsidize something (or reduce costs) and you get more of it

90. 90 Marriage, Divorce, Natality How would you expect the parties to react to the increased probability of divorce?

91. 91 Marriage, Divorce, Natality How would you expect the parties to react to the increased probability of divorce? Fewer marriages

92. 92 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

93. 93 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

94. 94 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?

95. 95 Children as marriage-specific assets Divorce rate 1965-83 Natality rate for married couples 1965-83

96. 96 Contractarianism Might other branches of the law, apart from contract, be amenable to bargaining?

97. 97 Contractarianism Might other branches of the law, apart from contract, be amenable to bargaining? Family Law Corporate Law Bankruptcy Secured Lending

98. 98 Contractarianism Might other branches of the law, apart from contract, be amenable to bargaining? What might constrain the parties from entering into a bargain?

99. 99 Contractarianism What might constrain the parties from entering into a bargain? Illegal Contracts Article 9 barriers to security interests in consumer goods Waivers of divorce rights

100. 100 Contractarianism What might constrain the parties from entering into a bargain? Illegal Contracts Article 9 barriers to security interests in consumer goods Waivers of divorce rights Recall Jessel in Printing & Numerical v. Sampson

101. 101 Contractarianism What might constrain the parties from entering into a bargain? Transaction Costs

102. 102 Contractarianism The Coase Theorem: Parties will enter a binding contract to exploit all bargaining games unless prevented from doing so by transaction costs Ronald Coase

103. So what are transaction costs? 103 Give examples of things that get in the way of bargaining

104. So what are transaction costs? 104 Too many parties. Eg, pollution

105. So what are transaction costs? 105 Emergencies: No time to bargain

106. So what are transaction costs? 106 Information processing problems

107. 107 War as a Coasian Problem: Why no peace treaty? Uccello, Battle of San Romano

108. 108 War as a Bargaining Problem The Absence of a Bargaining Space President Bashar al-Assad

109. 109 War as a Bargaining Problem Too many parties?

110. 110 War as a Bargaining Problem Informational Problems So youre telling me theres something wrong with attacking uphill and across a river? Ambrose Burnside December 1862

111. 111 War as a Bargaining Problem Agent Misbehavior What was Sir Charles Napiers explanation for his capture of Sindh in 1843?

112. 112 War as a Bargaining Problem Agent Misbehavior Peccavi.

113. 113 All we are saying is … Give Contracts a Chance Iranians employing the defect strategy

114. Is there no cooperation without binding contracts? 114

115. Cooperation without Law? Voting as an economic puzzle 115

116. Cooperation without Law? Voting No littering 116

117. Cooperation without Law? Its 1998. There are two plans for an online dictionary. One is Encarta, promoted by Microsoft, which hires editors. The other relies on individuals to submit entries for free… 117

118. Wikiconomics Its 1998. There are two plans for an online dictionary. One is Encarta, promoted by Microsoft, which hires editors. The other relies on individuals to submit entries for free… 118

119. Open Source Software 119 Linux Mascot

120. Crowdsourcing 120

121. Bloggers vs. Mainstream Media 121