1 George Mason School of Law Contracts I Bargaining Gains F.H. Buckley [email protected].

1

George Mason School of Law

Contracts I

Bargaining Gains

F.H. Buckley

[email protected]

mailto:[email protected]

Last Day: A Challenge

How to explain why we ought to perform our promises or contracts

2

What books did the Founders read?

3

Don Lutz, Origins of American Constitutionalism (1988)


4

The Bible


5

The Bible

The “celebrated Montesquieu”


6

The Bible

The “celebrated Montesquieu”

Blackstone


7

Henry Fonda as Young Mr. Lincoln

Sir William BlackstoneWhy did the Founders read him?

8

“This review of our situation may fully justify the observation of [Montesquieu] that [England] is the only country in the world where political and civil liberty is the direct end of its constitution.”Commentaries I.1

Sir William BlackstoneSo where did English liberties come from?

9

But the systems of jurisprudence, in our courts both of law and equity, are now equally artificial systems, founded in the same principles of justice and positive law.”Commentaries I.3

Blackstone was simply adopting what Sir Edward Coke had said 150 years before

10

Then the King said, that he thought the Law was founded upon reason, and that he and others had reason, as well as the Judges.

To which it was answered by me, that true it was, that God had endowed his Majesty with excellent Science, and great endowments of nature; but his Majesty was not learned in the Lawes of his Realm of England, and causes which concern the life, or inheritance, or goods, or fortunes of his Subjects; they are not to be decided by naturall reason but by the artificiall reason and judgment of Law, which Law is an act which requires long study and experience, before that a man can attain to the cognizance of it;

12 Co. Rep. 63

Things which cannot be explained naturally, without artificial reason

11


12


13

How did IOU’s get reified (turned into a species of private property)?

14

How did IOU’s get reified (turned into a species of private property)?

15

UCC 3-201. Negotiation means a transfer of possession, whether voluntary or involuntary, of an instrument by a person other than the issuer to a person who thereby becomes its holder.

So what purposes do such legal fictions serve?

We seem to need a justification from outside, in the consequences which flow from adopting the institution.

16

So what purposes do such legal fictions serve?

Autonomous lives are happier ones—but why this kind of autonomy? Why promissory games and not

tiddleywinks?

17

A Natural Law account of promising?

“X is unnatural.”

“It follows that we ought not to do x.”

18


“Promise-breaking is unnatural.”

“It follows that we ought not to break our promises.”

19

Let’s look at that…

“Promise-breaking is unnatural.” Really?

20


21

“No trustworthy primitive record can be read without perceiving that the habit of mind which induces us to make good a promise is as yet imperfectly developed, and that acts of flagrant perfidy are often mentioned without blame, and sometimes described with approbation.”

-- Ancient Law, 1861

And even if it were otherwise…

Just what would that tell you?

22

Hume’s Challenge to Natural Lawyers

The “is-ought” distinction

23

In every system of morality, which I have hitherto met with, I have always remark'd, that the author proceeds for some time in the ordinary ways of reasoning, and … makes observations concerning human affairs; when all of a sudden I am surpriz'd to find, that instead of the usual copulations of propositions, is, and is not, I meet with no proposition that is not connected with an ought, or an ought not.

This change is imperceptible; but is however, of the last consequence. For as this ought, or ought not, expresses some new relation or affirmation, 'tis necessary that … a reason should be given; for what seems altogether inconceivable, how this new relation can be a deduction from others, which are entirely different from it.

Hume’s Challenge to Natural Lawyers

To say that people generally act in a certain way is not to say that they ought to do so unless some value is independently attributed to the act.

24

Can one derive an “ought” from an “is”? John Searle thought so.

Promising is an institution in our language under which those who promise ought to perform. It is the case that I have promised. Therefore I ought to perform

25


Promising is an institution in our language under which those who promise ought to perform.

It is the case that I have promised. Therefore I ought to perform But suppose I think the institution an

evil—or morally indifferent one.

26


But suppose I think the institution an evil—or morally indifferent one.

If I promise and fail to perform I will weaken the institution—but so what? The case of dueling

27

Let’s turn the syllogism around

Promising is a just institution andthose who promise ought to perform. It is the case that I have promised. Therefore I ought to perform

28

After Hume, we distinguish positive and normative theories

Positive theories explain what is

Normative theories explain what out to be.

29

Posner’s Positive Thesis

30

The common law IS efficient

A Normative Thesis

The common law ought to serve efficiency goals.

31

A Normative Thesis

The common law ought to serve efficiency goals.

Whoa…

32

A Normative Thesis

But in the case of promising, is there anything else going on?

33

A Normative Thesis

The institutions of promising and contract law promote trust and permit people to rely on each other.

34

A Normative Thesis


And that results in a wealthier society.

35

A Normative Thesis


And that results in a wealthier society. And that results in a happier society.

36

A Normative Thesis

In which case, the normative theory of promising comes down to a form of utilitarianism Social and legal institutions should

promote the happiness of their members.

37

That’s not to say you have to buy into this

38

“What’s so good about happiness? It can’t buy you money”

George E. Jessel

Charles Baudelaire

39

I feel sorry for you, M’sieu, that you are so easily made happy.

But what value would we want our legislator to embrace?

40

41

Why Enforce Contracts:An Economic Analysis of Bargaining Gains

42

Modeling Bargaining Gains

Indifference Curves The Budget Line Consumer Choice Beneficial Reliance The Edgeworth Box Function Pareto-Superiority and Pareto-

Optimality

43

0

Two dimensional Commodity Space:Every point represents a combination of the two commodities

X axis

Y axis

Commodity x

Commodity y

44

0

Two dimensional Commodity Space:Every point represents a combination of the two commodities

X axis

Y axis

•A

X*

Y*

44

45

0

The Commodities: Dollars in Two Time Periods

Dollars in Time 2

Dollars in Time 1

•A

X*

Y*

45

46

Dollars in Time 1

0

Dollars in Time 2

Commodity space: Dollars consumed in two time periods

More of both

47

The Budget Line: Allocating $100 between two periods

Dollars in Time 1

100

0

100

Dollars in Time 2

The budget line in red represents every trade-off of $100 in two periods

48

Indifference Curves: Preferences about Consumption

Dollars in Time 1

0

Dollars in Time 2

An indifference curve represents a set of trade-offs to which the subject is indifferent

49

A C: Subject is willing to give up $BC in Time 2 for $AB in

Time 1

Dollars in Time 1

0

Dollars in Time 2

BC

A

50

A C: Subject is willing to give up $BC in Time 2 for $AB in

Time 1

Dollars in Time 1

Convexity (curve bends inward) assumes decreasing marginal utility

0

Dollars in Time 2

BC

A

51

Indifference Curves: Preferences about Consumption

Dollars in Time 1

0

Dollars in Time 2

One is better off the further one gets from the origin

52

Dollars in Time 1

0 Dollars in Time 2

More is better:I2 > I1

I1

I2

More is better

53

Dollars in Time 1

0 Dollars in Time 2

Ordinal Utility: We can’t say how much better I2 is than I1

I1

I2

I3

54

Consumption Decision:Uncle Ebenezer gives David $100

I3

Time 1 I2

I1 100

I2 I1

0

100 Time 2

55

Consumption Decision:David has $100 and is best off at A

Maximization subject to the constraint of the Budget Line

I3

Time 1 I2

I1 100

50 A I2 I1

0

50

100 Time 2

56



I3

Time 1 I2

I1 100

50 A I2 I1

0

50

100 Time 2

B

C

B is not feasible

C is not optimal

56

57



I3

Time 1 I2

I1 100

50 A I2 I1

0

50

100 Time 2

B

B is not optimal

57

58



I3

Time 1 I2

I1 100

50 A I2 I1

0

50

100 Time 2

C

B

C is not feasible

B is not optimal

58

Ebenezer gives David another $100: The Shift to a New Budget Line

200 I200

100 A50, 50

50

I100

0 100 59

A new Consumption Decision

B 100, 100

100 I200 A50, 50

50

I100

IDR

0 50 100

Time 1

Time 2

60

61

What happens when the donor promises to give in the future?

Uncle Ebenezer doesn’t have the $100 to give today but promises to give it to David in the next period

What Should David Do?

62

What happens when the donor promises to give in the future?

Uncle Ebenezer doesn’t have the $100 to give today but promises to give it to David in the next period

David’s election: to rely or not to rely on the promise in the first period

The good scenario: David relies and Ebenezer performs

B 100, 100

100 I200 A50, 50

50

I100

0 50 100 200

200

Reliance by David means spending $100 in period 1

63

B 100, 100

I100 I DR

0 50 100

A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches

C 100,0 D

A50, 50 50

Time 1David spends 100 in period 1 and now has nothing left to spend in period 2

64

B 100, 100

I100 I DR

0 50 100


C 100,0 D

A50, 50 50

Time 1What do we need to give David to make him as well off as he would be had the promise been performed?

65

B 100, 100

I100 I DR

0 50 100


C 100,0 D

A50, 50 50

Time 1

The Expectation Interest is CB, or $100

66

B 100, 100

I100 I DR

0 50 100


C 100,0 D

A50, 50 50

Time 1 What do we need to give David to make him as well off as he would have been had the promise not been made, or had he not relied?

67

B 100, 100

I100 I DR

0 50 100


C 100,0 D

A50, 50 50

Time 1

The Reliance Interest is CD, or about $25

68

69

Fool me once…: Non-reliance: David assumes Ebenezer will breach

Time 1 I1

100 50 B I1

0 50

100 Time 2

Now David spends only 50 in period 1

70

Fool me once…: Non-reliance: Ebenezer breaches: No harm, no foul

Time 1 I1

100 50 B I1

0 50

100 Time 2

Now David spends only 50 in period 1

100

I200

50

E150, 50

0 100 150

Loss of Beneficial Reliance:

David doesn’t rely and Ebenezer performs

Ino-reliance

Goetz and Scott, 89 Yale L.J. 1261 (1980)

David spends only 50 in period 1

71

Where David is on performance

B100, 100 100

I200

50

E150, 50

0 100 150



Ino-reliance

Goetz and Scott, 89 Yale L.J. 1261 (1980)

David spends only 50 in period 1

Where David would have been had he relied

72

B100, 100 100

I200

50

E150, 50

0 100 150



Ino-reliance

Goetz and Scott, 89 Yale L.J. 1261 (1980)73

74

Enforceable Contracts provide the gains

associated with beneficial reliance

Now: How parties gain from contracting

75

“If one person does not lose, the other does not gain.”

St. Augustine

76

Modeling a Bargain: Mums and Roses

0

Mums

Roses

77

Mums

Mary Roses

Two bargainers

Mums

Bess Roses

78

Mums

Mary Roses

Rotating Bess’s diagram I

Roses

Mums

Bess

79

Mums

Mary Roses

Rotating Bess’s diagram II

RosesMums

B

ess

80

Rotating Bess’s diagram III

Mums

Mary Roses

Mums

Bess

Roses

81

Rotating Bess’s diagram IV

Mums

Mary Roses

Mums

Bess

Roses

82

Rotating Bess’s diagram V

0

0

Mums Roses Bess

Mums Mary

Roses

83

Mary

Edgeworth Box Function: Bargaining from endowment point A

0

Bess

A

0

84


Mary

Bess

A

0

0

85


Mary

Bess

A

0

0

Rosesbess

Mumsmary Mumsbess

Rosesmary

86

Paretian standardsVilfredo Pareto (1848-1923)

Pareto-superiority: A transformation from A to B is Pareto-superior if at least one person is better off and no one is worse off

Pareto-optimality: No further Pareto-superior transformations are possible

87

Are these attractive moral standards?

Paretian man is not an altruist He takes no interest in the other person

88


The bourgeoisie … has pitilessly torn asunder the motley feudal ties … and has left remaining no other nexus between man and man than naked self-interest, than callous “cash payment.” It has drowned the most heavenly ecstasies of religious fervour, of chivalrous enthusiasm, of philistine sentimentalism, in the icy water of egotistical calculation.

89


What’s so good about altruism?

90

Are these attractive moral standards?Altruists

Sir William Beechey, Sir Francis Ford’s Children Giving a Coin to a Beggar Boy

91


Which child is showing empathy?

92


Who is showing empathy?

93


Who is showing empathy?

94


What happens to him tomorrow?

95


Is sentiment a substitute for social and economic policies that reduce the distress that prompts sentimentality?

96


Sentiment: I observe your distress and feel your pain

Sentimentality: I observe the pain I feel at your distress and feel good about myself

97

Are these attractive moral standards?Here’s another altruist

Gericault, Portrait(Envy)

Is a complete lack of empathy an attractive quality for bargainers?

98

Defining Paretian Standards

Pareto-superiority

Pareto-optimality

99

100

B and C as Pareto-superior to A D and E as Pareto-inferior

Mary

Bess

A

B

C

D

E

Coleman, 8 Hofstra L.Rev. 905 (1980)

101

Are all bargaining gains exploited at F?The bargaining “lens” shrinks through bargaining

Mary

Bess

A

B

C

D

E

F

102

Are all bargaining gains exploited at G?The bargaining lens disappears when the indifference

curves are tangent

Mary

Bess

A

B

C

D

E

F

G

103

A ~ C, A ~ B

Mary

Bess

A

B

C

D

E

F

G

103

104

A < F

Mary

Bess

A

B

C

D

E

F

G

104

105

A < F < G

Mary

Bess

A

B

C

D

E

F

G

105

106

G is on the contract curve and no further Pareto-Superior transformations are possible

Mary

Bess

A

B

C

D

E

F

G

106

107

Mary

The Contract Curve: All possible Pareto-optimal contracts represented at the

points of tangency

Bess

A

B

C

D

E

FG

108

Further Readings

Blackstone’s Commentaries, Book I, chapter 1 “Of the Absolute Rights of Individuals”, at lonang.com

Goetz and Scott, Enforcing Promises: An Examination of the Basis of Contract, 89 Yale LJ 1261 (1980)

108

109

Contract Law in the State of Nature

III.State of Nature.ppt

109

1 George Mason School of Law Contracts I Bargaining Gains F.H. Buckley [email protected].

Documents

Transcript of 1 George Mason School of Law Contracts I Bargaining Gains F.H. Buckley [email protected].