Contract Theory Contract Theory Are Term Paper

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Because promises are usually kept, it is usually reasonable to rely on a promise, and promises are usually relied upon. (p. 1)

Despite its centrality to the human condition, the social practice of promising remains primitive and incomplete in comparison to other disciplines such as mathematics and linguistics (Mather, 1999). When it comes to the promises contained in contracts of any type, there are some general guidelines but these do not embrace all of the issues involved by any means. For example, "We have our basic rule, 'Keep your promises!,'" Mather advises, "But the practice of promising does not determine, in any precise way, what counts as a promise. It is generally agreed that one need not say "I promise" in order to make a promise, but we have no agreed-upon test specifying which kinds of words or actions constitute a promise and which do not. Nor does our promising practice include a set of rules determining what counts as an excuse or justification for breaking a promise" (pp. 1-2). With regard to the private law of contract, three crucial sources of normative standards should be emphasized to help understand why promises are made and contracts are created: (a) theories of political obligation, (b) doctrinal integrity, and - market conventions, which are described further in Table 1 below.

Table 1.

Three Normative Standards of the Law of Contract.



Political obligation

Because the application of sanctions by the state comprises the practical outcome of the application of legal doctrine, private law responds to the governing political theories about the appropriate occasions for the use of state power and the type of sanctions which can be employed; since the law of contract transforms a social arrangement into a potential instrument for the application of sanctions backed by the force of the state, the legal system must ensure that this application of state power conforms to appropriate principles of justice, including due respect for liberty, equality, and solidarity. The relationship codified by legal doctrine can therefore be understood in part as a specialized branch of theories of justice and political obligation relating to the formation of binding associations between citizens.

Doctrinal integrity

The authority of law in modern societies depends in part on the perception that it achieves a system of governance that conforms to the ideal of the Rule of Law. This ideal is generally interpreted to require consistency in the application of law and the ability to justify the content of the law through rational evidence. These considerations exert a force on the development of legal doctrine because they require that its elaboration of the law of contract be presented as a coherent system of rules, based upon principle, without arbitrary distinctions. Legal scholarship perceives its central task to provide the rational elaboration of a coherent doctrinal system of law. Because of the economic importance of contractual relations in a market society, scholarship in the law of contract has been robust and profound.

Market convention

Private law cannot develop in complete isolation from one crucial normative dimension of social practice in markets; the law could not ignore conventional understandings of when binding commitments have been made, when they have been broken, and where unfair market practices have been deployed. These differ from country to country and region to region, but the parties themselves through their contractual agreement specify many of their reciprocal undertakings; however, these specifications will only incompletely describe their expectations. These expectations will also be discovered in the norms derived from the embeddedness of their relation, both in the sense of their personal relationship and their implicit reference to market convention. When pursuing the task of providing support for market transactions, in its application of state sanctions, legal regulation cannot ignore these conventional understandings because they may differ substantially.

Source: Collins, 1999, pp. 35-6.

According to Cheffins (1997), "Clearly, legal rules do matter sometimes. Nevertheless, they are certainly not always of fundamental importance. Often, company participants pay little attention to the state of the law. Furthermore, when they do, they are just as likely to be contracting around legal rules as complying with the applicable doctrines" (p. 31). Consequently, it is unrealistic and inappropriate to assume that the law will always control how companies are operated because the law is only one factor which influences corporate activities, and in many circumstances it is not the key one (Cheffins, 1997). This point is also made by Deakins and his colleagues (1994) who report that:

Empirical studies have consistently demonstrated a low level of awareness of contract law and legal sanctions on the part of business contractors themselves.... Trade customs, 'unwritten laws,' and repeat trading were found to provide an important mechanism for fostering trust, while contract law provides a residual form of security should all other things fail, and a basis for systematic planning over risk in certain agreements, particularly where firms deal overseas or with firms outside the industry where the normal trade customs do not apply. (p. 337).

Despite the growing body of research into contract theory and its interpretation, though, there remains a need for a comprehensive approach to analyzing the fundamental trust and obligatory issues involved. In their essay, "Contract Theory and the Limits of Contract Law," Schwartz and Scott (2003) report that, "Contract law has neither a complete descriptive theory, explaining what the law is, nor a complete normative theory, explaining what the law should be. These gaps are unsurprising given the traditional definition of contract as embracing all promises that the law will enforce" (p. 541). There are also inherent problems involved with the method concerning issues of justification. In this regard, Charney asks, "Why are we bound by obligations to which we did not assent explicitly, but only hypothetically? It is by no means clear that individuals should be bound to hypothetical -- as contrasted to actual -- contracts, or even that it is appropriate to call such hypothetical contracts 'contracts' at all" (1991, p. 1817). The autonomy- or rights-based arguments for promissory obligation do not readily extend to merely hypothetical agreements; further, it is unclear from a consequentialist perspective that a rule implying obligations to which transactors "would have assented" generally will reduce, rather than increase, the costs of transacting (Charny, 1991, p. 1817).

Given the wide range of issues that can be embraced by contract theory, then, identifying an appropriate analytical approach has therefore assumed increasing importance in recent years but the authorities largely agree that no such technique has been forthcoming. For instance, Craswell (2003) maintains that economic analysis has failed to provide such a mechanism in two respects, both as a descriptive theory and as a normative one. "Descriptively," he advises, "economics fails to predict existing doctrine: Either existing doctrine differs from the rules that economics identifies as efficient, or economics is too indeterminate to identify the most efficient rules. And normatively, this same indeterminacy also prevents economics from making any suggestions for the reform of contract law" (p. 903). Despite these constraints, Posner (2003) suggests that the economic analytical approach to understanding contract theory represents the most effective approach:

Modern economic analysis of contract law began about thirty years ago and, many scholars would agree, has become the dominant academic style of contract theory. Traditional doctrinal analysis exerts less influence than it did prior to 1970 and enjoys little prestige. Philosophical work on the nature of promising has captured some attention, but petered out in the 1980s, with little to show for the effort other than arid generalizations about the nature of promising. Academic critiques from the left no longer stir up excitement as they did twenty years ago. Scholarship influenced by cognitive psychology has so far produced few insights. Only economic analysis seems to be on solid footing. (Posner, 2003, p. 829)

This point is echoed by Deakin, Lane and Wilkinson (1994), who report that, "The possibility that the parties to a contract can independently enforce their agreement without recourse to law is addressed by the economic theory of repeated games. It is assumed that the parties will act in their own self-interest but that they will be able, through interaction, to develop cooperative strategies which will minimize the possibility of breach" (pp. 334-5). Such an economic analysis of contract law carries with it some fundamental assumptions. For example, a commonality involved in almost all types of economic analyses is the precept that individuals have preferences over outcomes, that these preferences tend to follow basic consistency conditions, and that individuals satisfy these preferences subject to an exogenous budget constraint (Posner, 2003). Contracts scholars typically assume that individuals do not have preferences regarding the consumption or well-being of other individuals, nor regarding contract doctrine itself; in fact, there is no preference for expectation damages, for instance (Posner, 2003).

The standard economic analytical approach to contract theory also assumes that the parties enter a…

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