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Contracting in the shadow of the law

Chakravarty, Surajeet; MacLeod, W. Bentley

Economic models of contract typically assume that courts enforce obligations on the basis of verifiable events. As a matter of law, this is not the case. This leaves open the question of optimal contract design given the available remedies that are enforced by a court of law. This paper shows that standard form construction contracts can be viewed as an optimal solution to this problem. It is shown that a central feature of construction contracts is the inclusion of governance covenants that shape the scope of authority, and regulate the ex post bargaining power of parties. Our model also provides a unified framework for the study of the legal remedies of mistake, impossibility and the doctrine limiting damages for unforeseen events developed in the case of Hadley vs. Baxendale.

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More About This Work

Academic Units
Center for Contract and Economic Organization
Published Here
December 21, 2010

Notes

RAND Journal of Economics, vol. 40, no. 3 (2009), pp. 533-557.