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Contracting in the Shadow of the Law

  • Surajeet Chakravarty
  • W. Bentley MacLeod

Economic models of contract typically assume that courts enforce obligations based on verifiable events (corresponding to the legal rule of specific performance). As a matter of law, this is not the case. This leaves open the question of optimal contract design given the available remedies used by the courts. This paper shows that American standard form construction contracts can be viewed as an efficient mechanism for implementing building projects given existing legal rules. It is shown that a central feature of these 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 implies that the legal remedies of mistake, impossibility and the doctrine limiting damages for unforeseen events developed in the case of Hadley vs. Baxendale are efficient solutions to the problem of implementing complex exchange.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13960.

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Date of creation: Apr 2008
Date of revision:
Publication status: published as Surajeet Chakravarty & W. Bentley MacLeod, 2009. "Contracting in the shadow of the law," RAND Journal of Economics, RAND Corporation, vol. 40(3), pages 533-557.
Handle: RePEc:nbr:nberwo:13960
Note: LE LS
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