Term Paper: Contract Theories

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Contract Theory: Contract Theory: Are Contracts Required for an Efficient Marketplace?

Contract Theory: Are Contracts Required for an Efficient Marketplace?

The primary business document that is used in the United States and most other countries of the world today is the contract. Contract law generally attempts to consider questions such as whether an enforceable contract actually exists, what the true meaning of that document is, whether a contract has been broken, and what compensation is due the injured party. This research paper is about theory of contract and provides a review of contemporary legal contract theories to answer the questions, "Why do we have contract law, anyway?," and, "Is contract law justified because people require a moral framework in which they are bound by what they agree to, or is contract law a fundamental necessity for a functioning market? How does that inflect on the freedom of contract principle as courts started to restrain the freedom of contractors to promote welfare and to protect certain sectors of society such as consumers and employees?" To this end, this study provides a timely discussion concerning the relation between contract law and trust. A description of various analytical approaches to understanding contract theory is followed by a discussion concerning how important lawyers are in contract law for promoting trust in commerce will be provided. In this regard, some lawyers view contract law as a major factor in promoting trust in the market; other lawyers think that many other factors contribute to trust and they think that indeed contract law would undermine trust if it was the dominating factor.

Review and Discussion

Developing an Analytical Framework for Contract Theory.

Given its importance to the efficient functioning of an open market economy, it is not surprising that there has been much attention given to contract theory and its implications for consumers and businesses. In his book, Binding Promises: The Late 20th Century Reformation of Contract Law, Slawson (1996) reports that, "Contract law remained in its classical state until late in the 20th century, when the courts of the United States began reforms" (p. 3). Such classical contract had three distinguishing characteristics:

Virtually unlimited freedom of contract. Freedom of contract is the freedom to choose the contents of a contract. For example, a law that requires employers to maintain safe working conditions limits freedom of contract by preventing employers from contracting with their employees to accept unsafe working conditions;

Nearly unlimited contracting power. Contracting power is the power to make contracts; for instance, the Statute of Frauds constrains contracting power by preventing people from making contracts without writing and signing them; and, clear separation from tort. Tort is the category of laws that hold people liable for their harmful conduct; for example, tort laws require careless drivers to pay compensation to the victims of their actions and these characteristics have traditionally allowed people to make the contracts they chose, practically without limitation as to kind or extent (Slawson, 1996).

Such classical contracting was based on two fundamental precepts: (a) that people can serve their private interests by contracts, and (b) that contracts can serve the public interest well enough to enable governments to limit their functions to law enforcement and national defense; while these premises were unrealistic even under the relatively simple societal conditions of the nineteenth century, they were rationale and supportable in terms of the social context in which they emerged (Slawson, 1996). Today, though, in an era of increasingly globalized marketplaces, these expectations and guidelines have become unrealistic and the courts responded by making laws that increased consumers' bargaining powers and placed public responsibilities on producers (Slawson, 1996).

Before examining any regulation of contracts, though, Collins (1999) suggests that it is important to gain some concept of a typical contractual relation itself: "This relation plainly differs from other types of human association, such as those found between friends, neighbors, members of a club, and between members of a family. Such an investigation of the social institution of contract presents a considerable problem, because the idea of contract possesses a confusing surplus of meanings" (p. 13). On the one hand, Black's Law Dictionary (1990) defines a contract as "An agreement between two or more parties which creates an obligation to do or not to do a particular thing. As defined in Restatement, Second, Contracts, Section 3, 'A contract is a promise or a set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty'" (p. 322). In addition, contracts "contain the agreement of parties with the terms and conditions, and which serve as a proof of the obligation" (Black's, 1990, p. 322).

On the other hand, though, Collins (1999) points out that in spite of the standard legal definition, contracts are viewed differently by different professionals depending on their respective roles in the contractual administration:

practicing lawyer identifies the key function of contracts as the planning of an economic relation;

The legal scholar views the rules of contract law as a particular source of private law obligations;

The socio-legal scholar perhaps considers contract law as a tool for the regulation of economic and social transactions; and, judge may treat contracts as creating binding rules of law between the parties, breach of which provides a justification for the imposition of state sanctions (Collins, 1999, p. 13).

The foregoing interpretations suggest that the multiplicity of contexts and meanings clearly indicates that the concept of contract is used not only to describe a key economic institution in a market economy, but to express more generally a central form of human association in modern society today (Collins, 1999). At its core, contract law therefore governs transactions that involving one or more promises. According to Mather (1999), "A promise is a commitment or assurance that something will (or will not) be done in the future. This commitment or assurance invites reliance by the promisee. When a person makes a promise, he in effect tells the promisee, 'You can count on me, you can trust me, you can rely on me.' As one commentator puts it, 'promises are given to induce people to act upon them'" (p. 1).

Much of the research to date has been focused on some of the more nebulous aspects of contract theory, such as the legal codification of a moral commitment in the form of making a promise. According to Craswell (1989), "Among the topics addressed by moral philosophy is the obligation to keep one's promises. To many philosophers, there is something strange (or, at least, something calling for explanation) in the idea that moral obligations can be created simply by an individual's saying so -- yet this is what seems to happen when a person makes a promise. Consequently, there is by now a large body of literature attempting to identify the exact source and nature of this moral obligation" (p. 489). Such moral obligations are in fact as old as mankind itself: "Since Roman times, the law of contract has been located as a part of the private law of obligations. The body of rules, principles, and concepts that comprise the private law of contract have their immediate source in authoritative legal materials such as Codes, statutes, and precedents. These positive statements of the law express interpretations and decisions about fundamental normative standards appropriate for the law of contract. Legal rules invariably rest on interpretations of other normative standards (Collins, 1999).

One such standard, for instance, might be the moral idea that promises should be kept which would subsequently be translated into a positive legal rule; however, more commonly, the transition from normative standard to a particular legal rule does not allow a simple transposition, and in fact, no legal system has ever simply adopted a legal rule requiring that all promises should be kept (Collins, 1999). Rather, the content of the law must be drawn from the robust dialogue that contains a variety of normative standards drawn from politics, morality, economics, public policy, conventions, and values internal to the legal system (Collins, 1999). These normative standards frequently compete and contain mutually exclusive or inconsistent values; therefore, the process of translation of these issues is accomplished through legal doctrinal writers, judges, and legislators, that may be viewed as being engaged in a dialogue both with the background normative standards and the legal system itself (Collins, 1999). According to Mather (1999), the promises codified in contracts take place in an overwhelmingly social context:

Promising takes place within the context of a social practice and derives its significance from that practice. A social practice is established whenever people engage in a regular pattern of conduct because they agree that this is the right way to act. The behavioral regularity that we observe in a social practice is the result of people internalizing the rules of the practice and judging each other's conduct by these rules. In the social practice of promising, we have one important rule: "Keep your promises!"… [END OF PREVIEW]

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