Econ 522 - Economics of Law - Spring 2014 - Homework 3 - Contract Law

Question 1.  Renegotiating Contracts

I run a retail store that hires extra cashiers for the holiday rush.  Each year, we sign six-week contracts with short-term employees, under which we train them for two weeks before Thanksgiving and then employ them as cashiers for all of December at a pre-agreed wage.

Consider the following two scenarios:

• You agree to the contract. The day after Thanksgiving, I've already invested time and money in training you, and don't have time to train a replacement; you suddenly realize you're in a strong bargaining position, and threaten to quit unless I raise your salary. Feeling I have no choice, I rewrite the contract to pay you more.
• You agree to the contract. Watching you interact with customers and other employees during training, I realize you're better suited to be a store manager than a cashier. The work is harder - you wouldn't agree to do it for the same wage - but your additional value to me as a manager is much greater than the additional cost (effort) to you. We rewrite the contract to make you a manager and pay you more.

(a) Give an economic argument why the renegotiated contract should be enforced in the second scenario, while the original contract should be enforced in the first.

(b) Would either renegotiated contract be enforced under the Bargain Theory of contracts?

Question 2.  You Should Really Read the Contract

In Allied Van Lines v. Bratton (Florida Supreme Court, 1977), the court writes,

"No party to a written contract in this state can defend against its enforcement on the sole ground that he signed it without reading it."

What would be the impact if one could always get out of a contract by claiming you had failed to read it?  What exceptions to this rule seem necessary for efficiency?

Question 3.  "Zero-Sided Contracts"

David Friedman's book, "Law's Order" (p. 160), discusses the following situation:

"A physician comes upon an auto accident, stops, and treats an unconscious and badly bleeding victim.  A week later the victim receives a bill for services rendered.  Must he pay it?

Under current U.S. law the answer is yes."

Consider the following alternatives:

(i) The victim need not pay anything

(ii) The victim must pay only the value of whatever materials were used up in treating him (bandages, etc.)

(iii) The victim must pay the going market rate for comparable medical services

(iv) The victim must pay whatever the doctor demands

Which of these do you expect to lead to the most efficient outcomes?  Why?

Question 4.  Mutual versus Unilateral Mistakes

In 1887, the Michigan Supreme Court decided the case Sherwood v. Walker.  The defendant, Hiram Walker (yes, that Hiram Walker), contracted to sell a cow to the plaintiff, Sherwood, for $80.  A barren cow is worth its weight in beef, around $80; a fertile cow is worth much more (at least $750) as a breeder and milk-producer.

Before Walker delivered the cow, he discovered she was pregnant, and refused to hand her over.  Sherwood sued, asking that the contract be honored.

 The court ruled for Walker, saying, "A barren cow is substantially a different creature than a breeding one"; as long as both Walker and Sherwood both believed the cow was barren, there was a mutual mistake about the object being sold, and the contract was void.

The dissenting opinion, however, thought Sherwood believed the cow might be able to breed, in which case there was simply a disagreement over what the cow was worth, and Sherwood shouldn't be penalized for being right.

In general, mutual mistake (both sides being mistaken about the true value of an object) is grounds for voiding a contract, but unilateral mistake (one of us being mistaken) is not.

(a) Consider a contract to sell an old piece of furniture which looks worthless, but turns out to be a valuable antique.  Explain how the principle of "uniting knowledge and control" supports this rule.

(b) Consider a contract to buy farmland that may or may not have oil underground.  Give another argument against voiding a contract due to "unilateral mistake".

(c) Do the same arguments hold with a painting that appeared to be valuable, but turned out to be a worthless forgery?

(d) From Thomas Miceli, "The Economic Approach to Law (Second Edition)" Stanford University Press, 2009, p. 106:

Consider a contract for the sale of a parcel of land from seller S to buyer B at a price of $15,000.  After the sale is complete, the local government announces plans to build a highway near the property, which raises its value to $100,000.  S sues to have the contract invalidated on the grounds of mistake.  Suppose it is learned at trial that the land would only have been worth $5,000 if the highway had not been approved. What does this information tell you about S's claim that the mistake was mutual?